Monetary Crisis … USA is also part of the equation

It is perhaps time to look at the USA again.

Capitalist Markets or the free economy can only work when unfettered from government interference.

Since 1971 the USA economy has been run on a basis that they are the reserve currency of the world and they don't have to produce as much as they consume, the rest of the world will simply have to accept their IOU s (Dollars that they print pretty readily).

I can't remember which Secretary of the Treasury (Possibly John Connally just after Nixon had unlinked the Dollar from Gold) once said “The Dollar is not our problem it is yours!”

While from time to time there have been bubbles and fears of a total collapse, the USA have been able to rely on the rest of the world not attempting to redeem the dollars it had printed and continue printing money themselves. By and large they have managed their economy fairly responsibly with foreign debt reaching $12.25 trillion at 30th June 2007 compared with a GDP of $13.84 trillion. The alarming factor is the rate at which that foreign debt has been growing in relation to GDP over the last few years. In 2003 it was around 40% of GDP and now it is sitting at 90%.

Largely to blame is of course the war in Iraq and Afghanistan.

Now let’s look at the shenanigans.

Let’s start with Fannie Mae and Freddy Mac.

Here is a quote from the Fannie Mae website

Fannie Mae is a shareholder-owned company with a public mission. We exist to expand affordable housing and bring global capital to local communities in order to serve the U.S. housing market. Fannie Mae has a federal charter and operates in America's secondary mortgage market to enhance the liquidity of the mortgage market by providing funds to mortgage bankers and other lenders so that they may lend to home buyers. In 2008, we mark our 70th year of service to America's housing market. Our job is to help those who house America.

As we see Fannie Mae is in the same game as Northern Rock … only a step up the ladder. The smaller Banks are discounting their mortgages with Fannie Mae who is parcelling them up and selling on the international capital markets. In this case the crisis was not precipitated by lack of finance to fund loans but by the fact that they had to drop their quarterly dividend from 35c to 5c in order to preserve capital of $1.9 billion. The dividend announcement on the 8th August resulted in a 90% fall in their stock value, over the next couple of weeks. Obviously there had been a major fall in profits probably as a result of defaults in mortgage repayments as people moved into negative equity seriously impairing their ability to raise new funds on the International markets.

The USA response of effectively nationalising both Fannie Mae and Freddie Mac has to be questioned although we still have to see the full detail of the extent of the problem and no doubt, with the nationalisation, that will be obscured. However the treasury did pump $100 billion into each of these companies … suggesting gearing ratios in excess of 50:1 a large part of those $100 billion are going to be needed to be converted to fixed capital if these companies solvency is to be fully restored.

Short on the heals of this, comes the decision to allow Lehmann Bros to go to the wall, followed a day later to the loan of $85 billion to AIG, and the major world central banks putting $400 billion into the market … to try and stop the migration out of US treasury bonds. We now hear that the USA treasury will be stumping up $750 billion to shore up its home mortgage markets.

As I see it the USA is trying to shore up its markets by increasing its foreign debt by another trillion dollars all done in two frenzied weeks.

Really makes Gordon Brown look a beginner!

The question is … Does it all work?

Far be it for me to say that I believe they are wrong. The commentators on Friday were telling us that the markets were showing their appreciation of the actions taken. Here are my takes on Friday.

There was a scramble from around the world to get out of USA treasuries to the extent that they were actually paying buyers to relieve them of the dollars and allow them to put their money elsewhere … anywhere but US treasuries. I wonder how much of the $400 billion from Central Banks was left at close of play on Friday.

Stocks around the world rebounded as everyone recognised the USA was going for reflation in a big way … the dollar would be heading down, there would be a continuation of the USA consumption culture and exports would not suffer. So up goes the gold price and up go shares around the world the USA is still going to buy our goods.

I started this off with the question … Where to now?

Leave a Reply