October 07, 2008

The Nightmare and Oil

More than a year ago, I wrote this about the nightmare scenario. We've experienced spot shutdowns in CP for more than year which has squeezed the investment banks. Unfortunately, it's now spread to a systemic problem which prompted the Fed to step in this AM to become the lender of last resort for commercial paper.

A year ago I said an event like this could well cause the dollar to lose 30% of it's value. That flawed analysis was based on a breakdown mostly in the US. However, as the freeze in the capital markets has spread worldwide and as write downs have basically eliminated $2-3 trillion from the money supply, there is a flight to the perceived quality of US Treasuries.

Voila! Instant dollar appreciation vs. other major currencies.

What's the net effect? Well, for the $4-5 trillion on the sidelines, it's a wakeup call that the Fed and Treasury, working in concert with other central banks, will not let the entire global system go down the drain. Further, it lets them know that there are safe risks. Finally, they have got to get this money to work and were charging exorbitant rates to borrow. Now they have an absolutely massive competitor which will have a cooling effect on credit cost increases. This should accelerate a return to normalcy.

This was the bogeyman in the closet. Now that it's come out, we realize it's not carrying a chef's knife. It's carrying a plastic potato peeler. And we have gun.

This doesn't mean all is rosy. Unwinding AIG and Lehman will be very difficult and probably will cause temporary shocks in certain areas as distressed assets are sold into weak markets. This is unavoidable but it's not fatal.

But all the news is not bad. Some buyers are stepping back into the market. Take Wells Fargo's offer for Wachovia. And Citi's subsequent lawsuit. The bottom line is that Wachovia, even with it's problems, is worth a lot of money. By Citi's estimate, $60 bn. Which means shareholders won't get screwed in the ultimate sale because a buyer is going to have to pony up some money... they won't walk away with it for free (as Citi tried to do).

One positive? With demand dropping and dollar strengthening, oil prices have fallen through the floor at $90/bbl. As the picture in financial securities begins to clear up, look for more and more speculative money to come out of oil and other commodities, dropping them still further. I do not think oil will drop much below $60-67 range which will leave intact the transition to biofuels and more efficient vehicles.

Still, wages are slack and unemployment is climbing. That's the official number. The unofficial one is far higher. All that aide, we're heading for a recession. Which is a relief considering what we were looking into last week.

Posted by mcblogger at October 7, 2008 12:30 PM

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