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That great churning sound of the money printing press..

October 8th, 2008 · 1 Comment

The printing presses are doing overtime, just as they should. We argued yesterday that we expect more from money creation and a well-designed fiscal stimulus than from interest rate cuts. We covered the fiscal stimulus here, so now we provide you with some background on the money printing, from Money Morning.

That Sound You Hear is the Government’s Printing Presses Running Overtime

  • After some of the most tumultuous trading in history – not to mention the most pathetic political posturing we’ve ever seen – my e-mail box has overflowed with questions, comments and suggestions.
  • This week, I want to answer one of the most frequently asked questions that I’ve received: “Where does all the bailout money come from?
  • Clearly, Uncle Sam doesn’t have a safety-deposit box – or even a greenback-stuffed Chock full o’Nuts can buried out in his back yard – but right about now I’m betting that he wishes he did.
  • To pay for the new $700 billion bailout bill, or even to cover the ever-growing federal debt, the U.S. government sells securities – lots of securities. The money is literally created from thin air by authorization and subsequently lent to institutions, individuals, foreign governments and others for what basically boils down to the mother of all IOUs. A portion of it, of course, is physically printed by Team Bernanke and the U.S. Federal Reserve on its turbocharged printing presses – and put into circulation as currency.
  • With regard to the bailouts, theoretically the Fed accepts an institution’s assets as collateral. Warts and all. In exchange, the Fed’s money is regarded as “senior” to even other senior debt holders, meaning that the Fed gets repaid ahead of paying everybody else including other debt holders.
  • Earlier this month, for example, the U.S. Treasury Department sold $40 billion in short-term debt that it would buy back in 35 days as part of a special program that will allow the central bank to keep pumping cash into the system on top of hundreds of billions it is making available through other channels.
  • Most Treasuries are auctioned off more regularly by so-called “primary dealers,” which are those financial institutions engaged in buying and selling U.S. government securities and which have established business relationships with the Federal Reserve Bank of New York, the biggest and most important of the 12 Fed banks. Individual investors can buy smaller amounts directly from the Treasury Department at auction or in secondary markets.
  • All of this is pretty plain vanilla stuff. But here’s something that’s actually very interesting: I’m hearing reports that at some of these auctions in recent weeks, several investors have literally bid zero – as in $0.00.
  • On the surface, that could be interpreted to mean that Treasuries are worthless. But in reality, this is one of the smartest moves I can think of for a professional trading house to make right now with cash it can’t afford to lose.
  • What these guys are doing is simply lending money to the Treasury – knowing full well that they’ll get it back in just over a month – instead of risking it in the stock market, or loaning to some other bank that has even more “toxic waste” on its balance sheet. In some cases, they’re even reportedly paying for the privilege of knowing their short-term money is safe.
  • This reminds me of something that I saw in Japan in the early 1990s, at the start of that country’s “Lost Decade,” when there was actually a premium associated with the “short-term investment funds,” or STIFs, that were held overnight.
  • In fact, the situation got so bad during the early days of Japan’s collapse that banks were basically paying each other – and the Japanese government – to take overnight deposits. Many refused … and we know the rest of the story.
  • Admittedly, the comparison I’m drawing is sort of apples to oranges, but the idea is similar, as are the underlying circumstances. Financial institutions want to transfer risk from their books to Uncle Sam so that they can ride through this unscathed – or at least to minimize any additional damage they might incur.
  • What all this says about our own immediate financial future is open to debate. But one way to look at this is that these institutions – which are running hundreds of millions of dollars they can’t afford to lose – believe the overall financial situation could get worse before it gets better. And that’s why they are going to extraordinary lengths to protect their assets, just as their counterparts in Japan did nearly two decades ago.
  • Having personally lived through those events in Japan 18 years ago, my instincts tell me we’d be wise to pay attention. Now isn’t the time to take anything for granted – and I do mean anything.

Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

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