Dizard: Don’t Worry About Iran, Worry About Central Bankers

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Only the Financial Times’ John Dizard would say straight out that monetary authorities (and diesel) constitute a bigger threat to our collective security than America’s pet nemesis, Iran. I would not be surprised to find some readers in agreement.

Dizard dispatches Iran first. He starts with some colorful quotes, from Talleyrand (in French) and Lord Curzon, both saying that the Persians are lousy fighters.

I’d feel slightly more confident if Dizard cited sources more current than the nineteenth century. Nevertheless, he contends that while an attack on Iran is a manifestly bad idea, the Muslim nation would not succeed in interfering with oil shipments. He recommends shorting oil if war breaks out even as little as a month out.

That’s the cheeriest news I’ve heard in a while.

On the central bank front, however, the writer is adamant that the combination of policies that the Fed and its friends are pursuing now are contradictory and doomed to end badly unless they hold some in abeyance for a while:

It will take serious demand destruction in the jewellery market to bring [platinum] supply and demand into balance, absent a real world depression.

Um, does Dizard know anyone in the diamond district? Visit Ten West 47th Street. All through the 1990s, the booths, which are very expensive, were all taken. At least a third, maybe closer to half, are now empty. There’s been pretty serious contraction for at least the last six years. Third generation dealers have gone out of business, as have very serious estate jewelers I know, as in their clients included the Basses, Bronfmans and Mnuchins. If that level of buyer has backed away from the market, you can imagine what average folk have done.

Back to Dizard

Of course, one should never entirely discount the ability of central banks to engineer just that outcome. The victory of Spain over Germany on the football field has not, sadly, been duplicated in the European Central Bank, as we saw with last week’s policy rate hike. Soon, though, the increasingly obvious vulnerability of European banks may even prompt Trichet & Co to consider how nice it is to have solvent – or at least liquid – lenders.

To hear them talk, central bankers and regulators believe we can continue to have, at the same time, accelerating asset writedowns, stricter capital ratios, and flatter yield and credit curves. That is, without having the real economies shut down from lack of liquidity.

The only way the banks can reconstruct their balance sheets, or at least their cash flow statements, is from years of steep yield curves caused by artificially low policy rates. Is there an inflation risk to that? Yes, of course. But, given our inability to travel in time, there is no way to go back and undo what Alan Greenspan and the others did starting a decade ago.

Banks will need years of cash earnings from positive yield curves, along with accountants’ forbearance, to maintain, let alone expand, their economies.

So, since we are trying to find a few more or less sure things to bet on this unsettled week, I stick by my position that the risk of Federal Reserve policy rate increases is much less than is discounted by the markets. That has worked out in recent weeks and I think will continue.

The level of gloom on housing finance has now got to the point where banks are competing to come up with yet more dire worst-case scenarios for valuing mortgage paper. Interestingly, though, even those cases appear to show some value in certain housing-backed paper.

For example, Bank of America’s fixed-income group, using a “stress case” analysis based on a further 27 per cent decline in house prices over the next two years, found some value in non-US government agency-backed paper.

Given the rate of dumping and consequent low prices, the bank says, “AA rated bonds backed by seasoned collateral offer double-digit returns with no principal writedowns . . . while AA bonds backed by 2006/2007 alt-A collateral take massive writedowns, their adjusted yields are in excess of 40 per cent even in our most conservative [house price decline] scenario.”

Of course, even with those calculations you cannot give the things away. Think about it.

The last few paragraphs bear out the message of Mohamed El-Erian in an earlier post, that there will be great buys for those with iron constitutions. But even the seeming screaming bargain highlighted by BofA could (likely will) get cheaper. Investors also have to be willing and able to ride out volatility and intervening mark to market losses.

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  1. donna

    Before when there were lots of little banks you could afford to let some fail. Now, by allowing these huge financial conglomerates to buy all the small banks up, if they fail the whole system can go under.

    We should never, ever allow financial conglomerates of this size to exist again.

    My small little credit union is doing just fine, thanks. No stupid loans, no huge debts, just lots of us with good credit and able to get the loans we do need.

    And they actually give a shit and take care of us when we call. I spent five frickin years trying to get JP Morgan Chase to settle my mom’s estate. I only wish they could actually go under, since they destroyed my faith completely in our banking “system”.

  2. Anonymous

    Let me get this straight: BofA is talking up its book and Dizard treats that as “analysis” that he seems to buy into. I’m not impressed.

    The wave of defaults is still rolling; there are credible reports that servicers aren’t keeping up; there is very little transparency and he suggests bargain hunting.

    Also, does anyone remember if Dizard was one of the many who voiced concern about the Fed confusing liquidity with solvency thus risking hyperinflation?

    I don’t recall if he was, but I notice that as the ECB chose to take inflation seriously, they got criticized by those that bashed the Fed for doing the opposite. I’ll bet that if they had cut, some of the same people would level the opposite criticism.

    It’s very discouraging to hear the threat of inflation discounted when since the advent of paper money (fiat or not) inflation has been the rule, with deflation the rare exception. While I don’t have the stats handy, I’ll bet that periods of hyperinflation were far more numerous than those of deflation. Has everyone forgotten that only a few years ago Greenspan held out the specter of deflation to justify policies that contributed greatly to the current mess?

  3. russell1200

    Does he explain what Tallyrand has to do with Russian design rocket assissted mines, or cruise missles.

    The Iranians have both, and the US Navy is notably poor in anti-mine warfare capabilities.

    Even if the one (yes one) Arleigh Burke class with the new remote anti-mine underwater drone is in the areas, it is hard to see how you keep the straights from being closed for at least a number of weeks.

  4. Danny

    “If the American people ever allow private banks to control the issue of their currency, first by inflation then by deflation, the banks and the corporations will grow up around them, will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”
    Thomas Jefferson

    I think he put it quite nicely. I’m still shocked at the erudition that he displayed. It makes you think that the mistakes we’re making now have happened before. I thought we had a ‘new economy’, and things weren’t the same. You’re right Yves, Neo-liberal corporatism is dead. The big question is, what do we replace it with?

  5. Danny


    Don’t worry, deflation is well on its way. It will be the key word of 2H08/09. If you misunderstand the difference between credit and money, then you can certainly say that hyperinflation is a possibility. But unless the Fed starts furiously printing PAPER money, which is a possibility but is not happening yet, we won’t have hyper inflation.

  6. Anonymous

    Danny – that depends on the Fed. Bernanke has all but said that he’ll stop at nothing and has suggested that they can provide infinite “liquidity.” With a few keystrokes, they can more than make up for the current and imminent credit destruction.

    I don’t know whether they will do that – they’re probably hoping that by restoring confidence they won’t have to, but the odds are greater that they will than that they won’t.

    If they do, hyperinflation is indeed a threat.

    Steven Randy Waldman at Interfluidity had several excellent posts on the subject months ago, even before the Bear Stearns bailout. It was remarkably prescient.

  7. Yves Smith

    Critics of Fed’s actions in the early 1930s claim the Fed allowed money supply to fall, turning a slump into a depression.

    The critics are wrong. The Fed then did increase what it controlled, namely the monetary base, Money supply shrank anyhow because people didn’t trust banks (with good reason, they were failing right and left) and hoarded cash.

    The modern analogue would be a dramatic fall in the velocity of money, which is not impossible, particularly given how consumers voluntarily and involuntarily will probably be using a ton less credit.

  8. mxq

    RE: Dizard’s point: “(iran) would not succeed in interfering with oil shipments”…he’ probably right…

    According to the CIA guessb…er…factbook, oil provides 85% of Iran’s government revenue.

    Coupled with almost 20% inflation, it looks like Iran can ill-afford to shut-in oil production for very long (counted in days, maybe?).

  9. Peripheral Visionary

    “Coupled with almost 20% inflation, it looks like Iran can ill-afford to shut-in oil production for very long (counted in days, maybe?).”

    Agreed. They need the oil income, and the West needs the oil, so regardless of all the saber-rattling, it is highly likely that conflict will be avoided.

    “The big question is, what do we replace it with?”

    Excellent question. I don’t think anyone has the answer to it, but we had better start thinking fast, because unless someone puts something else forward, we could be looking at Smoot-Hawley II.

  10. russ

    The critics are wrong. The Fed then did increase what it controlled, namely the monetary base, Money supply shrank anyhow because people didn’t trust banks (with good reason, they were failing right and left) and hoarded cash.

    Yves the Rothbardian.

  11. roger

    The insanity of the hawks is never ending: Iran is such a big threat we have to bomb them now, because Iran is such a little threat that there will be no consequences. I wonder how often this has been said? From: Afghanistan will never be a quagmire in Dec. 2001 to Afghanistan will never be secure until it has 400.000 soldiers there; from the Iraqis will give us flowers and candies to we have to stay there or everybody will die; from Wolfowitz’s war that will pay for itself to the war that is now estimated at 1.5 trillion dollars, including the costs of the injuries to those American soldiers that somehow tripped up during the cakewalk.

    This is like a bad three stooges film. Here’s a suggestion: although Americans can hardly believe it, people don’t like being bombed. Although it is just our way of saying hello. And in fact, those people just might include the Shi’a majority in Iraq. They might not like Iraq’s airspace used for the U.S. to bomb Iraq’s neighbor.

    Somehow, I’m such a sucker that I believe the collective wisdom of the oil futures market over a man who has his assistant dig up Tallyrand quotes.

  12. David Hannaford

    on Persians being poor fighters … during the Iraq-Iran war (1980-88), tens of thousands of Iranian men and boys, without being asked, armed themselves; equipped themselves, and transported themselves to the front to confront the Iraqis. One of them, a boy, is credited with inventing the suicide bomb as a military tactic when he took out an Iraqi tank.
    Poor fighters?

  13. Yves Smith


    Actually, I got the monetary base versus money supply stuff from Krugman of all people, who IMHO was being far too deferential in a review of a book on Friedman.

    I will confess I have not studied Bernanke’s comments and papers on the Depression in depth, so please amplify or correct as needed. However, I found one quote very troubling if it does represent his thinking accurately.

    Bernanke has said something along the lines of ” A determined monetary authority can always reflate” and used the US in 1934 as proof. The US in 1934 was AFTER the banking system had collapsed and after the FDIC had been created.

  14. a

    “The only way the banks can reconstruct their balance sheets, or at least their cash flow statements, is from years of steep yield curves caused by artificially low policy rates.”

    Um maybe lower bonuses? Maybe even 0 bonuses and salary cuts? Let’s not forget that Morgan Stanley last year paid out twice in bonuses than what it got from recapitalization. The numbers for employee pay-out are not trivial and are a real drain on the real economy. CB support should not go into the undeserving pockets of bankers – which is exactly where it’s ending up now. Once the salaries and bonuses are brought back to normal numbers (60 000 USD / year should be tops for a banker who’s basic job is to f**k things up in the rest of the economy), then maybe we can begin to talk about CB help for banks.

  15. Anonymous

    We could close the FED and take back control of our money supply.

    Why the government borrows money from itself and then pays interest on this money smacks of pure lunacy.

    And the income tax implications of this move are absolutely delicious.

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