Northman's Fury

Capt. Fogg on the central banks pumping billions into the market to keep them from crashing further:

Maybe it will work, maybe it won't, but calling it a recovery is only slightly less honest as seeing a sign of strength in the turning on of the Titanic's bilge pumps.

Global markets have been rattled by worries over financial institutions' exposure to bad credit in the US sub-prime mortgage market.

. . .

The European Central Bank injected cash into the money market for a second day, as did other central banks worldwide.

The ECB move was to "assure orderly conditions in the euro money markets".

The bank injected 61.05 bn euros (£41.65bn; $84.2bn) into the eurozone money markets on Friday.

Japan's central bank had earlier pumped one trillion yen ($8.5bn; £4.2bn) into the financial system to boost liquidity.

How long the central banks can continue to pump cash in to keep the markets from collapsing is debatable, and the cash infusions themselves can cause more inflation. Add to the sub-prime mess the jitters over the unregulated hedge fund market, throw in the growing spat between the US and China over currency valuation, and the growing push for oil-producing countries like Russia to stop selling their oil in dollars but instead demanding euros, and you can begin to see why this crash is going to be ugly.

Too many negative factors converging at once.

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

There's a fair number of caveats to go along with this story. The major one being that China and the US are in a sort of symbiotic relationship where the Chinese can't afford to devalue the dollar too much and cause inflation is the US because that would in turn hurt their ability to sell goods to American consumers.

Of course, the same logic holds true with upping the value of the yuan, except that it won't be just American consumers that will find Chinese goods more expensive, and while China and the US do have a great deal of trade between them, China still has more trade with neighbours like Japan and South Korea. So for China, losing a share of the American market has to seem like a better option than losing market share everywhere.

More to the point, the US dollar has already dropped a great deal in the last few years without any let-up in the American trade deficit with China, and the dollar's continued weakness means that China dollar reserves keep losing value the longer they hold them. Diversifying makes sense, even if it has a negative effect on your consumer base, because like it or not, the US is due for a correction of its market regardless what the Chinese do. If you spend more than you earn, and the US has been doing so for years now, at some point the bills come due and spending has to be tightened. Or you go bankrupt. either way, your credit isn't going to be that good.

And the Chinese have one other ace up their sleeve; regardless how bad the US dollar gets, they are still going to need to buy plenty of manufactured goods, and all of the factories are still in China. That's the reason the weakness in the US dollar hasn't affected the trade imbalance, and why it will take a long time for even a collapse in the dollar's value to change it. Money valuation can change rapidly, factories don't move nearly as fast.

So how bad will the fallout from the sub-prime market be? It's hard to say, but I came across a couple of stories today that indicate it won't be nice.

First, you have to watch Jim Cramer lose it. It's almost funny how worked up the guy gets.

On a more serious note, this news:

American Home Mortgage Investment Corp. became the second-biggest residential lender to file for bankruptcy protection this year, adding to signs that late payments have spread to homeowners with good credit records.

The company sought federal court protection from creditors in Wilmington, Delaware, today, saying it had assets of more than $100 million and debts of more than $100 million owed to more than 100,000 creditors. The filing comes after the company announced Aug. 2 it would halt operations and slash staff.

American Home specialized in mortgages for people who fall just short of top credit scores. More than half a dozen competitors have declared bankruptcy this year as defaults spilled over from ``subprime'' borrowers with the worst repayment records to those with more reliable payment histories.

All this leads me to an excellent post at the Agonist where Numerian lays out the issues and possible effects of the sub-prime collapse. Read the whole thing if you want a good understanding of the situation.

I'm no expert on the markets, but the feeling I have is that this is going to be ugly.