Taxpayers as Mouse Models

It is Thursday night and I am both pretty happy and worn out. My mother has been at home for two days and is doing very well. Thanks to all for the kind sentiments. I am myself fighting a sinus issue that is making breathing all kinds of fun. Add to this an entire spectrum of news to cover, and you have a tough mix. I will see what I can do.

Existing Home Sales and Research in Motion: Failure to Clear End of World Expectations
You know the drill: talking heads and our own officials let us know that estimates for various numbers and earnings are were priced for the "end of the world" scenario and thus as stocks and data either beat those marks or just get worse at a lower rate then the markets meteoric rise is not only justified, but lagging behind the recovery. All was going very well as fractal 5th derivative rates o change were looking great and estimates of losses of the GDP of Japan by the Nasdaq were overshot by a wide margin. A great tale indeed.

Then you get two non performers today, I mean, did they not get the memo?:
RIM results, outlook disappoint, shares tumble
and
Existing-home sales drop 2.7% in August to 5.1 million pace

In regards to RIMM, I cannot figure their report out anyway, a huge one time charge and other baloney, but guidance was lower, and that does not fit the mold.

The housing numbers were especially bad as this is the sweet spot for sales and for the $8k bonus pool to be helping things along. Guess what the NAR wants? An extension of course!

These two items were blames for a move down was the conventional wisdom, but I really do not think either point was the culprit. I see many adjusting charts and wave counts getting excited about a 1% drop in the indices. I think the bearish sort underestimate the suspension of disbelief at this time.

Taxpayers as Mouse Models
As a molecular biologist I focus my attention to science on the very small scale. I design experiments that can be tightly controlled. I use test samples to try out new ideas. I keep things "in vitro" which means "in glass". I am responsible for early testing of many ideas. As things progress, and only after exhaustive testing do things progress to the "in situ" or "in vivo" level which means testing either cell lines or even using mouse models to study experiments. In classical science this is how things are done.

Enter economics. Here testing is done on a grand scale by a central bank. Unfortunately the public are the real live mouse models. To be fair, math models and theory presentations can never really reflect the real world (though this is how they get their ideas) and thus their pool of test subjects is very limited.

The first example of yet another creative FED program was unveiled today through various rumor channels. This is always done to gauge opinion before an action is taken. Early in the week many thought a large exodus of cash from money market(MM) funds was due to:
-expiration of the money market guarantee by the government
-a move into equities
-some combination of the two

As with most things, it just seems those in the know were first to move. What am I talking about? How about this:
Fed's exit strategy may use money market funds

The Fed would borrow from the funds via reverse repurchase agreements involving some of the huge portfolio of mortgage-backed securities and U.S. Treasuries that it acquired as it fought the financial crisis, the newspaper reported, without citing any sources.
This would drain liquidity from the financial system, helping to avoid a burst of inflation as the economy recovered.

You have my attention! I will be checking in with my MM managers and make it clear if they accept MBS as collateral on a swap from the FED I will withdraw my funds. More:

The Fed is considering whether to conduct a pilot scheme, but worries such a test might be seen as a signal that the central bank was about to drain liquidity on a large scale, the newspaper said. In the near term, a big drain remains unlikely, it added.

I could ask why, if the market is doing great and all is well, any minor hint of any liquidity reversal would cause a panic. I could ask that. Moving on:

The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion, the Financial Times said.
Money market mutual funds have about $2.5 trillion under management so they could plausibly provide between $400 billion and $500 billion, it said.

I feel sick.

And the grand plan is revealed. Foreign debt holders have swapped their MBS/Agency debt for treasuries the FED has taken them onto their balance sheet. Add to that mix all the garbage collateral they have from the banks in the "Operation Restoration of Liquidity" assault and we are talking big numbers.

Instead of the public serving as a backstop, it seems their most trusted place holder of investor cash, the money market, will now serve as the long term storage facility for much of this kind of toxic debt. Call it the Yucca Mountain of MBS if you will.

What could go wrong?

Any serious call on the MM reserves may force selling of these instruments which while I am sure they are all triple dog AAA rated, may find it hard to find a buyer at par who is not named THE FED (roundabout, yes?). If that happens, the "breaking of the buck" may occur again, and it was this very item that really almost ended the financial world as they know it. Sorry, as "we" know it.

Zero Hedge offers this:

Heaven forbid PDs [Primary Dealers] have to sell any of the Treasuries they are sitting on to free up some cash. One also wonders just how much in excess reserves the PDs are currently in possession of. But that would be counterproductive to the Fed's every day scam of running the markets higher. How can PDs, and banks in general keep buying equities, if they are forced to give cash to the Fed? Furthermore, if regular investors perceive some threat to the MM liquidity pool, it will of course pile into other riskier assets.

All in all, the Chairman is determined, come hell or high water, to part consumers with their savings: whether it be through zero deposit interest rates, through money market guarantee removals, through talk of inflation or, ultimately, through actions like these. After all, America has gotten to the point where the Fed is beating the drum on the need to keep blowing the capital market bubble bigger and bigger: anything less, and just as Madoff investors discovered, the entire pyramid collapsed overnight, and where people thought there was $50 billion, there was really $0.

A great summary.

Last night I was in a debate with my friend from Illusion of Prosperity and I had left this line of thinking in the comments section:

We are fast approaching a time where the Keynesian's may finally have an answer to the age old question: "Can a central bank in good standing create all the money they want?"

While thus far the money created by the FED has not made its way into the money supply (for various reasons) it is an easy breezy argument that it indeed has caused massive inflation. How so? Imagine home prices without the FED help? Imagine stock prices without government backstop. Imagine banking without the taxpayer safety net. While deflation in real terms is occurring right now, relatively inflation of asset prices is running very high indeed (as opposed to where they would be). Again, leave the inflation out and I think about it terms of eventual dollar devaluation.

I think this is another example of experimenting in real time on real people.

What I am looking at is the FED/Treasury/Associated Agents have papered over bad debts with created money, but that money has only replaced destroyed capital (or as Mish thinks, just barely made a dent). This has lead to no real inflation as that money never really existed and never entered the money supply per se. But I wonder why can this not be done all over the world everywhere at all times? Have a rough year due to low oil prices in Russia? Print up 300 Billion, swap it for the losses in the business world, have them pretend they only lost 1/10th of that, and carry on the game. Can losses always be squared as long as money does not enter the system? Where are the problems? How can that be possible?

This is a dangerous game being played right now. Where it not for our "reserve currency" get out of jail free card this game of Monopoly ended long ago. You can do whatever you want right up until the point you cannot. Would you guess we are closer to the point when this ability started, or closer to the point when it ends?

All Inclusive Gold Article
I have never before read an article by the author Laurie McGuirk, but his offering on Minyanville today really encapsulates my thinking on gold in many ways. Check it out here.

Have a good night.