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Strategies & Market Trends : Waiting for the big Kahuna -- Ignore unavailable to you. Want to Upgrade?

To: Moominoid who wrote (30105)	10/3/1998 11:32:00 PM
From: Mosko	Read Replies (1) \| Respond to of 94695

Excerpts from the latest from Princeton Economics: princetoneconomics.com Can the World Be Saved? Global Meltdown post July 20th Hedge Funds – Fed Social Threats of War & Designing A New World Financial System by Martin A. Armstrong copyright October 3rd 1998 Princeton Economic Institute www.pei-intl.com The next victim in this Russian debacle has been the hedge funds. Besides the Fed intervention to stem the effects of the collapse of Long Term Capital Management, rumors have been abundant about several hedge funds that have lost more than 50% on this entire crisis. The cause of this appears to have been the drive to produce high quarterly returns that drove these fund managers into high risk, high yield trades. The problem that arises from his trading behavior is that many of these funds found themselves all on the same trade. As losses mounted and liquidity disappeared, volatility increased exponentially and positions moved into liquidation only mode. The implications of this hedge fund disaster presents a new twist to the Panic of 1998 compared to previous debacles in history. Already we are seeing the collapse of Long Term Capital Management causing disruptions to the entire world economy far beyond what the Fed or anyone one else has publicly explained. The Fed has pushed the banks involved in derivative trading to come up with billions to hold the current positions at LTCM in order to facilitate the orderly liquidation of those positions. Several important facts about this issue must be understood. 1. The Fed did NOT put up any public funds; it only put pressure on the banks to step up to the plate. 2. LTCM positions were predominately within the interest rate markets worldwide. 3. The amount of leverage used by LTCM was astronomical, giving it positions in excess of $1 trillion. The impact that LTCM is having upon the entire world economy is significant. Mr. Greenspan did not testify as to why LTCM's positions were important enough to warrant the Fed's concern when no previous fund has ever risen to such importance. He did state that "hedge funds are beneficial" to the free market system and Mr. Rubin also stated that these funds were NOT responsible for the Asian currency crisis. The seriousness of LTCM's positions goes beyond a mere threat to the marketplace; they have in effect usurped the power of all central banks by default! In other words, the one tool that any central bank has is the ability to establish the wholesale interest rates to the banking sector, thereby indirectly influencing the demand within the economy. However, by LTCM leveraging its capital base into $1 trillion and then playing within the interest rate markets in particular, they in reality are bigger than all the central banks combined, and the unwinding of such positions could in effect disrupt the interest rate policies of all nations. It is also important to note that there is a serious misconception about the black-box model that LTCM was using. The first assumption that this has all been computer driven is ABSOLUTELY FALSE! The majority of LTCM's trades have been FUNDAMENTAL views on the world, NOT COMPUTER DRIVEN MODELS. Any simple trend following system would have shown that the US bond market was in a bull market. Why was LTCM short US bonds? This was based solely on their view that the Fed was more likely to tighten than loosen due to the rise in the stock market and strength on the US economy. They were also long just about every debt market within Europe with a short position on Germany. Again, we do not see any model that defined this trade. The reason behind these "convergence" trades in Europe was the politically stated goals for the Euro that all nations will end up with their bonds becoming one bond – the Euro bond with interest rates that were equal. In reality, ALL of LTCM's trades were based FIRST upon a fundamental view of the world and then a computer arbitrage model to extract minute differences between two instruments. While on the surface they may have appeared to be diversified, in fact, all their trades became one single giant bet on a fundamental assumption – European convergence along with higher interest rates in the US and Japan. All three assumptions have proven to be dead wrong to the tune of $1 trillion. The single greatest threat that LTCM poses right now is by unwinding the European trades; they in effect cause the Euro to blow up or force a surprise readjustment before it begins. While the European politicians touted the brilliance of their policies and the success of European convergence ahead of the start date of January 1st, 1999, in reality it has been the hedge funds that accomplished that – NOT the politicians or central banks. This is why Greenspan referred to hedge funds as at times being "beneficial" to the free market system. The politicians set their goals and the hedge funds carried out the deed without the need for European central banks to put up public money to force that convergence within the marketplace. This is one reason why LTCM needed to be "managed" in the liquidation process. The Fed is NOT trying to save investors nor will it EVER bail out any fund for that reason. What is at stake here is that the positions of LTCM, which were in fact the political views of Europe and not the economic realities of a flawed single currency policy. There is no way that the Euro can begin in 1999 and offer a stable currency environment over the next 4 years while the economies of Europe are still moving in different directions. A FINE MESS YOU'VE GOTTEN US INTO OLI Whenever panic strikes, immediately governments spring into action. They will inevitably seek more regulation than less, more power and control whenever possible and seek to lay the blame upon external forces other than themselves. We must step back and deal with reality. This entire mess was set in motion back in 1985 with the formation of the G5. The aftermath of the Reagan tax cuts changed the dynamics of the US economy. No major foreign manufacturer could be found in the United States BEFORE the Reagan tax cuts. Afterwards, a 33% US corporate tax rate compared to 60-70% in Japan and Europe, provided the incentive for business to move directly into the domestic US economy. That shift in global capital flows in early 1980s caused the dollar to rise dramatically going into 1985. Because of trade, James Baker, then current Secretary of the Treasury organized the G5 at the time. The G5 was formed in September 1985 and boldly began a program of attempting to manipulate the world economy by vocally stating that they wanted to see a 40% decline in the US dollar. They scared the marketplace and the traders followed their direction. By 1987, the 40% depreciation in the dollar was accomplished. The problem was simple. The G5 was looking at manipulating currency values for the sake of trade. They never considered what might happen when capital investment lost 40% on their US bonds and shares. This mistake set in motion the 1987 Crash. Capital was forced out of the US and then concentrated within Japan leading to a bubble top in their economy by the end of 1989. When Japan peaked, crashed and burned, capital began to look around the world for value. They immediately focused upon Southeast Asia, China and Russia. 1989 marked not merely the peak in Japan, but also the changes in China and the fall of communism in Russia. With these events, emerging markets began. An expectation that vast sums of money could be made if you were the first to get into these areas was appealing. The IMF encourages such investments and loved the chance to find some way of becoming useful. The first crack came 4 years later in Mexico. The IMF bailout appeared to have worked, when in fact Mexico only repackaged its debt and sold it into the Euro market taking those funds and paying off the US Treasury. In reality, the debt was never paid, it was merely redistributed. Nonetheless, the details were never fully aired and Clinton was eager to take the credit for the Mexican bailout so no one bothered to ask the hard questions about how Mexico could pay off billions in such a short period of time. The Mexican bailout created the FALSE image that the IMF was this new agency that could solve the problems of the world. Meanwhile, capital shifts from South East Asia were underway and the new focus became Russia. Nearly 50% of all new money raised by mutual funds prior to 1994 had been for emerging markets and now Russian stories of untold wealth acted like a bug light on a hot summer night. Capital, looking for high yields, was far too eager to believe in the ability of the IMF. When capital continued to migrate from Asia toward Russia, the first crack appeared in Thailand during late 1997. While the IMF rallied to the moment, it sought to impose old ideas from a fixed exchange rate world into a new modern age of floating exchange rates. It insisted that nations hold their currencies at all costs and they did. The reserves of all nations right up to Korea vanished under the ill-fated philosophies of the IMF. The drain was far too great and the demands for capital funding by the IMF rose exponentially. They poured billions down the drain into both Asia and Russia and to this day have NOTHING to show for it other than sheer chaos and rising social unrest. The G7 meeting this weekend will bring to many a final flicker of hope. Hope that their shares will once again rise to new highs if someone puts the global problems to rest. We may see the silent capitulation of the IMF and its subjugation to the G7 itself as a reporting body. We will hear calls for boosting up the IMF and the leaders of the G7 will hope that the world will once again believe in this fallen angel of mercy. We may even hear grand new proposals for restructuring the world monetary system and there will be some closet aspirations that even suggest a one-world currency, but not publicly as yet. All these announcements are possible along with the IMF "liquefying" its own assets, which is a code word for selling off its gold reserves. In the end, any rally will still be merely a relief, but we cannot hope for the impossible.