Andrew Busch

There appears to be a race to see who can warn and downgrade the most from the ratings agencies. Yesterday, Fitch downgraded Mexico’s foreign currency rating to BBB on the ability of the government to meet their fiscal obligations (reduced maneuverability of fiscal accounts) and their increasing debt to GDP. Today, they warned about Japanese banks saying that weaker loan quality may put pressure on Japan’s “mega” banks’ performance and in turn capitalization, which remains somewhat weak by international standards, especially in terms of the “core” capital levels

The FT reports that S&P released a study of the world’s major banks that uses the risk adjusted capital ratios (RAC) that foreshadow the new capital ratio structure expected to be set by the Basel committee on banking supervision next year. S&P’s Bernard de Longevialle said: “Our study shows that capital for the majority of banks remains a relative weakness.” Moody’s cautions India today that deteriorating credit conditions in their banking system have raised concerns about rising problem loans and weakening bank profitability. “The rapid expansion of retail lending in recent years, combined with the slowdown of the Indian economy, has led to increased delinquency rates, especially for unsecured retail loans,” according to Nondas Nicolaides a senior analyst at Moody’s and author of the report.

Extending this theme, China’s five largest banks submitted preliminary plans for raising capital to the industry regulator after they extended unprecedented amounts of new loans this year, according Bloomberg. The China Banking Regulatory Commission evaluated the finances of Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Bank of China Ltd., Agricultural Bank of China and Bank of Communications Ltd. last week. Lenders were told to estimate potential capital shortfalls in 2010 based on their own lending forecasts and capital ratio targets for the year, and to make plans to plug the deficits. Remember, Chinese bank loan volume exceeded their full-year targets in July.

This Chinese story caused a shift in market sentiment as Risk Off has regained preeminence for the day. Yesterday’s BU discussed the fiscal problems of governments around the world struggling with spending and debt levels. The above stories show that the world still has a major problem with debt. Today’s US GDP report shows growth has not yet returned to levels that can support this debt.

This is the critical issue going forward for governments. By piling every increasing amounts of debt on to the market and on to the backs of taxpayers shoulders, they are stealing future growth. This is why interest rates can paradoxically go down while debt levels go up. It is Japan and it is our future if governments continue down this path.

The Debt-Interest Rate Paradox

There appears to be a race to see who can warn and downgrade the most from the ratings agencies. Yesterday, Fitch downgraded Mexico’s foreign currency rating to BBB on the ability of the government to meet their fiscal obligations (reduced maneuverability of fiscal accounts) and their increasing debt to GDP. Today, they warned about Japanese banks saying that weaker loan quality may put pressure on Japan’s “mega” banks’ performance and in turn capitalization, which remains somewhat weak by international standards, especially in terms of the “core” capital levels

The FT reports that S&P released a study of the world’s major banks that uses the risk adjusted capital ratios (RAC) that foreshadow the new capital ratio structure expected to be set by the Basel committee on banking supervision next year. S&P’s Bernard de Longevialle said: “Our study shows that capital for the majority of banks remains a relative weakness.” Moody’s cautions India today that deteriorating credit conditions in their banking system have raised concerns about rising problem loans and weakening bank profitability. “The rapid expansion of retail lending in recent years, combined with the slowdown of the Indian economy, has led to increased delinquency rates, especially for unsecured retail loans,” according to Nondas Nicolaides a senior analyst at Moody’s and author of the report.

Extending this theme, China’s five largest banks submitted preliminary plans for raising capital to the industry regulator after they extended unprecedented amounts of new loans this year, according Bloomberg. The China Banking Regulatory Commission evaluated the finances of Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Bank of China Ltd., Agricultural Bank of China and Bank of Communications Ltd. last week. Lenders were told to estimate potential capital shortfalls in 2010 based on their own lending forecasts and capital ratio targets for the year, and to make plans to plug the deficits. Remember, Chinese bank loan volume exceeded their full-year targets in July.

This Chinese story caused a shift in market sentiment as Risk Off has regained preeminence for the day. Yesterday’s BU discussed the fiscal problems of governments around the world struggling with spending and debt levels. The above stories show that the world still has a major problem with debt. Today’s US GDP report shows growth has not yet returned to levels that can support this debt.

This is the critical issue going forward for governments. By piling every increasing amounts of debt on to the market and on to the backs of taxpayers shoulders, they are stealing future growth. This is why interest rates can paradoxically go down while debt levels go up. It is Japan and it is our future if governments continue down this path.

Tonight at 7PM ET, I’ll be appearing on CNBC’s Kudlow Report w/ Steve Forbes discussing the US fiscal deficit and the US dollar.

Before everyone gets their underwear in a bundle, the Senate merely voted to start the debate and amendment process for the Reid Health Care bill. The 60 vote barrier was almost pre-ordained before it took place. The fun starts now with several Democratic senators warning they won’t vote again on the bill without significant changes. Make no mistake, this bill has traveled far and wide from it’s original intent of inclusion and improvement that was promised at the start of this process.

Remember, the reason why we started down this path was to bend the cost curve back downwards for the ever increasing expenditures associated with health care. These costs were considered detrimental to the fiscal health of the United States in the long run. There was also a goal of getting more covered or into insurance to reduce the overall costs for the nation. How far have strayed from this dual purpose.

The Reid bill is a potent mix of tax increases and mandates that will still cost between $800 billion to $1 trillion depending on what will be included in the final bill. There are tax increases on individuals and workers, there are fees on the health care industry, there are increasing costs for consumers, and there are tax increases on businesses. From the tax on the high cost health plan to fees on insurance plans for comparative effectiveness research trust fund to the “free rider” penalty excise tax, this bill is amazingly complex and diverse in it’s scope to raise receipts to pay for what it wants to do.

Taking a step back, this is indicative of what is happening throughout the US government as it struggles to pay for new programs and new initiatives. A massive budget deficit and opinion polls showing voter concern over this deficit is why the Democratic majority is growing increasing reluctant to expand spending. The best example is over Afghanistan. Senate chairman of the Armed Services committee Carl Levin (D, MI) said that an “additional income tax to the upper brackets, folks earning more than $200,000 or $250,000” a year, should be used to pay for more troops sent to Afghanistan.

The Hill reports that Rep. David Obey (D-WI.), the chairman of the House Appropriations Committee, warned that if President Barack Obama decides to send additional troops to Afghanistan, it should be funded with the new tax. “If we have to pay for the healthcare bill, we should pay for the war as well,” Obey told ABC News in an interview, “by having a war surtax.” (Maybe he’s still angry Northwestern beat Wisconsin on Saturday.)

With financial newsflow heavy today with stories of global fiscal imprudence, Greece, Japan, UK, and US are in the spotlight. The NYT runs a story today about how current low rates mask an increasing debt load that is unsustainable should rates move up. “With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.”

This situation is emblematic of a global concern about government’s finances and is why sovereign CDS spreads continue to move higher. The markets are assessing the potential for a sovereign default and trying to figure out who is most likely to go.

http://www.businessinsider.com/lou-dobbs-will-be-on-the-kudlow-report-tonight-2009-11

This will be fun……

As part of the ongoing reconfiguring and reregulating of the American financial system, the House Financial Services Committee today will take up an amendment that seeks to audit Federal Reserve monetary policy. As so many things are backward in Congress, the vote today is actually a vote on a proposal to retain a ban on audits of Fed interest rate decisions. If it is voted down, then the Ron Paul bill to audit monetary policy could see the light of day.

The Paul bill has 300 cosponsors and clearly has struck a nerve in Congress. I’d go back to the fall of 2008 when Bernanke and Paulson shocked legislators during discussions over what the Fed could do to stabilize the markets and how much money the Fed could marshal to aid the situation. Bernanke stunned the group by saying $900 billion as this was the entire balance sheet of the Fed at that time.

This was the ultimate wakeup call to Congress that a fourth entity had control of the taxpayer’s money and could act on it without the approval of Congress. While the Fed and the Treasury acted quickly to stem the financial panic, the question remains: is there any section of the US constitution that provides this much financial power to such a small group of individuals? I don’t think so and neither do 300 cosponsors of Paul’s bill.

Now the question becomes what’s worse, Congress involved in monetary policy decisions or a fourth, unelected branch of government usurping powers granted only to Congress? As Chairman Bernanke put it in July, “I don’t think the American people want Congress running monetary policy.” But do the American people want the Federal Reserve running fiscal policy?

A real time example of this situation is being battled out in New Zealand. The opposition Labour leader Phil Goff said today that the RBNZ inflation policy targets don’t work. “Our Reserve Bank policy targets are not well designed to produce a stable and competitive exchange rate, nor to keep interest rates as low as possible.”

Next, the NZ government has been struggling with the impact that a strong NZ dollar is having on their export sector and their economy. The strong currency is seen as a symptom of the central bank’s inflation stance and lack of monetary support to the economy. The NZ Treasury is putting forth a policy to front load fiscal policy accompanied by significant tax reform to make the New Zealand dollar materially lower for several years.

This is the ultimate end game for central banks and governments around the world: who will control the purse strings and who will control the monetary levers to get the economy moving. Today’s vote in Barney Frank’s committee will give us an indication of where the US is heading. A no vote to retain a ban on audits should be seen as a sell signal for the US dollar.

Congratulations Sen. Reid, it’s a 2074 page Health Care Bill! Here are the Fun Facts:

Spending: The cost of the bill is $2.5 trillion over 10 years of full implementation (2014-2023).

Taxes Increases: Taxes will go up $493.6 billion—nearly half a trillion dollars.

Medicare Cuts: Medicare will be cut $464.6 billion—another half a trillion dollars.

Public Option: The bill includes a government run plan and provides states with the possibility of opting out of participating in that plan. According to CBO, the government run plan “would typically have premiums that were somewhat higher than the average premiums for the private plans in the exchanges.

Employer Mandate: The bill will impose $28 billion in new taxes on employers that do not provide government approved health plans at a time when businesses are still cutting workers.

Bottom Line: Should this bill become law in its current form, it will be a short term, medium term, and long term negative for the US economy and the US dollar. It fails to reduce costs and it increases the government role in 17% of the economy.

http://www.huffingtonpost.com/2009/11/18/going-rogue-goes-rogue-sa_n_361803.html

President and CEO of the Federal Reserve Bank of St. Louis James Bullard said that policy makers may not start to raise rates until early 2012 while facing a “too low for two long” argument that may “weigh heavily” on the central bank. “The main challenge for monetary policy going forward will be how to adjust the asset purchase program without generating inflation and still providing support to the economy while interest rates are near zero.”

This should come as no surprise coming from Bullard. Back on September 1st, Bullard said the Federal Reserve interest rate hikes may be “quite a ways away”. Today, we now know how far. Remember, this is important because Bullard will become a voting member of the Federal Open Market Committee next year. Unlike most Fed presidents, he is clearly a big dove now.

However, he won’t be in the future and that will mean excellent interest rate volatility in the future. He believes that the Greenspan method of incrementalism had no merit and no theory behind it. This means that when the Fed gets actually in a tightening mode, they could tighten aggressively by 50 or 75 basis points. Volcker Volatility!

I believe this is the way going forward and what I warned about on CNBC’s Kudlow Report on Monday. My outlook is that the inflation that will be generated by the Fed’s massive easing today will show up in 2 years or less. If I want to get very negative about inflation, I would say that this inflation will show up precisely at the same time that tax rates are going up in the United States and the current Health Care bill is getting implemented.

This evokes many of the images from the 2012 movie except we won’t conveniently be in an airplane when it starts happening. (BTW, any recent movie with John Cusack is ripe for crashing.)

Tonight at 7PM ET, I’ll be appearing on CNBC’s Kudlow Report discussing President Obama’s trip to China and Fed Chairman Ben Bernanke’s US dollar policy.

Over the weekend, China’s chief banking regulator sharply criticized the US Federal Reserve and the monetary policy of the United States. Liu Mingkan said that the U.S. Federal Reserve’s promise to keep U.S. interest rates at extraordinarily low levels for an extended period “has already led to a massive U.S. dollar carry trade and massive speculation.” He said that the weak U.S. dollar and low U.S. interest rates are creating “unavoidable risks for the recovery of the global economy, especially emerging economies” and that the situation is “seriously impacting global asset prices and encouraging speculation in stock and property markets” according to the WSJ.

On the offensive, the head of the IMF said the Chinese yuan needs to strengthen to ease global imbalances. Dominique Strauss-Kahn said that Beijing needs to implement a stronger yuan and increase domestic consumption to achieve this goal. China’s Ministry of Commerce chimed in by saying that international pressure for appreciation of the yuan was “not fair” and is not conducive to global economic recovery. Ministry spokesman Yao Jian said, “It’s necessary for us to provide a stable and predictable environment in terms of macro-economic and exchange rate policies.”

By looking at the NDF forwards, the FX markets are anticipating about a 3.6% appreciation of the yuan over the next 12 months. The Bank of China is noticing that demand for dollar loans in China is climbing and deposits for the US dollar are declining, reflecting increasing speculation that the yuan will resume appreciation. Bank of China’s Shi Lei said, “No one wants to hold dollars in their hands if they can exchange them for yuan and benefit from the potential appreciation. Companies prefer to borrow dollars now to meet overseas payments with a view to repaying the loans once the yuan has risen.”

As I wrote last week, the world is beginning to wake up to the fact the Chinese have increased their competitive trade position via the link between the US dollar and the yuan. We see this in the commentary by finance ministers and increase in filings of trade suits by countries to the WTO against China. However, the lack of any specific commentary from the APEC meeting underscores the inability of the Far East/United States to force China to an agreement.

While trade imbalances are not something I believe are a concern, global reserve imbalances are a different story. The massive increase in Chinese holdings of US dollars and US Treasury securities has two big potential problems. One is the United States government dependence on a foreign entity for loans. Two is the facilitation of borrowing to the United States that perpetuates a belief that massive and ever increasing borrowing can continue without a cost. Both contribute to a dangerous situation should a sudden shift in the structure occur.

As you may have read, the Chinese grilled OMB director Peter Orzag on the impact that the health care bill would have on the US fiscal position. As I have warned, the passing of the current bill by Congress is a negative for the US dollar and may trigger a re-evaluation of Chinese US Treasury purchases.