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Geithner Plan a Gamble, But Shows a Way Out

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Tuesday, 24 Mar 2009 12:39 PM Current | Bio | Archive

The Geithner plan appears to include a "new type of investment vehicle" with capital structure:

  • 3 percent private equity

  • 12 percent taxpayer equity

  • 85 percent debt, also provided by the U.S. taxpayers

    The holders of the 3 percent private equity would provide management and would bid for the distressed assets at auction. The hope is that the private guys would bid more than 30 cents on the dollar, thereby improving banks' balance sheets.

    The plan assumes, too, that buyers and sellers will agree on a price for bad assets if the government is willing to subsidize them enough. But no one knows whether the market malfunction is due to potential long-term losses or short-term liquidity risk.

    The only virtue of this plan, in my opinion, is that it should help us find out. Nevertheless, this is a gamble, which could fail in two ways. We'll see what happens. The only party that always will lose, in all conceivable scenarios, is the taxpayer.

    Meanwhile, the World Trade Organization has just issued the most pessimistic report on global trade in its 62-year history. Signs of the sharp deterioration in trade were evident in the latter part of 2008 as demand sagged and production slowed. Although world trade grew by 2 percent in volume terms for the whole of 2008, it tapered off in the last six months and was well down on the 6 percent volume increase posted in 2007.

    Full figures for exports and imports from the first two months aren't yet available but the numbers thus far look really bad:

  • China's exports fell 26 percent in January and 28 percent in February

  • Japanese exports dropped 35 percent in January

  • Canada exports down 34 percent

  • Finally, the U.S. dropped 21 percent, according to Global Trade Information Services, a Geneva-based monitoring firm.

    Germany kept its status as the world's biggest exporter, with $1.47 trillion in exports, compared with $1.43 trillion for No. 2 China. The U.S. was third at $1.3 trillion.

    The U.S. was easily the world's biggest importer, at $2.2 trillion, almost twice as much as Germany, in second place with $1.2 trillion.

    Moody's downgraded General Electric's credit rating two notches from triple-A (which it has held for 42 years) to Aa2. A downgrade was expected following S&P's decision to do likewise earlier this month. Triple-A companies are fast becoming a truly endangered species!

    Martin Feldstein, currently a member of President Obama's Economic Recovery Advisory Board, said: "I'm afraid that the economy will continue to slide down well into next year … I don't know when it will end, but the forecasts that it'll end later this year I think are too optimistic."

    He added: "The fiscal stimulus is just not large enough to offset the downward pressure that comes from reduced consumer spending. So, unless somehow fixing the financial markets is enough to offset that, which I very much doubt, I think there will be a need for another fiscal stimulus package at some point."

    As I mentioned yesterday, in the Q&A session with The Wall Street Journal, Jean-Claude Trichet stated clearly that the European Central Bank could cut rates again. This morning in Europe, the bank president's fellow ECB council members (Weber and Orphanides) reiterated that view.

    Now, of equal interest has been an accompanying emphasis on the bank's distaste for zero interest rates and the need for an exit strategy: "There are a number of drawbacks associated with policy rates deliberately put at a zero level by the decision of the central banks. That's the reason we do not think it would be appropriate," Trichet said.

    Subsequently, Axel Weber said: "It is essential to bear in mind that an expansionary monetary policy comes at the price of creating a breeding ground for future risks to price stability."

    Question is, what to think about Trichet speaking yesterday through the press about the possibility of "unconventional measures." Could it be that that the council is becoming nervous about the euro's strength?

    The ECB is, after all, aware that, with more and more central banks opting for the radical policy of quantitative easing, the euro has become a conspicuous favorite in the game of elimination, one which sees the winner burdened with a strengthening currency at the most inopportune of times.

    Indeed, yesterday a number of bodies published new forecasts for the Germany economy that point to GDP contracting 5 percent in 2009 — more than double the decline expected in January.

    This was by no means the worst prediction: Commerzbank expects a contraction of 6 percent to 7 percent in 2009. RWI in Essen forecasts a 12 percent drop.

    In the face of such forecasts, a strengthening euro is a most unwelcome development and can only exacerbate the pain for a region whose growth has been, like Japan's, overly dependent on exports. Make no mistake: Last week's 5 percent appreciation in the euro/dollar pair made serious inroads into the ECB's policy stance.

    I think that last week saw a defining moment, an inflection point, in the currency markets this year, one that may underpin further dollar weakness and reciprocal euro strength. Hence, if the ECB is becoming wary of this prospect, then it may feel obligated to become more vociferous in its suggestions that it is 'willing' to embrace Anglo-Saxon radicalism if needs be.

    In Asia, the minutes of the Bank of Japan's Feb. 18-19 meeting show that with economic conditions deteriorating quickly and demand for central bank funds stronger than anticipated, board members felt they must extend emergency measures for an extra six months and make a greater effort to target longer-term interest rates.

    A Finance Ministry official at the meeting urged the BOJ "to support the economy ... by providing funds more actively." Finance Minister Kaoru Yosano said: "The appropriate level of foreign exchange reserves is an important issue, but there's no international consensus … In Japan's case, we'll continue to use our reserves to promote currency market stability." Yosano added that the government would extend its ban on naked short-selling of stocks until the end of July.

    China's People's Bank monetary policy advisory committee member Fan Gang said: "Inflation threat is on the rise in the United States and the trend for the (yuan) to appreciate may not change … Liquidity is increasing in the United States at a pace faster than China, and the (dollar) has a potential to depreciate."

    China's central bank on Monday proposed replacing the U.S. dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.

    In an essay posted on the bank's Web site, Zhou Xiaochuan, the central bank's governor, said the goal would be to create a reserve currency "that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies."

    Most importantly, the Chinese proposal is a clear indication of Beijing's fears that actions being taken to save the domestic U.S. economy could have a negative impact on China.

    By the way, John Maynard Keynes made a similar suggestion in the 1940s. In the mean time, we all know that the dollar became the only world reserve currency since it substituted the British pound in that role after World War II.

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    The Geithner plan appears to include a "new type of investment vehicle" with capital structure:3 percent private equity 12 percent taxpayer equity 85 percent debt, also provided by the U.S. taxpayers The holders of the 3 percent private equity would provide management and...
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    2009-39-24
    Tuesday, 24 Mar 2009 12:39 PM
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