Friday, August 26, 2011

The Buffett Bailout

For those who haven't seen it already, Berkshire Hathaway agreed to invest $5 billion in Bank of America this morning. The pop in stocks lasted all of 30 minutes.

But I wanted to discuss the last Buffett Bailout - of Goldman and what it may portend. My operating thesis is that WB has morphed into a completely political creature and will only make big, publicized investments for propaganda purposes. That certainly was the case with GS in 2008.

But like any actor, he has to receive something in return for the use of his name and image. That something is a political guarantee for his "investment" and the history of 2008 supports this. Buffett's deal with Goldman was announced before the US market opened on September 23, 2008. But behind the scenes a lot of political moves were being made that he obviously knew about but few others did at the time.

The Fed of course was involved. Over the next few days (through 9/29) they established or increased swaplines with a large number of foreign central banks. In effect they lent out $360 billion to foreign banks. The FDIC closed Wachovia and WaMu - pushing them to merge into the already bloated and insolvent Citibank and JP Morgan respectively. Wells ultimately outbid Citi for Wachovia. The Treasury moved to guarantee all money market funds and the TARP bailout was cooked up as a bill and submitted to the House over the weekend prior to initial rejection on the 29th.

The Bottom Line
My point is this. Last time Buffett was part of a full-court press designed to fool people into investing their earned money right along side his borrowed bank credit. Every lever was pulled by Wall Street and the Government in order to "restore confidence" and as the price of his participation, Buffett was given the privilege of front running virtually every central bank and government policy change.

I expect this time will be no different. The Fed is likely to announce something desperate and stupid tomorrow morning. It will likely be accompanied by something out of the Treasury and/or FDIC shortly thereafter if the Fed move proves insufficient to pump asset prices higher and bail out Warren after he stuck his neck out financially for favorable propaganda effect.

Of course the bad news if you're a bull is that it didn't work in 2008 despite truly extreme measures. Stocks, after a short sharp bounce continued to fall for another 6 months and housing prices merely rebounded slightly before resuming their decline. In 2008, stocks had already been falling for a year and had nearly been cut in half before they got that desperate. This time, we are 3.5 months past the rebound high and six weeks from the secondary peak. We are also only 15% off those highs - not 45% like in 2008.

There is probably a trading opportunity on the long side for the next week or two but I'm not going to get greedy or stupid. History indicates that Buffett is likely front-running SOMETHING here. But it sure as hell isn't fundamentals.

Wednesday, August 17, 2011

That Seventies Show

There is a serious situation brewing that few people are talking about. This absolutely required a blog update.

One of the most dramatic features of the economic landscape during the 1970s was the disruption of the Oil Shock. Today, people are misled to believe that this was THE cause of inflation in that disastrous decade but that is a long way from the truth. In reality, it was more of a reaction to inflation. LBJ's creation of the modern welfare state combined with his escalation in Vietnam put the US on the path of permanent debt.

Accelerating inflation rapidly ensued for nearly a decade had already resulted in cumulative dollar inflation of over 50% before the Arab Oil Embargo and overnight tripling of prices. OPEC was using their market power and leverage to compensate for the falling value of the dollar and to get ahead of the galloping inflation our government and central bank had created. They noticed that they were being robbed via currency debasement and were in a position to do something about it because they controlled a large chunk of the oil export trade.

Unfortunately, we may be about to see history rhyme if not repeat in the near future. The effects could be extremely serious, with social consequences much greater than in 1974. And it could all be triggered by one medium-sized Southeast Asian nation that few people focus on when looking at economics. That nation is Thailand and the critical commodity that will be impacted is rice.

The likely result arises from the politics of inflation. Thailand's exports are priced in dollars and the severe erosion in value of the dollars earned has created pressure to increase income to revive living standards damaged by inflation. Because Thailand is the largest rice exporter by far in a tight market, they are in a position to demand higher prices - just as OPEC was in 1973-74. The current ruling party in Thailand is committed to increasing the income of farmers and is pursuing policies to control the rice supply and push up prices. From Bloomberg:

Yingluck has said the government will buy unmilled grain from farmers at 15,000 baht ($502) a ton at harvest in November, above current market rates of 9,900 baht. With Thailand the world’s biggest exporter, that may raise rice prices across a region that accounts for 87 percent of global consumption. The leader presented her economic policies to Cabinet yesterday and is scheduled to announce them publicly by Aug. 24.

Food makes up more than 30 percent of inflation indexes on average in Asia, according to Rabobank Groep NV. The weighting of rice in consumer-price indexes varies from 9.4 percent in the Philippines, 4.7 percent in Indonesia and 2.9 percent in Thailand, according to Bank of America.

Collateral Damage
The sad irony is that the people most affected by this will be innocent bystanders. The western central banks most responsible for currency debasement will hardly even notice. Few people in the West will be impacted at all. The people who will feel the pain will be Asian city dwellers. Middle and lower class urbanites will be especially hard hit. There will be a partial offsetting benefit in rising incomes for rice farmers but the disruption from shifting so much money from urban consumers is sure to trigger political unrest and likely a great deal of violence as well.

The numbers suggest a 50% increase in rice prices if the official Thai government pricing dictates to the world export market. This seems likely to us since they account for over a third of all rice exports nearly every year. With rice in short supply already, it is doubtful that importers will be able to refuse to buy at the higher price for very long. Because of rice consumption patterns, the effect will be overwhelmingly confined to Asia (85% of world consumption) and North Africa. As if those areas needed more economic pressure place upon them.

Once the Asian nations understand the full consequences of this move, the drive to move their economies away from the dollar should accelerate. With the dollar as the global reserve currency, the Fed is able to inflict widespread damage with its irresponsible policies. It appears the casualties in this round will be overwhelmingly Asian. That will increase the urgency to find alternatives to a dollar that is being sabotaged at the whim of Ben Bernanke.