The Swiss Franc Is Still Strong

20 July & 9 August 2008

On November 9, 2007, within days of the start of its current move upwards, I recommended that Canadian buy the Swiss Franc.

On July 15, 2008, I noted that Switzerland, along with Japan, is one of only two major world powers to be managing its money supply conservatively (that is, to be refraining from the practice of inflating the money supply in order to finance irresponsible government behaviour).

Accordingly, I though it might be timely once again to examine the value of the Swiss Franc relative to the Canadian dollar.

I have done that, and have reached two conclusions.

1. From a technical perspective, the Swiss Franc still has ample room to increase against the Canadian dollar - even though it has already gained 25% since its early November 2007 low. This can be seen in the moderate values of the RSI and MACD indicators, as well as the evident position of the Swiss Franc at the midpoint of its relative position against the Canadian currency over the past 12 years.

2. Fundamentals also favour the continuing recovery of the Swiss Franc. The Swiss are refraining from inflation of their money supply, and global realities no longer support the borrowing of the Swiss Franc to win more lucrative gains in other currencies. It is becoming too risky to borrow at low interest rates in conservatively managed currencies to make investments in high risk currencies that are managed irresponsibly - the US dollar being a prime example of this latter case.

The chart for the Swiss Franc against the Canadian dollar since 1996, presented above, reveals that the Franc has already won a tidy 25% gain against the relatively strong Canadian Loonie. But the Swiss manage their currency more conservatively than do we Canadians - and so, in my view, the Swiss Franc can rise further still. Its time to increase is not yet done!

Here is a list of my blog entries concerning the Swiss Franc:

1. Canadians, Buy the Swiss Franc Now!

2. The Swiss Franc Continues To Climb in Canadian Dollars.

3. My first compliment from Fleck.

4. Currencies 101.

5. Another Swiss Franc Buying Opportunity for Canadians.

6. All You Need To Know About Global Money Supply in One Place.

7. The Swiss Franc Is Still Strong.

8. Use "FXF" (CurrencyShares Swiss Franc Trust) To Buy the Swiss Franc.

9. Gold is Better Than the Swiss Franc.

10. Swiss Franc Alert.

11. Gold Isn't Gaining All That Much... In Canadian Dollars!

Addendum: Many visitors to this site have enquired about how to purchase the Swiss Franc. The most direct method is simply to purchase Swiss Francs from a currency dealer. In Canada, Custom House Currency Exchange offers competitive rates. You may also wish to contact your broker about an exchange-traded fund or a Swiss Franc government bond (which would pay interest on your investment, but could be subject to decline in value even if the currency itself rises relative to other currencies). Additionally, some banks permit investors to maintain foreign currency accounts. Sophisticated investors may wish to enter this trade through purchasing futures contracts or other types of options, such as calls. Many brokers specialize in foreign currency purchases, so I suggest that you start with a broker familiar to you. As I understand it, Pamela and Mary Anne Aden at Aden Research, for example, will execute foreign currency trades for their customers. But for those who don't know how, simply purchasing the currency from a competitive currency trader (possibly your local bank, or a trader recommended by your bank) will be a good place to get started. Ideally the "spread" between the buy and ask price for the currency should be less than 4 cents on the dollar (roughly 4%). That is, you should not pay a premium of greater than 2% to purchase the currency. This being said, my own experience with currency dealers is that it is very difficult to exchange currencies in this idealized range. Our local broker's rates are much higher, for example. Never exchange currencies in large amounts at airports, hotels and other locations that are charging large premiums to provide a convenience service to travellers. Look for the best rates any time you exchange currencies!

August 5, 2008: As currency purchases at fair exchange rates are extremely difficult to obtain, I am now recommending that mainstream investors simply purchase the FXF exchange traded notes, "CurrencyShares Swiss Franc Trust" (denominated in US dollars) through their broker. This exchange traded note uses the interest on its deposits to cover the management fees of the fund, with the result that you will receive modest interest income via this method.

Note (9 August 2008): Most global currencies happen to be weak against the US dollar right now, as the US market is presently driven by the fantasy that the US government's now $800 billion rescue of the financial system by "nationalizing" the government sponsored enterprises (Fannie Mae and Freddie Mac) and using taxpayer money to guarantee worthless bank assets will make everything "all right again." That fantasy will persist for a season, and then it will fade, as all fantasies do.

In the meantime, the Swiss Franc may not have bottomed for US investors. However, I note that the Franc is holding up fine against the Canadian dollar, as both are under pressure versus the US dollar, which is presently enjoying a transient upward move due primarily to concerns about the stability of the Euro. Pamela and Mary Ann Aden advise that the market value of the Euro is presently stronger than that of the Swiss Franc. My own take is that the Swiss Franc clearly possesses superior fundamentals compared to the Euro, which relies upon the historically unproven concept of international cooperation (don't expect the cooperation of the European countries to be maintained in hard times or in crisis!).

October 11, 2008: If you're interested in Swiss Franc Government Bonds, here is a recommendation from WikiAnswers. This brief note recommends EuroPacific Capital. Its C.E.O. and Chief Global Strategist, Peter Schiff, is a long-term US dollar bear who saw the present economic meltdown coming years ago. EuroPacific Capital is a secure and well-managed company, and I can certainly vouch for the reputation of Mr. Schiff, whose articles on the mismanaged US economy I have been reading for years on Safehaven.

While I am currently recommending gold as a superior store of value to the Swiss Franc, gold trades as both a commodity and a currency, with the result that its market price is much more volatile. If you are a long-term buy-and-hold investor, gold will certainly outperform the Swiss Franc as a long-term store of value. But if you don't like $100 price moves in a day (gold has had two such moves in the past month - including only yesterday!), then holding the Swiss Franc may prove less unsettling.
_

All You Need To Know About Global Money Supply in One Place

15 July 2008

Thank you Mike Hewitt!

I have written fervently and often that secular trends are the most important factor in investing, and that excess (monetary) liquidity is at the root of our most fundamental social and economic evils.

Almost no one ever talks about either of these factors, despite their driving influence beneath the surface of global political and economic events.

Now Mike Hewitt has pulled together all you need to know about the money supply of the world's major economies in one place.

What are the money supply levels in each leading nation? What is the rate of money supply growth in each country? How does each nation compare as to its total money supply and its level of money supply growth?

Mike Hewitt has answered all these questions for you in a single article.

Click here for his very valuable interpretation of this information.

And... here are the summary tables and charts to get you started....

By the way, M3 is the best measure of money supply, as it is the most inclusive - leading one to wonder, perhaps - why the US government has stopped publishing this figure (obfuscation is the last refuge of the scoundrel?)!!!

First - what is the money supply (in US dollar terms) in each leading nation?

Name of Country	M0 (US$bn)	M1 (US$bn)	M2 (US$bn)	M3 (US$bn)	Exchange (1USD = )	Date Taken
Australia	37.7	208.0	459.3	962.0	1.0426 AUD	Apr-08
Brazil	56.3	114.3	519.2	1,060.8	1.6141 BRL	May-08
Canada	49.0	386.6	800.1	1,228.6	1.0114 CAD	May-08
China	440.5	2,236.2	6,363.0	N/A	6.8552 CNY	May-08
Denmark	10.6	162.6	211.7	237.3	4.7401 DKK	Feb-08
E.U.	1,013.4	6,072.7	12,039.9	14,197.4	0.6355 EUR	May-08
India	139.9	256.6	947.9	949.1	43.200 INR	Jun-08
Indonesia	16.6	39.7	151.9	N/A	9174.3 IDR	May-07
Japan	680.1	3,641.4	6,901.6	11,367.9	107.01 JPY	Apr-08
Kuwait	2.7	19.9	80.2	80.2	0.2667 KWD	May-08
Mexico	38.1	132.0	575.0	606.4	10.310 MXN	Apr-08
Norway	8.6	144.3	281.9	N/A	5.1225 NOK	Apr-08
Poland	47.4	165.1	283.0	288.2	2.0822 PLN	May-08
Russia	153.8	N/A	570.1	N/A	23.412 RUB	Apr-08
Saudi Arabia	19.8	111.6	187.2	224.9	3.7547 SAR	May-08
Singapore	12.7	52.6	233.9	240.8	1.3607 SGD	Apr-08
South Africa	13.9	96.2	192.1	235.2	7.7208 ZAR	May-08
South Korea	56.7	300.7	1,350.1	2,163.5	1000.6 KRW	Apr-08
Sweden	16.1	222.6	N/A	315.4	6.0088 SEK	Dec-07
Switzerland	35.4	257.3	421.9	609.5	1.0298 CHF	May-08
Turkey	22.8	45.2	199.7	215.5	1.2228 TRY	Jun-08
U.A.E.	7.1	49.4	154.0	189.5	3.6742 AED	Dec-07
U.K.	99.1	1,990.7	3,291.1	3,882.3	0.5055 GBP	May-08
U.S.	832.6	1,388.3	7,688.1	13,800.0	1.0000 USD	Jun-08
Venezuela	6.2	43.7	71.9	71.9	2.1522 VEF	May-08

Here is the same information in graphical form:


Next, what is the rate of money supply growth in each country?

Name of Country	M0 (Y/Y%)	M1 (Y/Y%)	M2 (Y/Y%)	M3 (Y/Y%)	Date Taken
Australia	5.2%	3.3%	16.9%	20.4%	Apr-08
Brazil	21.1%	16.8%	26.2%	17.4%	May-08
Canada	3.4%	7.9%	8.8%	13.2%	May-08
China	12.9%	17.9%	18.1%	N/A	May-08
Denmark	N/A	10.5%	18.5%	22.3%	Feb-08
E.U.	7.5%	2.3%	10.1%	10.5%	May-08
India	19.3%	19.8%	21.8%	22.5%	Jun-08
Indonesia	21.5%	28.1%	14.9%	N/A	May-07
Japan	1.86%	-1.22%	0.71%	0.92%	Apr-08
Kuwait	10.8%	28.2%	23.0%	23.0%	May-08
Mexico	9.2%	10.2%	12.0%	14.1%	Apr-08
Norway	10.7%	7.6%	14.0%	N/A	Apr-08
Poland	5.2%	17.3%	16.7%	15.1%	May-08
Russia	25.9%	N/A	33.4%	N/A	Apr-08
Saudi Arabia	13.0%	27.0%	21.4%	21.6%	May-08
Singapore	9.7%	29.0%	11.9%	12.4%	Apr-08
South Africa	14.1%	12.4%	19.5%	20.9%	May-08
South Korea	N/A	-0.6%	16.3%	14.6%	Apr-08
Sweden	0.5%	10.7%	N/A	16.4%	Dec-07
Switzerland	2.1%	-2.0%	-4.5%	2.6%	May-08
Turkey	20.0%	20.1%	21.5%	21.1%	Jun-08
U.A.E.	18.8%	51.4%	41.7%	37.4%	Dec-07
U.K.	5.7%	16.0%	12.6%	13.8%	May-08
U.S.	1.6%	1.5%	6.0%	18.8%	Jun-08
Venezuela	1.6%	1.5%	6.0%	18.8%	May-08

Again, the same information in graphical form:

Here are a few things to remember....

Money supply is not wealth. If the growth in money supply exceeds a nation's level of productivity growth, the addition to money supply is merely inflationary, devaluing the currency and fomenting social instability. Productivity growth varies considerably from country to country.

For example, Chinese productivity is growing much more rapidly than is that of the US, so the Chinese can get away with a higher rate of increase in the money supply (though the Chinese money supply is nonetheless increasing too rapidly - spelling danger for the Chinese economy - because the Chinese have tied their currency to the US dollar to maintain a stable level of exports to the US).

Note that there are only two "good guys" here - Switzerland and Japan.

The Swiss are controlling money supply growth because they are fiscally prudent and responsible.

That is why the Swiss Franc has remained a sound investment over many generations.

The Japanese story is a little different.

Prior to the US internet/equity and real-estate/debt bubbles, the Japanese ran the biggest real-estate and debt bubble in world history in the 1980s. The bubble caught up to the Japanese, forcing their economy into deflation.

In short, the Japanese are "good guys" on the money front because they now have to be.

The Swiss are good guys because they know how to manage money wisely.

Therefore, the Swiss Franc remains a wise investment, though in my opinion, as you have heard many times before on this site, gold and silver are better investments still! (My own comments on the Swiss Franc in other posts start here.)

By the way, I'm not a precious metals investor because I'm especially enamoured of metals.

I invest in gold and silver because the irresponsible inflationary policies of every major global economic power - apart from Japan and Switzerland - are forcing my hand.

In essence, inflationary monetary policy eventually devalues every product save the precious metals.

Why?

Because gold is a reliable store of value when all other currencies are inflating excessively. It's that simple.

When tough times - much tougher than now, by the way - eventually force world governments to return to conservative financial practices, I'll be back investing in the common shares of sound business enterprises.

Unfortunately, current international government and central bank practices are wrecking the economic climate for business everywhere in the world, driving the international business scene into recession, and possibly into depression.

This is what drives secular trends.

And investment is a fruitless exercise without analysis and consideration of the present secular trend that is dominating economic life.

What, by the way, is our dominant secular trend at this time?

It's safe to say that the answer to this question is that the current secular trend is propelled by the unwinding of speculation and excessive risk.

That is, risk and speculation have taken us as far as they can take us. We are now at a financial dead end, and the answer to our present quandary is to seek out investment sectors that are sheltered from risk, speculation and excesses of all kinds.

Gold and silver - and the Swiss Franc and the Japanese Yen - are all that are left for now....

(By the way, Mr. Hewitt has also published a comprehensive inventory of the world's failed currencies here. Should the US dollar eventually fail, it will constitute the third occasion that a US currency has lost all of its value.)

For those interested in the Swiss Franc specifically, here are links for all my entries concerning the Swiss Franc:

1. Canadians, Buy the Swiss Franc Now!

2. The Swiss Franc Continues To Climb in Canadian Dollars.

3. My first compliment from Fleck.

4. Currencies 101.

5. Another Swiss Franc Buying Opportunity for Canadians.

6. All You Need To Know About Global Money Supply in One Place.

7. The Swiss Franc Is Still Strong.

8. Use "FXF" (CurrencyShares Swiss Franc Trust) To Buy the Swiss Franc.

9. Gold is Better Than the Swiss Franc.

Addendum: Many visitors to this site have enquired about how to purchase the Swiss Franc. The most direct method is simply to purchase Swiss Francs from a currency dealer. In Canada, Custom House Currency Exchange offers competitive rates. You may also wish to contact your broker about an exchange-traded fund or a Swiss Franc government bond (which would pay interest on your investment, but could be subject to decline in value even if the currency itself rises relative to other currencies). Additionally, some banks permit investors to maintain foreign currency accounts. Sophisticated investors may wish to enter this trade through purchasing futures contracts or other types of options, such as calls. Many brokers specialize in foreign currency purchases, so I suggest that you start with a broker familiar to you. As I understand it, Pamela and Mary Anne Aden at Aden Research, for example, will execute foreign currency trades for their customers. But for those who don't know how, simply purchasing the currency from a competitive currency trader (possibly your local bank, or a trader recommended by your bank) will be a good place to get started. Ideally the "spread" between the buy and ask price for the currency should be less than 4 cents on the dollar (roughly 4%). That is, you should not pay a premium of greater than 2% to purchase the currency. This being said, my own experience with currency dealers is that it is very difficult to exchange currencies in this idealized range. Our local broker's rates are much higher, for example. Never exchange currencies in large amounts at airports, hotels and other locations that are charging large premiums to provide a convenience service to travellers. Look for the best rates any time you exchange currencies!

August 5, 2008: As currency purchases at fair exchange rates are extremely difficult to obtain, I am now recommending that mainstream investors simply purchase the FXF exchange traded notes, "CurrencyShares Swiss Franc Trust" (denominated in US dollars) through their broker. This exchange traded note uses the interest on its deposits to cover the management fees of the fund, with the result that you will receive modest interest income via this method.

Note (9 August 2008): Most global currencies happen to be weak against the US dollar right now, as the US market is presently driven by the fantasy that the US government's now $800 billion rescue of the financial system by "nationalizing" the government sponsored enterprises (Fannie Mae and Freddie Mac) and using taxpayer money to guarantee worthless bank assets will make everything "all right again." That fantasy will persist for a season, and then it will fade, as all fantasies do.

In the meantime, the Swiss Franc may not have bottomed for US investors. However, I note that the Franc is holding up fine against the Canadian dollar, as both are under pressure versus the US dollar, which is presently enjoying a transient upward move due primarily to concerns about the stability of the Euro. Pamela and Mary Ann Aden advise that the market value of the Euro is presently stronger than that of the Swiss Franc. My own take is that the Swiss Franc clearly possesses superior fundamentals compared to the Euro, which relies upon the historically unproven concept of international cooperation (don't expect the cooperation of the European countries to be maintained in hard times or in crisis!).

October 11, 2008: If you're interested in Swiss Franc Government Bonds, here is a recommendation from WikiAnswers. This brief note recommends EuroPacific Capital. Its C.E.O. and Chief Global Strategist, Peter Schiff, is a long-term US dollar bear who saw the present economic meltdown coming years ago. EuroPacific Capital is a secure and well-managed company, and I can certainly vouch for the reputation of Mr. Schiff, whose articles on the mismanaged US economy I have been reading for years on Safehaven.

While I am currently recommending gold as a superior store of value to the Swiss Franc, gold trades as both a commodity and a currency, with the result that its market price is much more volatile. If you are a long-term buy-and-hold investor, gold will certainly outperform the Swiss Franc as a long-term store of value. But if you don't like $100 price moves in a day (gold has had two such moves in the past month - including only yesterday!), then holding the Swiss Franc may prove less unsettling.
_

It's Going to be a Double-Header!

7 & 14 July 2008

The current financial crisis is often likened to a baseball game. The optimists suggest this might be the 7th inning stretch, and the pessimists believe we might just be starting the second inning.

Bill Fleckenstein commented on this phenomenon today, citing Brian Carney's interview of Ted Forstmann (entitled "The Credit Crisis Is Going to Get Worse") in the weekend Wall Street Journal.

According to Wikipedia, Mr. Forstmann (born in 1940) is one of the founding partners of Forstmann, Little & Company, a private equity firm. He was featured prominently in the book Barbarians at the Gate: The Fall of RJR Nabisco, as he and his company attempted to acquire RJR Nabisco.

In the subsequent (1993) film adaptation, he was portrayed by actor David Rasche. The book portrayed Forstmann as a critic of KKR's Henry Kravis and his investment methods.

Forstmann's criticism of Kravis (and much of the rest of the financial industry during the 1980s) centred around the use of junk bond (high-yield) investments to raise large amounts of capital. When the junk bond market later fell into disfavour as a result of scandal, Forstmann's criticism was seen as prescient, as his more conventional investment strategy had been able to maintain nearly the same level of profitability as companies such as KKR and Revlon that built their strategy around high-yield debt.

The WSJ interview begins: "Twenty years ago, Ted Forstmann contributed a scathing – and prescient – op-ed to this newspaper warning that the junk-bond craze was about to end badly: 'Today's financial age has become a period of unbridled excess with accepted risk soaring out of proportion to possible reward,' he wrote in October 1988. 'Every week, with ever-increasing levels of irresponsibility, many billions of dollars in American assets are being saddled with debt that has virtually no chance of being repaid.'

"Within a year, the junk-bond market had collapsed, and within 18 months Drexel Burnham Lambert, the leading firm of the junk-bond world, was bankrupt. Mr. Forstmann sees even worse trouble coming today."

Mr. Carney offers the following background: "Mr. Forstmann denies being an expert in the capital markets. But he does have some experience with them. He was present at the creation of the private-equity business.

"The firm he co-founded, Forstmann Little, rode the original private-equity boom in the 1980s while skirting the excesses of the junk-bond craze in the later years. It was for a time the most successful private-equity firm in the world, renowned for both its outsize returns and its caution. For two years after Mr. Forstmann wrote his 1988 op-ed, Forstmann Little sat on $2 billion in uninvested funds, waiting for the right opportunities. Savvy investments in Dr. Pepper and Gulfstream, among others over the years, helped make Mr. Forstmann a billionaire."

Mr. Fleckenstein cites Mr. Forstmann's following warning, which is stated later in the WSJ interview: "We are in a credit crisis the likes of which I've never seen in my lifetime. . . . The credit problems in this country are considerably worse than people have said or know. In order to fix what's going on in the United States, there's going to have to be a certain amount of pain. The market's going to have to clear somehow . . . and it's hard for me to believe that it gets fixed without upheaval in the financial system.... This all started in August (2007), and it was going to get cleared up by October. It hasn't gotten cleared up at all. Things are going to fail. Enterprises are going to fail. The economy is going to slow."

Mr. Fleckenstein adds that, "as to a timeline, he tells Carney: 'I think we're in about the second inning of this.'"

Mr. Fleckenstein ("Fleck" to his loyal readers) adds, "That guess is not so dissimilar from (that of another commentator and close friend of Mr. Fleckenstein's), who says he's not sure what inning it is, but he is sure it's going to be a double-header."

In summary, a growing roster of financial commentators are concluding that the financial (read debt, deception and spending-related) difficulties of the United States are greater than those of the most recently analogous 1970s period.

It's looking more and more like the roaring 20s and the dirty 30s.

Imagine, by analogy, that this actually is a baseball game.

Find yourself a comfortable seat and keep some extra cash in your pocket for refreshments. In fact, you'd better keep that in gold, as in a long ball game, your cash could lose quite a bit of its value.

It looks as if we're in the early innings - maybe the second - and remember, this time you've bought tickets to a double-header.

Prepare yourself for a lot more baseball before this all-day event is done....

And bring a jacket. It's going to be a lot cooler by night time!

By the way, there has been notable action in financial markets over the past week. Fannie Mae (Federal National Mortgage) fell 16.19% today, plumbing its lowest levels since 1992.

Zion's Bancorp is also collapsing, looking at its lowest levels since 1997.

Lehman, on the investment banking side, is revisiting its 2000-2001 lows. Single digits could follow soon thereafter.

I offer this as a backdrop for what is currently occurring in the world of US financial companies. In essence, the common stocks of these companies are in free fall. This cannot be a good omen for the economy in general.

14 July 2008: For more on Treasury Secretary Paulson's plan to launch yet another taxpayer-funded bailout of two additional careless and imprudent financial companies, this time for the federally-sponsored mortgage lenders Fannie Mae and Freddie Mac, which back about half of all mortgage debt in the United States (most, but not enough, of it still good - at least for now), click here.

If you wonder how Fannie Mae & Freddie Mac work, here is a link (courtesy of the New York Times), and here is a diagram:

As the NYT explains, the two companies (government-sponsored entities formed in 1938, privatized in 1968-1970) "provide the capital that banks use to write new loans. If Fannie and Freddie stop buying loans, banks may stop making new loans, freezing the United States housing market. Fannie and Freddie provide stability and liquidity to the mortgage market. If it is harder for them to borrow money, mortgage interest rates will rise.... Fannie's and Freddie's combined cushion for absorbing losses is thought to be too small."

According to the Times, "Fannie Mae and Freddie Mac own or guarantee about half of the nation's $12 trillion mortgage market." The implication is that a bailout "could raise the government's potential obligations, which currently stand at about $9 trillion, by an additional $5 trillion" to $14 trillion, an increase in the US government's accumulated present debt obligations of 56% in a single step. In an understatement, the Times adds, this "would most likely make it more expensive for the United States government to borrow money in the future."

John Doody, the Gold Stock Analyst, asserts that the problem in the capital markets is that under new legislation intended to make financial companies dealing in mortgages and loans more responsible, the mortgage lenders are supposed to raise $75 billion in new cash to back their securities, but their combined market capitalization has fallen to $15 billion, only 20% of that amount. (Mr. Doody explains: "new FASB rules are to be implemented Nov 15, 2008. The rule brings formerly off-balance sheet liabilities onto financial statements and requires $75 billion more equity to meet required minimum levels.")

I calculate that if the companies were to follow the normal mechanism of raising cash through an equity sale, the current outstanding shares would account for only 16.7% of the equity of the company following the sale of securities - an 83.3% dilution of shareholders' equity - and this is assuming that anyone would buy them at this point - - - certainly a questionable proposition in itself!

In other news (courtesy of the AP), the U.S. government signalled that "it won't throw a lifeline to struggling financial companies — except for mortgage linchpins Fannie Mae and Freddie Mac — marking a shift to a new and potentially more volatile phase of the credit crisis.

"Such an approach could mean beaten-down investment banks like Lehman Brothers Holdings Inc. (whose shares have lost 78 percent since this year's peak in February) and regional banks must now fend for themselves as they try to recover from billions of dollars in mortgage-related losses — unlike Bear Stearns Cos., whose buyout the government helped orchestrate in March.

"That is bound to unnerve an already turbulent Wall Street and make investors even more anxious as they await financial companies' earnings expected to be down a stunning 69 percent from a year ago when all the numbers are in....

"Some of Wall Street's biggest investors believe there was another message in the government's announcement — the rest of the financial sector seems unlikely to get a helping hand. Global banks and brokerages have already written down nearly $300 billion in soured mortgage investments — a number projected to ultimately reach $1 trillion.

For more on this story, click here.

Mr. Mortgage adds that $700 billion of Fannie Mae and Freddie Mac's $5.3 trillion in receivables (outstanding loans) are in non-insured (highly at-risk, possibly worthless) subprime and Alt-A mortgages. That is 13% of the total outstanding loan portfolio, leaving $4.5 trillion in insured loans. Mr. Mortgage (who has basically been right on everything so far) estimates that if bondholders absorbed this loss, taxpayers would not have to pay the $700 billion (or more) bill for bad loans, nor take over the company (assuming $5.3 trillion in additional US government liabilities).

Oh, and another point of interest, SPDR Gold Shares (formerly Streettracks Gold Trust, US trading symbol GLD) added 46 tons of gold to its holdings on Friday, July 11. Yes, you heard that right - tons! The recent addition to this conservative investment vehicle's holdings constituted a one-day increment in the gold holdings of the trust from 660 to 706 tons, setting a new record for the trust.

SPDR Gold Shares' holdings (accumulated over just the past 3 years) presently surpass the gold holdings of all but 7 of the world's nations, according to Wikipedia. The US continues to hold the most tonnage of gold by far, at 8,133.5 tons, but SPDR Gold Shares now holds more gold than such countries as China, Russia and Saudi Arabia.

As you may know, the once massive gold holdings of the United Kingdom (now only 310 tons) were decimated by Prime Minister Gordon Brown, who sold most of that nation's gold at the bottom of the market at the turn of the millennium.

Bad news for Canadians - the Canadian government in its wisdom has sold all but 3.4 tons of the country's gold holdings, placing Canada in the same league as Bangladesh and Slovenia as a holder of national gold reserves.

For much more in-depth running commentary on the mortgage-based US economic meltdown, visit Mr. Mortgage's website here.
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Man To Watch at the St. Louis Fed: James B. Bullard

5 July 2008

I haven't yet done detailed research, but the Federal Reserve Bank of St. Louis seems to have a new President and CEO who is worthy of being watched.

James B. Bullard replaced William Poole in his present position on April 1, 2008. He is so new in the national limelight that his name entered into Wikipedia is more likely to get you a British soccer player, though as you'll see, he has a worthy and extensive resume. He will now represent the Bank on the Federal Open Market Committee (FOMC), the Federal Reserve’s chief monetary policymaking body.

Mr. Bullard seems to be talking a new line. Perhaps he is only saying the things he is saying because he is new to the game. But if he keeps up this kind of talk, real changes at the Fed (which are now two decades overdue) could be possible.

What is Mr. Bullard saying?

How about this (quoted by Reuters on July 3, 2008):

"The Federal Reserve's use of core inflation measures is harming its credibility."

Or this:

"Focusing on inflation indices that exclude food and energy work well when those prices are rising at rates similar to those of other prices, but that is not what is happening today."

What about writing this in the bank's official magazine, The Regional Economist:

"It is hurting Fed credibility to say that we are trying to keep inflation low and stable, but at the same time we are not counting some of the prices that are going up at the most rapid pace."

In June, Mr. Bullard said that the Fed needed to start raising interest rates this year to tamp down inflation.

"Price stability should be the number one goal of policy-makers today," he wrote, defining price stability as "a small, positive rate of inflation, say 0.5 to 1.5 percent a year, depending on the price index being used."

Want to know more?

Here is Mr. Bullard's official biography:

James B. Bullard President and Chief Executive Officer Federal Reserve Bank of St. Louis

James B. Bullard took office as president and chief executive officer of the Federal Reserve Bank of St. Louis on April 1, 2008. He directs the activities of the Bank’s head office in St. Louis as well as its three branches in Little Rock, Ark., Louisville, Ky. and Memphis, Tenn. In addition, he represents the Bank on the Federal Open Market Committee (FOMC), the Federal Reserve’s chief monetary policymaking body.

The Federal Reserve Bank of St. Louis is one of 12 regional Reserve banks which, along with the Board of Governors in Washington, D.C., constitute the Federal Reserve System. As the nation’s central bank, the Fed is responsible for conducting monetary policy, supervising banks and operating the nation’s payment system.

Mr. Bullard joined the Research division of the Federal Reserve Bank of St. Louis in 1990, and held increasingly responsible positions in the division. Prior to being appointed president, he was deputy director of research for monetary analysis.

A native of Forest Lake, Minn., Mr. Bullard holds a Bachelor of Science degree in quantitative methods and information systems and economics from St. Cloud State University in St. Cloud, Minn., and a doctorate in economics from Indiana University in Bloomington, Ind.

Mr. Bullard has written numerous scholarly papers published in professional journals and has been a peer reviewer for over two dozen periodicals or institutions. He has participated in over 150 conferences, symposia or lectures sponsored by foreign central banks, academic institutions and monetary policy groups around the world.

Mr. Bullard enjoys bicycling and tennis. He is married to Jane Callahan; they have two daughters.

I think this fellow might really be different. Since election to his new and influential post, he has been willing to take on Lewis Carroll's Humpty Dumpty (who, as you know, uses words to mean what he personally chooses them to mean).

Note what Mr. Bullard has to say about price stability in his address to the Macroeconomics Advisers' Quarterly Outlook Meeting:

"In contemporary discussions, the term 'price stability' has come to mean something other than 'stable prices.' In the late 19th and early 20th centuries, price stability meant that variations in the general level of prices would be transitory and the price index would revert to a mean.

"In recent policy discussions, however, price stability generally is interpreted as a small positive rate of inflation. If there is ongoing inflation, the level of prices does not revert to a constant, but trends upward. I am willing to accept this latter definition of price stability because there may be theoretical and practical reasons to believe that the best price indexes we have available are subject to upward biases. While I am not a big fan of the upward-bias argument—after all, the best-available adjustments are already made to the indexes—I admit that I do not have better measures myself.

"My preferred definition of price stability is that trend inflation, correctly measured, is zero. In practice, this likely converts into a trend in measured inflation on the order of ½ to 1½ percent, depending on the particular price index referenced."

I have read Mr. Bullard's recent speech in detail. I can assure you that he is making efforts to be politically accommodating. He praises Alan Greenspan's achievement of "low rates of inflation" without mentioning that under the Greenspan administration, the United States entered into what was probably the most horrific bout of asset inflation in its history (through the successive stock market and real estate bubbles).

He also states - very politically - that "the Fed’s new lending facilities combined with an environment of low interest rates have gone some distance to return markets to more normal operation."

One could also argue that the new lending facility has rescued the bad (financially reckless) guys at taxpayers' (prudent savers') expense, and many critics of broad government policy have made just that point!

In fact, the general practice of bailing out the irresponsible with the tab delivered to the provident taxpayer (at both the personal and business taxation levels) has driven both government and Fed policy with few exceptions since the institution of the Federal Reserve system in December 1913.

Nonetheless, let's allow Mr. Bullard to be politic. He still seems to be a voice in the wilderness in his present position, and that in itself is a welcome development.

In his June 11, 2008 speech, Mr. Bullard stated in moderate terms what he said more directly to the press on July 3:

"Let me turn now to make a few comments on the issue of core versus headline inflation. Since July 2004, the FOMC has focused on inflation measured by the core PCE price index in the semiannual Monetary Policy Reports. I think everyone in this room is aware of the fact that, for most of the time since 2003, headline inflation has exceeded core inflation.

"According to core PCE measures of the price level, prices are about 11 percent higher than they were in the beginning of 2003. But according to the headline PCE measures, prices are about 15 percent higher than they were in 2003. Unfortunately for all of us, we face the headline prices, not just the core prices. Many are asking, What are the relative merits of focusing on core rather than headline inflation?

"Core measures of inflation defined as excluding food prices have been constructed by the BLS at least since 1957. Core measures of inflation excluding both food and energy prices have been published since 1977. The rationale for these measures is not well documented, but it is likely that the original intent was to better reveal underlying inflation trends. Historically, real food prices have exhibited large transitory movements. Some of the major changes in real energy prices in the 1970s and mid-1980s also proved transitory.

"Under these conditions, a focus on core measures gave policymakers a clearer indication of changes in the trend of inflation that was subject to policy control. Much of the volatility of these prices originated with supply shocks in particular markets: droughts, crop failures, abundant harvests, OPEC boycotts, political disturbances in major oil-producing countries, and the collapse of the world oil market. Supply disturbances of this sort do not produce the persistent spreads between headline and core inflation measures that have been observed over the past five years.

"I believe that consideration has to be given to the hypothesis that different forces have driven the relative prices of food and energy in the recent past—namely, shifts in demand in world markets. These forces are likely to persist for some time. In particular, I have in mind rapid increases in standards of living in large emerging-market economies. Associated with these increases in living standards are higher consumption of calories and higher consumption of energy and thus increasing demand in the global markets for these products. With low short-run elasticity of supply for food and energy production, these trends in demand generate trends in relative prices.

"The best forecast is that China, in particular, will continue to grow at a rapid rate for the next decade. Longer-run elasticities of supply for agricultural products are likely substantially larger than short-run elasticities, and hence the recent trend in relative prices of food may be expected to moderate. Trends in relative energy prices may moderate with the emergence of new technologies. Nevertheless, a plausible case can be made that current trends in these relative prices will persist and that, therefore, headline measures of inflation will remain above core measures.

"Should policymakers take into consideration persistent differences in headline and core measures of inflation? I believe that consistency requires attention to such differences in the formulation of policy. Unless there are compelling reasons to do otherwise, policy has to focus on the prices actually faced by households and businesses.

"Persistent and substantial trends in other relative prices are not factored out in measuring overall inflation trends. The relative prices of computers, communications equipment, and consumer electronics, for instance, have been falling for decades. However, no one to my knowledge has argued that we are understating the fundamental trend in inflation because our core measures do not exclude these items.

"Let me stress that I do not have an answer to this question, but I think it has become an important concern for the FOMC. Again, what is new here is relative price trends in food and energy that may plausibly be expected to persist for some time. If it were just a matter of the food and energy components being volatile, I think a theoretical case could be made that these prices contain too much noise and so should be ignored in day-to-day policy decisions. Historically, the ex-food and energy calculation seems to have worked well, even though arbitrarily ignoring certain prices is not very elegant. With relative price trends, the ad hoc approach to this question is becoming increasingly untenable."

Wow!

Somebody - particularly somebody at the Fed - needed to say this!

Mr. Bullard is being "politically correct" for sure, but this is still new talk in the dark, twisted and obfuscated hallways of the Federal Reserve system.

I'm glad this gentleman will be sitting on the Federal Open Market Committee (caution: it's a rotating position, and his first turn doesn't come until 2010). I just hope that he doesn't get squashed like a bug by his considerably more profligate compatriots!

• Mr. Bullard's speeches since taking on his new position can be found here.
• Mr. Bullard's Curriculum Vitae can be found here.
• Extensive links to full texts of Mr. Bullard's speeches and writings are located here. (Caution: This is technical stuff written for an audience with Ph.D.'s in economics. Mr. Bullard has a particular interest in human behaviour and social learning, which appeals to me as a psychologist.)