February 16, 2010

What the Dollar and Blacksmith Bellows Have in Common

The derivative we need is a weather swap. The Winter Olympics would pay a premium for that spare snow lying around unused on the east coast.

Speaking of derivatives, the dollar retreated today, and US equities rebounded. We all want it to be about investing. Commentary everywhere today polished bullishness to an economic sheen. But that won’t make it reflect reality. Money keeps buying short-term love because the direction of the dollar is like a blacksmith’s bellows on equities.

Tomorrow starts three days of expirations. We saw speculative trading spike last week, while European money returned on Feb 10. Traders had already discounted Greece’s woes and had gone searching for alpha. There are too many reasons for traders to pursue global statistical arbitrage (and regulators keep giving them more). Translating, that means it’s fun trading similar instruments in opposing fashion in different places to profit on spreads and timing, and not much fun investing in stuff.

What changes that? Funny you ask. We want to hate banks. We’d like it all to be Goldman Sachs’s fault that our economy is bloated on derivatives. Those blasted Wall Streeters and their nefarious schemes, like borrowing money at 15 basis points from the Fed, then using it to buy Treasuries paying 350 points of interest. Taking TARP cash and trading with it. Manufacturing reserves and using them to float atmospheric notional value swaps for obscene fees.

All that may be true. But banks don’t set interest rates on Fed money. Banks don’t decide, “Hey, let’s go con the Fed out of some cash.” Banks don’t determine the size of the money supply. Banks don’t write reserve rules. No, while we’re all tarring and feathering sellside CEOs, the folks spraying gasoline on everything and playing toss-the-match can be found at the Federal Reserve.

If we don’t want our stock markets to behave like roulette wheels, we must stop playing with Federal Reserve house money, which is cheap and artificial – or shall we say, derivative. Primary dealers from Barclays to BofA march as the Fed orders. Don’t think those folks who OK’d 100-cents-on-the-dollar payouts to AIG counterparties are aw-shucks hayseeds who got jobbed. They knew what they were doing. We should be asking why, rather than railing at the foot soldiers. We may not like the answer, but it’ll be true.

Speaking of money, I personally put cursor to Excel workbook and tallied 2009 earnings before non-cash items and taxes for seven of the primary dealers – the eighteen big US, European and Japanese banks commissioned by the Federal Reserve to make orderly markets in dollar-denominated US obligations – and came up with $185 billion. With a ‘b.”

From whence came these profits? Who deployed cash in the capital markets? It wasn’t institutions and individuals. The US government deployed about $3 trillion. Lord only knows how much came from other global central banks.


Lesson of the day: Governments create money. Goldman Sachs is not responsible for it. Banks work with what they’re given. If they get a gigantic mountain of cash, you can bet they’ll work with it.

If we want more investing and less trading, we might dump all that snow on the east coast atop the Federal Reserve and put the fire out. Unless Whistler offers a better deal.

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