Signs Economic Commentary
Oil closed at 66.86 dollars a barrel on Friday, up 7.3% from what was already a record weekly close of $62.31 a week earlier. The Euro closed at 1.2436 dollars, virtually unchanged from the previous week’s close of 1.2437. Oil in euros would be 53.76 euros a barrel, up 7.3% from 50.10 euros a week earlier. The dollar, then, fell from 0.8099 euros to 0.8041 for the week. Gold closed at 451.60 dollars an ounce, up 2% from $442.90 on last Friday’s close. Gold in euros would be 363.14 euros an ounce, up 2% from last week’s 356.11. The Gold/Oil ratio closed at 6.75 barrels of oil per ounce of gold, down 5.3% compared to 7.11 on the previous Friday. In the U.S. stock market, the Dow closed at 10,600.31, up 0.4% from 10,561.14 a week earlier. The NASDAQ closed at 2,156.90 down 1% from 2,178.92 on the previous Friday. The yield on the ten-year U.S. Treasury note closed at 4.25% down 14 basis points from 4.39% at the previous Friday’s close.
Again, the big story last week was the rise of the price of oil to record levels. I think we need to be sceptical about this rise. Sure, the supply of oil is finite, but is it any more finite than it was five or six years ago? Do we really know how much oil there is? And, even if oil is limited, is energy in general limited? Currently it would seem very much so - but we really don’t know. People point to the growth of the Chinese economy as reasons for the rise, but the growth of China has been in the works for a long time and it is proceeding at rates that could have been and were predicted years ago. Remember that analysts are saying there is plenty of oil at the moment, but what is lacking is enough refineries in the United States. We should ask who high oil prices benefit and then ask why haven’t enough refineries been built in the United States. The invasion of Iraq and the consequent chaos has taken much of that country’s production offline. Could that have been intended? Could the oil interests behind the Bush regime have intended this chaos and these high prices? They are getting ultimate possession of Iraqi oil (or at least they think they are) without the disadvantage of putting it on the market and depressing prices.
We make a mistake if we assume that the markets for various commodities act as markets do in economic textbooks. Here is an excellent account by Robert Bell of how, by whom and for whom markets can be rigged, worth quoting at length but too long to quote in full. The article helps explain why those of us who thought the dollar would have collapsed by now were wrong. A major reason for this was the consequence of the law passed by Bush in the fall of 2004 allowing U.S. corporations to “repatriate” profits parked overseas and to have that money taxed at a much lower rate. According to Bell, that had the effect of propping up the dollar.
The Invisible Hand (of the U.S. Government) in Financial Markets
Robert Bell
Summary: The U.S. government is manipulating all major U.S. financial markets - stocks, treasuries, currencies. This article shows how it is possible and how it is done, why it is done, who specifically is doing it, when they do it, and where they get the money to do it.
Most people probably believe that the major capital markets in the U.S. are basically true markets with, occasionally, maybe very occasionally, a little bit of rigging here and there. But evidence shows that the opposite is the case - the rigging is fundamental with a little bit of true markets here and there. I have discussed how this works concerning U.S. and some other stock markets in an earlier article. Here I will primarily discuss the rigging of currency and U.S. Treasury markets.
Perhaps the main reason for the urban legend that major markets are not generally rigged is that they are assumed to be too big; the millions of independent buyers and sellers, worldwide because of globalization, make effective and sustained coordination impossible. The implicit assumption is that any market could be systematically rigged if it were small enough, or at least small enough at some critical choke point.
Little Markets
In the case of the market for U.S. Treasuries, the Financial Times summed up exactly how small it really is in two major stories, one just under the masthead on page one, on 24 January 2005. One story began, “During the past few years the US has become dependent, not so much on millions of investors around the globe but on a few individuals in a few of the world’s central banks.” In 2003 these central bankers bought enough treasuries to cover 83% of the U.S. current account deficit, and 86% of those purchases came from Asian central banks.
The two main sources of money for U.S. Treasuries are the central banks of Japan and China. Japan held about $715 billion in U.S. Treasuries, as of November 2004, and China held about $191 billion. All the other nations’ central banks hold altogether, about the same amount again, roughly another trillion.
As the total of all obligations is about $4 trillion, two central banks obviously hold about one quarter of the total. They are in the position to pump or dump the Treasury market all by themselves. They can sell what they have or simply stop buying when the Treasury sells.
Since the money comes from a handful of foreign central banks, the possible rigging of the Treasury market equals the possible rigging of the foreign exchange markets. These central banks have to buy dollars before they buy Treasuries. Even Alan Greenspan has acknowledged that the two go together, admitting that Asian central banks “may be supporting the dollar and U.S. Treasury prices somewhat.”
U.S. stock markets are also capable of being systematically rigged, and for the same reason - a handful of players can dominate if they coordinate their actions. The key choke point is in the number of mutual funds, which themselves hold about 20% of all the stock in the major markets. Of the over 8000 all-stock mutual funds, a mere 497 hold roughly three-fourths of the stock. This is easily a small enough number to pump the market, whether through coordinated buying disguised as programmed trading, or simply a follow-the-leader mechanism. All the other thousands of funds and the millions of individuals around the globe putting their money into these markets can do little more than follow the momentum. No major U.S. stock market writer, advisor or player seems to publicly acknowledge this, as far as I know. But the CEO (PDG) of the French insurance giant AXA has acknowledged it: Claude Bebear wrote in his 2003 book Ils vont tuer le capitalisme (They are going to kill capitalism):
“… today, shareholders are relegated to the role of quasi-spectators. The small shareholders that are now called ‘individual investors’ know that they have little weight. All together, they only represent a small percent of capital because the investments of households are more and more in the form of mutual funds, pension funds (fonds communs de placement) or life insurance funds. The shareholders today are thus the institutional investors.”
Bebear, in charge of one of the world’s biggest stock portfolios, adds:
“We are no more, in effect, in a world that one reads in the economic text books, with innumerable investors of various characterizations, choosing each in his own way the stocks that he’ll put in his portfolio; the results of their millions of decisions generating a sort of changing market equilibrium, but a stable one. The truth is that for several years, the reasoned investment on a stock has almost disappeared in favor of more and more mechanical behavior.”
Plunge Protection
Programmed trading in an utterly concentrated stock market pretty much guarantees the possibility of systematic and continual market rigging. But to accomplish this, and coordinate it with the currency and Treasury markets, some sort of orchestrating mechanism would need to exist. It does; it is known as the President’s Working Group on Financial Markets, occasionally referred to in the business press as the Plunge Protection Team. Then President Ronald Reagan signed it into existence on 18 March 1988, with the specific intension to avoid another stock market crash such as that of 19 October 1987. The Working Group’s existence is no mystery. See for yourself. Go to Google and type in Executive Order 12631. You will find the Executive Order, and even a 14 November 2003 statement from Secretary of the Treasury John Snow giving a brief history of the Working Group, describing its policy advisory activities, and concluding with these words: “It also is a forum used to exchange information during market turmoil through ad hoc conference calls and meetings.”
Presumably Plunge Protection doesn’t hold these ad hoc conference calls and meetings just to be passive bystanders. Executive Order 12631 specifically authorizes them to coordinate buying: “The Working Group shall consult, as appropriate, with representatives of the various exchanges, clearinghouses, self-regulatory bodies, and with major market participants to determine private sector solutions wherever possible.”
So not only is the fix in, it is legal.
In a 1989 Wall Street Journal article, then Federal Reserve board member Robert Heller even suggested a market intervention strategy: “Instead of flooding the entire economy with liquidity, and thereby increasing the danger of inflation, the Fed could support the stock market directly by buying market averages in the futures market, thus stabilizing the market as a whole.”
Guess Whose Money is Used to Buy Stock Market Insurance?
There is even a potentially unlimited source of money to do this pumping. Federal government contractors operate under a special law, CAS, in their defined benefits pension plans. This gives them stock portfolio insurance, something which small fry players would obviously like to get, but can’t find anyone willing to issue. Should the pension funds of the federal government contractors lose money in their investments to the degree that they fall below minimum reserve requirements imposed by other federal laws, they can simply make up the difference by adding it on pro-rata to subsequent items sold to the federal government. The vast sums of federal tax money devoted to plugging the holes in the pension fund for the largest Pentagon contractor, Lockheed Martin, were discovered by Ken Pedeleose, an analyst at the Defense Contract Management Agency. He was concerned about staggering cost increases for the C-130J transport but a chart he made public showed the mind boggling per plane cost increases for a number of Lockheed Martin airplanes. The chart amounted to a Rosetta Stone for the military-industrial complex. It showed, essentially, how the military-industrial complex linked to the stock market through the Lockheed Martin pension fund, and by extension through all the others covered by the same law.
No doubt a lot of government money has been flowing through Lockheed-Martin and others in the last four or five years!
Is there a corresponding source of tax money to pump the currency and Treasury markets? There is an official one for currency, the Exchange Stabilization Fund. It was established in 1934 to prop up the dollar in foreign exchange markets. But it can be used for any purpose determined by the Secretary of the Treasury. In mid-1995, the fund contained $42 billion. The actual amount varies depending on how well the Treasury does on its currency transactions. The money originally came from the sale of U.S. government gold, but the Treasury kept the money as a private fund, not under Congressional control. Since it is a finite amount of money, not appropriated by Congress, it probably is not often used to pump the stock market or even the market for Treasuries.
The markets for Treasuries, and also currency, are being pumped using the tax code and pension fund laws. But to understand this we have to first look at why pumping might be necessary.
Treasuries Exchanged for Jobs
The U.S. Treasury holdings of Japan and China are essentially a consequence of a trade imbalance between the U.S. and these two countries, with the balance heavily tilted to the latter. To maintain the imbalance, which they both clearly want to do, both countries must keep their currency pegged against the dollar at a lower rate than it might otherwise be. If they did not do that, the Toshiba computers, Toyota cars and other quality items made in Japan would be more expensive, and so Japan wouldn’t sell as many of them in the U.S. A similar case holds for vast numbers of Chinese manufactured items sold pretty much everywhere, but notoriously at Wal-Mart. To keep the items relatively cheap, the central banks of those countries keep their currencies cheap by buying a corresponding amount of dollars, thus supporting the dollar against their currencies. The dollar may essentially collapse against the euro, but not against the yen and the yuan.
With the dollars the Japanese and Chinese central banks have bought, they can buy something denominated in U.S. dollars; the item of choice is U.S. Treasuries since it is like holding dollars that pay interest. So this has the effect of pumping the price of Treasuries too. Because the items made in China and Japan are cheaper than those of corresponding quality made in the U.S. (in the case of many Japanese items, there may not be U.S. items of similar quality), the effect is to create manufacturing jobs in those countries while simultaneously losing them in the U.S. In effect the jobs are exported and foreign currency is imported to buy dollars and then Treasuries.
This has an advantage for the Bush administration, which has the ruinously ridiculous policies of simultaneously cutting taxes and waging wars or building up for them. In effect, the basic racket is: the Bush administration exports jobs to these countries, and in turn they finance Bush’s fiscal deficit so he can continue his wars and cut taxes for his friends. The deficit for 2005 will be at least $400 billion, according to the Congressional Budget Office. The Pentagon budget for 2005 was about $400 billion. Add in two supplemental requests for the costs of his Iraq war and the Pentagon figure is roughly $500 billion. “It is interesting to note that the military budget is about the same order of magnitude as the fiscal deficit,” said veteran Pentagon waste fighter Ernest Fitzgerald.
…But won’t the Japanese and Chinese central banks ultimately get burned by holding vast quantities of dollar denominated assets? Sure, if the dollar ever collapses against their currencies too. The dollar having fallen roughly 30% against the euro since the beginning of the war in Iraq, the same fate or worse could await these Asian currencies. With currently issued Treasuries paying a coupon rate of no more than 4%, they would be materially shafted on their investments in U.S. Treasuries. Then why don’t they bail out?
The Emperors’ Revenge
For the Chinese, the basic racket is too delicious and too ironical. They industrialize their country at the expense of the de-industrialization of the U.S. Not only is it sweet revenge for more than a hundred years of humiliation at the hands of Europeans and Americans, but also at the end they are relatively strong and the U.S. is relatively not. What do they care if the deal isn’t quite as good as it would be in a perfect world and they lose a third, half, two-thirds of their savings in U.S. Treasuries? Besides, in an even mildly less imperfect world, the U.S. President would not make such a blatantly corrupt bargain against the people of the U.S. Billionaire investor Warren Buffett calls this system of indebting U.S. citizens to foreign governments “a sharecropper’s society,” to distinguish it from Bush’s supposed “ownership society.”
…The overwhelming consensus of financial writers was that both the dollar and Treasuries would really hit the skids in the new year, 2005. The consensus was global. For example, the French financial paper, Les Echos wrote in its edition of 21-22 January: “Until now, it was a question of the great bet adopted nearly unanimously by foreign exchange traders - the dollar will fall in 2005.”
Of course, as implied by the quote, the dollar did not fall. Nor, of course, did its fat twin, U.S. Treasuries, which are little more than interest paying dollars. Is this because the trade deficit improved? Not really, although it showed a slight gain in early February, long after the dollar and Treasuries had materially improved. The dollar had gone up 3.6% from 1 January 2005 until 22 February 2005. Why? Did Bush raise taxes, thereby erasing some of the fiscal deficit? Not at all. On the contrary, he cut taxes - as usual for a select group - and that’s why the dollar rebounded.
Plunge Protection’s New Cash
In late October 2004, the U.S. public was looking the other way when the tax cut was passed. Most people were obsessing over who would win the presidential election. Few were paying much attention to what the Republicans in Congress were doing, which was giving billions in tax cuts to U.S. corporations which had profits parked in tax havens around the world, such as in Ireland or Singapore. Bush signed the law enabling this tax giveaway on 22 October 2004…
The law Bush signed in late October 2004 goes by the obscenely false name, the American Jobs Creation Act. If there is one thing it will not do, it is to create jobs. It will instead create takeovers, which nearly always produce losses in jobs - in the name of synergy. Takeovers are on the limited menu of activities companies are permitted to do with the money they can “repatriate” under this law. Not that the limited menu makes much difference, since the money brought in does not have to be fenced off in any way. So if $10 billion were spent by a company on takeovers, that frees up another $10 billion to do whatever was prohibited under the law, such as paying dividends, buying back stock, or filling the pockets of executives with extra bonuses. Normally such profits earned in foreign subsidiaries of U.S. companies would be subject to a tax rate of 35% if they were brought home, which is why the money had stayed parked in the tax havens. But the law gives companies a one-year window for the “repatriation” of this cash at a tax rate of only 5.25%. Nobody knows how much will be brought in. When the law was passed in October, the general expectation reportedly was that the figure would be about $135 billion. But one player has estimated it at $319 billion. “This has some investment bankers salivating,” wrote David Wells in the Financial Times. But how much would be converted into dollars from other currencies? According to two different investment banks, the figure is somewhere around $100 billion. That would be the minimum available from this source to pump the dollar for one year. Recall that the Exchange Stabilization Fund has less than half that for eternity.
The Bush administration’s use of repatriated foreign profits to pump domestic markets shows that they are not going to let “thin ice” signs stifle their version of the economy, at least not without a fight. However, the underlying weakness of the economy because of the twin deficits remains, so basically all that Bush and his Plunge Protection team are doing is moving the “thin ice” sign out onto thinner and thinner ice. The weight of the Bush team will eventually crash through that ice into exceedingly cold water…
Panic Buying
One short-term thing the money has already done is to pump the dollar. The mechanism by which this is accomplished is quite simple and is signature Plunge Protection. It is the device of the short covering rally. This is what happens when speculators sell an asset - stocks, Treasuries or dollars - short. With stocks, this means that they sell the asset without actually owning it. They borrow the shares they sell, betting the stock will fall. They then buy it at the reduced price and return those shares. Another way to accomplish essentially the same thing is through options. The risk in a short sale is that the stock will not go down but instead go up. The short seller literally is exposed to unlimited losses in this case. This is the basis for a short covering rally. Non-shorters buy in sufficient volume to force up the price. The price rise scares the shorters into buying right away before the price goes too high and they lose too much. This results in panic buying as large numbers of short sellers feel compelled to buy to limit their losses. Often when the stock market suddenly blasts up out of a long slide for little or no reason, we are watching a short covering rally. There have been several such rallies in the currency and Treasuries markets so far this year, and there will probably be quite a few more.
According to a J.P. Morgan survey, the year 2005 began with most U.S. and international speculators holding short positions on U.S. bond markets. Obviously this is because they had foolishly looked at the underlying economic reality, and failed to understand the profound import of the American Jobs Creation Act.
…How big are these chunks of cash? Johnson & Johnson announced in February that they would bring in $11 billion. Pfizer put its planned figure at $37.6 billion. But are these figures big enough to pump the dollar? You bet. An ABN Amro currency strategist, Aziz McMahon, has been quoted as saying, “The sums are so large that if even a small proportion is transferred from other currencies, the positive impact on the dollar could be substantial.” According to that bank’s calculations, each $20 billion pumped in from other currencies pumps the dollar against a broad index of currencies about 1%. So the announced amounts would be sufficient to trigger both momentum trading in the dollar and trigger short covering rallies which themselves would trigger further momentum trading.
Even the announcements of the currency repatriations can trigger short covering rallies. ABN’s McMahon added, “The psychological impact a wave of announcements could have on structural short-dollar positions should also not be underestimated.”
…All who imagine that the mythical market forces will prevail seem to deliberately avoid actually looking at what the so called markets really are, including their concentrations, Plunge Protection mechanisms, and Plunge Protection’s extensive access to a variety of pools of other people’s money. The mechanisms and the market concentrations permit the Bush administration to systematically sell off U.S. assets to pay for its more wars/less taxes policies. The Bush administration is comparable to a group of corrupt trustees for the family fortune of a lazy and incompetent heir. They siphon the money out by selling off the inheritance while the heir is too stupid or drunk to notice. He still has his mansion, his fleet of big cars and his monthly check, and he doesn’t notice that the assets are shrinking. He may not for a while. This family’s fortune is big and there are a lot of assets still to sell off.
Reading between the lines about the role of the military-industrial complex in “managing” the markets, it’s not too hard to see why some in the Bush administration might be tempted to see this Global War on Terrorism (and Iraqi civilians) as successful. The Deconsumption blogger, Steven Lavagulin, wonders why, with the preeminence in brand marketing that the United States holds, that it has done such a poor job lately in generating good feeling world-wide for the “America” brand. He concludes that it was no accident:
I don’t think the ball was dropped…I think the marketing campaign is in effect. In fact, it’s a raging success. It’s just that it was decided that “anger” and “resentment” were a better brand to market. The campaign was rolled-out, a campaign entitled: War on Terror™
Think about it…War on Terror™ It says “War. War with no boundaries. War with no goals. War with no rules. The enemy is anyone, anywhere. Live in fear. The enemy might be you… Don’t get out of line.”
If you’ll allow me to draw water from the [William] Kotke [in Final Empire] well once again:
“Although industrial investment in the colonies generally returns large profits (25% per year being the standard), super-profits since World War II have come from guns and drugs. The U.S. has been the largest armaments producer, with other countries now catching up rapidly. Alliances and militarization have been encouraged all over the world and this has seen the militaries take power (overt or covert) in most societies. The petroleum industry is the largest planetary industry but it is closely followed by the armaments industry in size and production. The armaments industry mushrooms as all forms of colonial exploitation grow. A modern example is the [1989] Iran-Iraq war, where 42 arms-exporting countries sold weapons to the combatants and 36 sold to both sides.
“…The quest for power (military and other) through science has become the central focus of the industrial empire. In the broad view, science is the means to power whereby the empire culture more efficiently extorts the life force of the planet. (Scientific agriculture does not concentrate on building the life of the soil; it concentrates on producing heavier tonnages for market). The reality that science is an integral component of the imperial social system is shown by the fact that more than half of the working scientists of the U.S. are employed in the military-industrial sector. This is hardly a dispassionate search for truth, as the propagandists would have it. The scientific establishment is deeply implicated in the social apparatus of coercion and death as a means of political control.”
Keep in mind this was was written in the early 1990’s, so Kotke is not merely striking an indictment against the neo-con agenda. He identifies “coercion and death” as the “product” in the general system of empire. So is it reasonable to conclude that marketing in America might consist of selling “goodness and light” on every scale and level save the very pinnacle one, Brand America!™ itself? Strangely, that may be precisely the case.
Clearly, economic analysis alone will not enable anyone to predict the markets. It may make more sense to observe where the power is flowing.
