MKT022207: Fed, “dark matter”, and Lin Biao

I always try to place & close my trades in AM (NY time) session, when mkt is still receiving and processing new info for the day. In PM, mkt tends to have gained its posture back, and I would try to stay away, not to have my fingers bitten in fooling around.

Bears are still in control today, with help of inflation and rate ghost.

Briefing.com writes:

"Money and bond markets are just as confused as economists about the prospects for monetary policy. For what it's worth, I think markets are still underestimating the likely scale of monetary tightening over the next 18 months. Our forecast of gradually rising inflation underpins further rises in the call rate. A gradual increase in the real policy rate would reinforce the policy tightening that we are seeing in other major economies. I expect further monetary tightening this year from the ECB, the Bank of England, the Fed and the PBOC. Japanese rate hikes are part of a global monetary tightening. Ultimately, I expect this monetary squeeze to affect financial markets. The muted response to [the] hike suggests there is still some life in the yen carry trade. But a global rise in real interest rates could yet provoke an increase in volatility in currency markets that could trigger an unwinding of the carry trade."

Bonds reacted by pretty much wiping out all its gain since Ben’s testimony, with TNX back to 47.3. By the why, this time last year, mkt had similar concern before and after  JCB ended its 5 Y “quantitative easing” in 032006, TNX actually went to as high as 52.5. The difference was at that time mkt was on the offensive, pushing Fed to tighten its monetary policy to control the inflation risk mkt saw from the data.

This time, mkt seems not convinced yet on the looming inflation risk as seen by gold, oil and perhaps currency mkt as well. “Show me the numbers”, and numbers could well come next month, who knows. Before more numbers coming out, bull just has to carefully dance on its toe with bear.  

Now the dark matter.  A successfully investor/trader (I will ask for his permission to quote his blog name) has been saying that Fed has been constantly manipulating equity, commodity and fixed income, mainly by buying, if I understand him correctly.

Here, is Fed just doing its normal job of adding money supply or Fed is doing significantly more than that to inflate asset prices? If it is the latter, I would call Fed’s buying the “dark matter” in mkt.

Speaking of money supply.  MV = PT, and  Over the long term, the US economy has grown at about a 3% real annual rate.  This has been the result of 2% annual growth in productivity and 1% population growth.  Fed’s 2007 forecast for core PCE deflator (inflation)  about  2% to 2.25%. So the nominal GDP growth Fed is targeting for 2007 would be 5%. If I understand correctly, that means Fed has to keep money supply grow at about 5%. US GDP Y2005 is about $12T, of which 5% is about $600B, almost about $2B a day on average. There are many ways for Fed to inject money supply into economy, and I guess buying equity, Bonds and commodities could be well among them.

Is Fed’s buying in financial mkt part of its money supply operation?  Or as widely speculated, Fed has been buying up mkt on top of its normal money supply operation, to ensure US middle and working class still have some appreciating assess in the face of housing slow down. If that is the case, Fed would have a “neutral” rate policy on one hand mainly targeted at real economy, and a “dark matter” operation in financial mkt. Grand design for soft landing. Why not?

Fed is part of US state power with its own agenda and means, which don’t have to be known to public, understandably. Aside from police and military power, monetary power is second to none in its importance, to a modern sovereign state,  that’s why I always have a hard time understanding why gold bugs,  “Austrian school”  and some monetarist as well have been worshipping gold standard so hard and for so long. Money is not an economic phenomenon only, it is also political phenomenon.  John Maynard Keynes is one of the few economists who understand politics, to him, there is no such thing as “Laissez-faire”, and gold standard is just a barbarous relic. In that sense, for the foreseeable future, dollar collapse and gold to $2000? Hard to comprehend.

Lin Biao is the last person I am going to talk about today, and he really understands politics. On the eve of Culture Revolution and in a politburo meeting he was talking about all kinds of “coup” which happened around world at that time and in history. All “coup” is about getting state power, he said. What is state power? State power is the will and power of a group of people, in the name of state and state’s interest. State power can make or break a person, a group of person, or a class of person, legally, politically, financially and/or physically.  Lin’s talk had shaken his audience. Definitely, Lin had Mao shaken as well, and what happened afterwards is well-known and a personal tragedy to him, a great strategist and a general of Mao’s time. Lin Biao is now already a “relic”, with some part of which may still hang somewhere in Mongolia desert. But what he said about the barbarous nature of state power is always true, and it has never changed at all, even a bit, despite its constantly changing make up on its face: the congress, the testimony, the vote, and so on so force.

Lastly, let’s make sure we get our piece of Fed’s dark matter, and my salute to John Maynard Keynes, an economist, an investor and a speculator as well. Let quote from him once more:

“For at least another hundred years,” “we must pretend to ourselves and to every one that fair is foul and foul is fair, for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still. For only they can lead us out of the tunnel of economic necessity into daylight.”

Mkt as well as capitalism is barbarous and brutal in nature, as Keynes had taught us, but there is no alternative for now. Let’s dance with wolf.