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Macro Economic Trends and Risks
Breaking the Bank

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By FastMike
July 21, 2008

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

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"I saw Mr. Wells after his return from Monte Carlo..... in my opinion he was carrying on a business...."; Herman Esham, witnesses for the Defendant, Charles Wells; (from the archives of the ‘Old Bailey' on line)

Dear midsummer Fools :

A Sojourn :

There is a commotion at the roulette tables. Suddenly, the manager and three assistants hurry towards a croupier. When they reach the table, the manager nods solemnly and the three assistants spring into action. They unfold a large black cloth, and drape the table. At the center of attention is a short, plump but well dressed man. A crowd begins to gather around him. He is speaking to people all around, with a joyous face. Another assistant carrying a tray of stacked chips approaches, and places it on top of the funereally endued table. Some bystanders begin to applaud. That cheerful man places his right palm to his vest, the other hand sweeping his silk top hat from his head, as he bows politely, all in one, graceful motion. All the while, the other players just look on with all the dignified, emotionless professionalism that they can muster.

It is Sunday, 19 July, 1891 and Mr. Charles Wells has just broken the bank at the Monte Carlo Casino.

'Breaking the Bank' doesn't actually mean what the name implies. In the case of Mr. Wells, and 18 years prior, that of a certain Mr. Jagger, a milling engineer, it means that the gambler has ‘outplayed the house' at some offered game of chance and has won more chips than present at the table.

It is said that Mr. Jagger, and our Mr. Wells had, apparently, noticed a ‘bias' in a roulette wheel that caused the ball to fall more often in one place, than any other.

Still, even with the ‘bias' in his favor, it took Mr. Wells a lot of nerve and luck : the nerve part, being that of doubling his bet each time, and the luck part being that the other players were so focused on their own convictions, that they failed to notice, as Mr. Wells had, that there was a flaw in the little wheel itself.

May I ask if any of you have ever experienced that unshakable belief that you were correct and stuck to your bet no matter what you heard or were being told or when everyone else was doing precisely the opposite? Even when you suffered the contempt of your own peers, you had stuck to it? There is no single word for it. It's like a revelation. A moment of clarity. And then to have that supreme moment: that of being proofed, being correct, being absolutely vindicated, to the chagrin of all you detractors.

Now my fellow Fools, let's sojourn further and peruse some of the players at the wheel of the Casino of International Finance and how they are betting at the roulette wheel called currency.

First, look at the stately, soft spoken, continentally dressed, Monsieur Jean-Claude Trichet. His bet is squarely on price stability, and in doing so, has made the Euro a world class currency. As early as June 2006 he was sounding the inflation bell raising both the refinancing and marginal lending rates, claiming upside risks in price stability. By early December 2007, the ECB raised its' benchmark rate for the sixth time. Monsieur Trichet acknowledges the threat of high energy prices but hedges that global growth will create enough demand for the EU to maintain growth. Monsieur Trichet is firmly betting straight up on price stability and has squarely stuck with that same bet and raised the stakes time after time, against the criticism of other bankers, financial experts, financial theorist and even an impassioned plea from the Monsieur Sarkozy, President of France. Does Monsieur Trichet detect something? Is he mad? Does he see an imbalance, a bias, in the little wheel?

But what is Monsieur Jean-Claude up to? He has kept the spread between the Euro benchmark rates and the US benchmark rates wide. By doing so, institutional borrowers can get a better short term rate outside of the EU. Hence, liquidity can be maintained as well as a strong Euro. Further, and most important, Monsieur Trichet has tested the strength of the ECB economy in a difficult environment.

Now turn your attention to the men in the ten gallon hats. A certain Mr. Ben Bernanke, chairman of the US Federal Bank and Free Market advocate, and his ‘pard', a certain Mr. Henry Paulson, Secretary of the US Treasury, adamant advocate of the strong dollar. These cowboys stand shoulder to shoulder, but their betting is confusing. One has been hollerin' and shoutin' that he'd rather let his cattle stampede clear over the Rio Grande, than let the dollar weaken. But his pard, has been borrowing money by the wagon load, and swapping US Treasuries for securitized debt that no one else wanted for cash loans, to cover some other cowboy's bad bet! The Americans are also a betting, heavily, that a slowdown in global growth will temper inflation. They keep losing, but they keep on covering and betting and they're woopin' like they're winning. And they keep on going back to congress for more money. Rates have come down 300 basis point from September 2007, to fight a recession that wasn't yet there. They've spent wagon loads, giving away money for citizens to spend. They've been bailing out institution after institution, then woopin' it up, and spinning them up. But the dollar is hitting lows against all other major currencies, week after week after week. This isn't a strong dollar policy by far. There are catcalls from the spectators : "You don't bluff in roulette!". The Americans players are stuck between a rock and hard place.

Steadfast and quite, Monsieur Trichet's ups his bet. He simply watches the wheel and table and wheel and table. Persistent. Resolved. Does the Monsieur notice something that the others don't? Has he observed a bias in the wheel? He's keeping that spread wide. And his critics are relentless.

The American betting has not gone unnoticed by the Arabians who, although in appearances seem united, in truth are much divided. But they are drawn together at this table anxiously watching the Americans whoop and holler and squander playing money, much of it theirs on loan or invested. One Arabian doesn't seem to concerned, since he had the foresight to take his currency off the dollar peg. Arabians are rolling in dollars, because of Asian demand for Arabian oil. And this is the critical difference : In the past the Arabians had to suffer along with the Americans in times of recession, because the Americans were their biggest customer. But no longer. The Asians are betting on growth outrunning inflation, and they're buying oil at any price. But Arabian losses are still mounting even though their bets are winning! And how can that be? Because they are getting walloped having their chips pegged to the dollar. And their income from Asia must come via the dollar. And those cowboys have inflated those dollars to cover their bad bets! And as if that isn't enough, there are very real internal pressures for some Arabians to ‘distance' themselves from the Americans. It seems that the Arabians too, are stuck, between a..., well lets just say that they're in a pickle, too.

Still, Monsieur Trichet ups his bet, still more. Unmoving, unflinching, with a pleasant smile, hardly looking up. Focused. Diligent. Keeping that spread wide.

There are other players in the casino this night. As mentioned, are the players from the Far East; they stay close to the Arabians. They need that oil. And by betting the price up, they're keeping other players in check. But they know that they can't subsidize forever. And that bubble is growing larger. But like a person on a bicycle, they can't stop, else they fall over. They too, it seems, have a tiger by the tail.

Notice that the Brits are playing ever so cautiously. Sometimes betting with the ECB, keeping their benchmark rate in a upper range, then betting with the Americans, sounding the recession alarms. They've got the continent on one shoulder, and the US on the other. Mr. Mervyn King is wanting not to win nor to lose, but, finding himself in an economic, political dilemma, wishing just to break even.

You'll see the Russians there, too, but they are playing poker, drinking the best cognac, enjoying their world famous caviar, smoking the best cigars, aristocratic and as cavalier as ever, just as they were before the turn of the 20th century. They've got there own game going, again, and don't seem to mind what anyone else is doing. They've got oil, money and resources. The 1891 ‘Old Russians', ironically, are much the same as the 2008 ‘New Russians'.

Our sojourn is almost complete. So we casually stroll towards the grand doors to leave the players at their game and we, to our Sunday morning coffee and newspaper.

Suddenly, a muffled shout of surprise. We turn and look. It comes from the roulette tables, there is some kind of excitement. The manager with three assistants are hurrying across the floor. When they reach the table, the manager nods solemnly and the assistants spring into action. They unfold a large black cloth, and drape the table. At the center of attention is a stately, continentally dressed man. A crowd begins to gather around him. He is speaking to people all around, joyfully. Another assistant, carrying a tray of stacked chips approaches, and places it on top of the funereally endued table. Some bystanders begin to applaud. You watch as that stately gentleman places his right palm to his vest, the other hand sweeping his silk top hat from his head as he bows politely, all in one, graceful motion.

And, all the while, the other players are just looking on with all the dignified, emotionless professionalism that they can muster.

End of Sojourn, 19 July, 2008.

Your rope jumpin' Fool,
FM