global agenda 88.
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'What we are witnessing is essentially the breakdown of our modern day banking system, a complex of levered lending so hard to understand that Fed Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August."
The quote is from Bill Gross's Investment Outlook, available on the PIMCO site. For those who don't know, Bill Gross is CEO of PIMCO, the largest manager of bond funds in the world. More importantly, he is highly respected, not least for his ability to write investment letters that explain complex topics and ideas to non-professionals in language they can understand.
Naturally, an outlook written in December contains a forecast for the coming year, and Gross has never been afraid to stick his neck out and give his views. In this case, his concluding sentence is to "stand by for a tumultuous 2008 as the market struggles to move from the shadows back into the sunlight of sounder banking and financial management, accompanied by Fed Funds levels at 3% or lower."
Not everyone agrees that Fed funds will fall from 4.5% today to 3% or less next year. Gross's assessment of Fed policy puts him in what is now the majority camp, which believes that the need to prevent or mitigate the impending recession will force interest rates much lower, despite the inflationary threat now becoming apparent. However, that's not what is interesting about his analysis. It's the opening quote, not the closing prediction, that is truly remarkable - not where we might be going, but where we are now.
It is advisable to read and re-read that opening quote and then ask yourself if you have absorbed and internalized the seemingly straightforward words in it. Gross says, as a matter of fact rather than conjecture or speculation, that the banking system is breaking down. Had he written that in December 2006, his colleagues would have had no option but to force him to quit and probably would have advised his family to get him the best doctors and treatment that his considerable wealth allowed. In any remotely normal circumstances, you can't just write about "breakdown of the banking system" as if it was an iPod or some other new toy. Banking systems, the blood vessels and oxygen of a modern economy, don't simply breakdown, and if we are indeed witnessing that happening we should be horrified, petrified and aghast.
Some of us are. Most professionals, no doubt including Gross, find what they are witnessing beyond belief. For instance, this week the European Central Bank (ECB) pumped into the European monetary system no less than $500 billion in one shot. This is a truly mind-boggling amount of money, and such a move was not merely unprecedented but also unimaginable in size - until now. The sheer amount of money is incontrovertible evidence that the banking system - in this case that of Europe, but ultimately all the national and regional systems are interlinked - is in the most terrible state.
But what is far worse is that this injection was not meant to solve any basic problem, merely to keep the banks functioning and willing to lend to each other through the critical year-end period. The first week of January is the time horizon of the global financial system now. If it survives until then, it will figure out what to do next.
What is worst of all is that this monstrous monetary move achieved only partial success. The inter-bank euro lending rate, which at 4.95% compared to an official rate of 4% had reflected the massive premium banks were demanding to lend to each other - so great is the lack of confidence in the markets today - fell by an unprecedented 50 basis points, or half a percentage point, to 4.45%. But that was still 45 points above the official level: half a trillion dollars had done half the job. But even the ECB is not a bottomless pit, and half a trillion dollars was its whole play. It may now have shot its bolt.
The other extraordinary statement that Gross tosses off matter-of-factly in that opening quote is that the banking system, which he describes as breaking down before our eyes, has become so complicated that the head of the American central bank doesn't understand it any more and needs help from the kids who run hedge funds, who created the "financial weapons of mass destruction" that have led them and the world into this mess, and who flourished because of the deliberate policy of the Fed and other central banks to allow them to do what they liked, with no supervision and virtually no accountability.
The Fed Chairman is often described as "the second most powerful man in America." No prizes for guessing who the number one is. Yet President Bush, soon to arrive here to sort out the Middle East, has not had coaching from hedge fund managers to help him understand what's going on - nor would it help much, in his case. That's why he told a Rotary Club audience in Fredericksburg, Virginia this week that "this economy's pretty good," and "there's definitely some storm clouds and concerns but the underpinning is good." Indeed, opined the president, "If I were an investor, I would be looking at the basic fundamentals of the economy. The fundamentals of this nation are strong."
Unfortunately for the American people, and the rest of the world, most investors are not convinced of that. They certainly don't believe Bush, Bernanke or anyone else in authority because along with the breakdown in the banking system, which, after all, is based on trust and mutual belief, we are witnessing an even more fundamental collapse in confidence in all the pillars of the establishment - notably the political and financial elites.
A recent article in Fortune magazine highlighted how the big investment houses are still pumping out optimistic music in their macro and corporate research, even as they themselves rack up losses running into tens of billions of dollars. But no one believes them any more. Although no one knows what lies in store, everyone now knows what they have been consuming these last few years has been an endless store of lies, stretching from Wall Street to Washington.
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