Archive for February, 2009

Wealth does not pass three generations – A Note on the Stimulus Plan

Friday, February 20th, 2009

Lately I’ve gotten interested in the how the financial markets work, how we got into the current crisis and all that. And I learned about an interesting Chinese proverb: 富不过三代 (fu bu guo san dai) Literally: Wealth does not pass three generations. I’ve read articles that hypothesize that the economy is in a phase of “resetting”, i.e. we are at the end of the the Kondratieff Cycle. If this is true, then there’s probably not much we can do about it. In fact, it looks like the next week will be very interesting in the capital markets since we are close to a crash. Let’s hope for the best…
Just a quick comment about the stimulus plan the US government is trying to implement. The problem I see with the idea is that they will need to raise the money with new debt. Quite a lot of new debt. This could prove more difficult than they think (quotes from a treasury press release; emphasis mine):

But the ramp up in debt issuance remains in its early stages. As the US government and also foreign governments continue their efforts to stabilize their respective economies, the supply of government and quasi-government paper will grow rapidly. The sheer magnitude of paper set to be issued raises the possibility that investors at some point will demand a concession of some sort, lifting yields in parts of the term structure beyond those justified by macro fundamentals. As a country with a current account deficit and a majority of Treasury debt held abroad, the US is more at risk of such a development than a country such as Japan where the government bond market is primarily domestically held.

The expansion in quasi-government paper contributes to the risk of market saturation. Banks have issued nearly $150 billion in FDIC-backed paper since the programs introduction. Spreads on this paper have been narrowing over time with the latest deal, paper offered by Citi, pricing just 30 basis points over Libor. Real money investors have purchased the bulk of this paper in an attempt to pick up yield over Treasurys while not taking on additional credit risk. In some respects, this paper has replaced GSE debt as the instrument of choice for real money investors looking for modestly higher yielding, quasi-government debt.

China, on the other hand, could slow its accumulation of dollar-denominated debt. Such a trend already has begun to develop with respect to its accumulation of overall dollar assets as the flow of private capital into China has cooled alongside the global downturn, alleviating the need to offset capital inflows.

What that means is that the interest rate that the government might have to pay on the money could rise to levels making the whole idea prohibitively expensive. Or it could be simply impossible to find that much money on the sidelines that they can borrow (there’s a limited amount of money out there available for investing). Also they are going to remove money from the regular capital markets – what is more save right now than treasuries? I hope the government knows what they are doing…

Valentine’s day tango

Sunday, February 15th, 2009

EN TUS BRAZOS from et su on Vimeo.