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Saturday, September 20, 2008

Paulson & friends, Plunge Protection, and commodities speculation

My article, "Capitalism kills itself" just got published in OpEdNews.com. The article talks about the AIG bailout, and the broader contagion threat posed by de-regulation and capitalism on steroids.

A point I want to reiterate is the fact that the bailout is really a move meant to benefit the financial service companies, which took on too much risk. Because Paulson is one of them--arguably taking a breather from his job as Goldman Sach's CEO to serve as our Secretary of the Treasury--his real loyalties lie with fellow bankers. To Paulson and his cronies, the needs of the Little People simply aren't as important as protecting his Wall Street friends. The federal money--taxed from the Little People and borrowed from foreigners--follows the priority, flowing into the coffers of companies too big to fail. It's worth realizing that it was their greed and mismangement that created the problem, alongside deregulation efforts cheered on by Republicans!

This really is quite a time to be a social capitalist! The monetary capitalist (shall we say the capitalist pigs?) are showing their real intent, to turn government into fascism--which has been defined as the perfect alignment of state and corporate interest. Dazzled with patriotism and intoxicated with nationalism, the public fails to see war ultimately as a tool meant to enlarge the state and restrict freedoms.

Another damning piece of evidence against the communist-style bailouts are the Bush administration's previous abuses of power. The American people simply can't assume their leadership intends to help them, much less really protect them.

Amazing it is how the mainstream media acts like a lapdog whenever it scents a real crisis. We're told how a bailout is necessary to stabilize the economy--well, what if it isn't? I mean sure, a limited collapse of the financial markets won't exaclty help the Little People, but just what will a bailout do for them? Unpunished, the companies that precipitated the crisis will now have the contrived financial authority of the state at their bidding. Knowing this, they'll surely take on ever greater risks in the future, knwoing they are simply too important to the economy--or key politicians--to be allowed to fail.

I had some additional comments that I wanted to publish at OpEdNEws but couldn't out of considerations of length. They are presented below as an exclusive. One section deals with the President's Working Group on the Financial Markets, which is an shadowy group formed after the October 1987 market collapse, the other on commodities specualtion, a topic largely undercovered by the press, and replaced by the rhetorically effective "drill-drill-drill" expedient.

More popularly known as the Plunge Protection Team, this gathering can intervene in any market meltdown, and purchase stocks to run up the Dow just as it should go down.

This week saw highs and lows that may have been manipulated by the PPT. I didn't see sufficient reason for the massive spikes in the Dow following Monday's 504 point plunge (it was up over 100 Tuesday) and its 400+ point dive on Wednesday (Thursday the Dow was up over 400.)

Quite conceivably, the PPT could have been meddling in the markets, trying to slow the market trend which is clearly negative.

Despite the broader market recovery, many financial stocks were decimated. As I say below, there are limits to how much the PPT can do after the fact. If a company is worthless, no amount of intervention in the markets can revive it--only direct handouts can, which are hardly opague, which would destroy the secretive nature with which the PPT works its dark magic.

Expanded article:
Backdoor intervention

One possibility is that our government has been actively meddling in the stock market for years, ever since the 1987 stock crash. One shadowy body controlled by the White House has been acting completely in secret, propping up stocks, and selling assets in accordance with informal Presidential directives.

Writing in truthout earlier this year, Kevin Philips takes a thorough look at the President's Working Group on the Financial Markets, more commonly referred to as the Plunge Protection Team. Philips takes up the general frame of mind held by PPT:
"Over the last decade or so, the Treasury Dept. and the Fed have both developed something of a scofflaw attitude toward strict interpretation of federal statutes and regulations. For example, both winked in the late 1990s, as federal regulators allowed Citibank to merge with Travelers Insurance, despite contrary law still on the books."

Phillips goes on to bring up a 1997 article in the Australian Financial review: "'There is a belief that this team represents a powerful and secretive hand that is ready to act any time the Dow looks ready to tank big time.'"

Scarily, Paulson's Blueprint offered in March, 2008, advocates an larger role for the President's Working Group, expandind membership in the organization. All their dealings would be kept behind closed doors.

The are limits to this group's effectiveness. Even if the Plunge Protection Team has infinite cash, it can only do so much to smooth over volatility in the stock market. It is possible however to use the power of the PPT to protect crony companies which have a good relationship with the White House. Also, it's feasible that the PPT did what it could to damage commodity prices, possibly by manipulating the markets (as everything it does is conducted in secret, any moves it makes could be considered manipulations.) Sabotaging commodity prices is a tall order--if the rest of the world lacks confidence in the dollar, there's little the PPT or anyone in Washington can do about. Even the Fed can't control interest rates--its overnight lending rate is just a quarter of what banks charge other banks.
De-regulation has played a prominent role in allowing derivatives to be created and sold with virtually no oversight. Here is another section which I omitted from my OpEdNews.com article:

Commodity market linkage

Coincidentally, the Republicans' ritual debasement of regulation helped speed speculation. Phil Gramm, who was an economic adviser to John McCain until he referred to the current economic environment as a "mental recession," relaxed numerous restrictions on commodities speculation. See more on the freeing of regulatory oversights on speculation in my post on the Commodities Futures Trading Commission, with special attention on comments by Michael Greenberger, a former chairperson at the CFTC. In his prepared statement before a Senate committe in June, Greenberger cites a Senate report from June 2006 that attributed "$20 to $30 dollars of that cost [$77/barrel at that time] was due to excessive speculation and/or manipulation on unregulated exchanges."
Greenberger's oral testimony delivered at the hearing on June 3rd is also worth seeing (within this C-Span video), as it's quite blunt and to the point yet was not widely disseminated. Greenberger has his own site, which offers links to numerous appearances in the media.

The massive run-up in commodoties began as a natural reaction to the debasement of paper-based assets, which rise or fall based on the demand for money, rather than real goods on which commodity values are based. While we need money, we need it for its ability to act as a store of value. As the dollar weakens, commodities like the precious metals, real estate (non-residential), and agricultural products become more attactive. Speculation naturally accelerated this trend.

Sky-rocketing commodity prices may have been a symptom of serious problems with the dollar--a currency whose value is tied to the price of oil, which we saw skyrocket. As a matter of fact, the lower dollar means oil is more expensive. One ounce of silver buys about 4 gallons of gasoline--a ratio of exchange that's been true for at least 100 years, with few exceptions.

The collapse in commodities prices that began about six weeks ago could be a response to the recent restrictions placed on futures and derivatives-based trading. Typically the speculative frenzy destabilizes the market, exacerbating huge swings in prices.

Low interest rates buoyed the recent speculative frenzy, encouraged by the lax enforcement of regulatory constraints. More expensive oil has made a more rational commodites trading scheme more politically acceptable. No longer is it enough to borrow at record low rates of 2% and speculate on rising prices without owning anything. Until recently, it bears mentioning that Morgan Stanley owned more oil than anyone else in North America. Rather than get the stuff out of the ground, it's become far more lucrative to invest in oil production and sell forward contracts with oil that has yet to be extracted.

The lower interest rates helped housing values. The government has long valued the home construction industry because it stimulates a number of industries. Yet the lower rates also made speculation easier, since speculators could get money for essentially nothing. Once the commodities train got rolling, speculators could simply throw more easily borrowed money on the fire and enjoy the run-up. The Fed may have been trying to forestall commodity speculation that accompanied the low interest rates, but the political will to regulate dissipated to the point that a speculative frenzy could occur. Even now, commodities prices are positioned to roar back, as politicians want to forestall a recession by keeping interest rates low. Another aim is to keep the economy rolling along until a new president takes over, and inherits the problem. Whoever it is will be forced to choose between a recession or rising prices and inflation--not an easy choice. In the worst case scenario--short of a full collapse of our monetary system, they could face stagflation, rising commodity prices with slow growth.

Also worth mentioning, the huge run-up in commodity prices is the result of a speculative craze which came before it--one which expanded the monetary base exponentially: the derivatives craze.

The spike in commodity prices revealed how weak the dollar really was. The dollar had become weak largely because of the creation of over $600 trillion in derivates products, an amount far surpassing the size of the world economy or its combines money supply. This completely unrealistic ratio of exchange meant that ultimately more people were owed more dollars than were avialable, spurring a liquidity crisis to cover the gap. If over-stretched creditors couldn't back up a large enough proportion of their borrowings--by selling some or securing new sources of capital--their debts could be called.

The threat of inflation compelled the government to head off speculation. Commodity speculation unmasked the quickly deteriorating positions of the major derivates players. Had the speculators not tried to profit from the massive run-up in oil prices, the derivatives crisis may have been much later in emerging. This means that the dollar will take a hit sooner and bigger, which could bode well for commodity prices. Still, at least the size of the problem is now know, which will hopefully limit the fiscal damage and amount of repairs needed. This could limit the safe haven appeal of commodities.
Finally, here are a few of the articles that came out in the beginning of this crisis:

"McCain Blasts Wall Street Failure, Neglects To Mention His Adviser Helped Cause It," by David Corn, Mother Jones

"Let the bank runs begin!" by Patrick Wood, August Review

"US Economy: Rudderless and Reeling From Direct Hits," by Paul Craig Roberts, InformationClearingHouse

"Who's to Blame for Market Failure? Clue: Not the Bankers" by Jeremy Seabrook, The Guardian


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  • At 11:57 AM, Anonymous David Phillips said…

    Interesting articles on the recent volatile events in the financial markets.

    I would agree that commodities have had a good run because the dollar has been weak and investors want to put their money into real assets, and avoid the destruction of capital by inflation.

    Now with the Paulson rescue plan we have moved into a new phase. The precious metals and particularly gold are starting to rise again as the markets are unsure about whether this plan will provide sufficient stability to the financial system.

    It is likely that gold could rise over $1,000 in the coming months with this uncertain scenario, where the dollar could continue to decline.

    The other key commodity is crude oil, and a few days ago it surged to around $120 a barrel on the news of the Paulson plan, believing that it would stabilise the economy and help to increase demand for oil and its distillates.

    The other problem now emerging, after addressing the investment banks and AIG, is the "small" matter of CDS, credit default swaps.

    This market is absolutly huge and if there were problems here, the systemic risk would dwarf even what wew have seen up to now.

    The stakes are very high and so it is not surprising that we are seeing a recovery in commodity prices, particularly among the precious metals such as gold.


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