Meet the New Boss…Same as the Old Boss?

Today is Alan Greenspan’s final day at the helm of the Federal Reserve and the Fed’s Open Market Committee. As per usual, the FOMC will release their decision on interest rates— except this time it will be accompanied by a piece of history.

Alan Greenspan is a behemoth of a man, whom cast a great shadow upon Wall Street and Main Street. From the Eccles Building on Constitution Ave. in Washington D.C., his steady hand has guided the world’s largest economy through both boom and bust. From his earliest challenge of Black Monday to the introduction of “irrational exuberance” into our national vocabulary, nary a Fed Chief will serve without being compared and contrasted with his period in office.

Nearly an octogenarian, Mr. Greenspan has managed our nation’s monetary policy since 1987, served as an economic advisor to the President, was CEO of Alcoa and is a Knight Commander of the British Empire (honorary). He is also an accomplished saxophonist and was a close friend of Ayn Rand.

Dr. Ben Bernanke has served on the Board of Governors prior to heading President Bush’s Council of Economic Advisors. Both gentlemen hold each other in high regard. It is said that the new Fed Chief was on both the President’s and Greenspan’s short list—an accomplishment in itself.

While early critics have eagerly pointed to a “helicopter money” reference from a 2002 speech on deflation (which might I add was a growing concern at the Fed), they are ignoring an economist well-versed in the lessons of monetary policy and history. Dr. Bernanke is a student of financial calamity, having studied the Great Depression at length. Amidst the celebrity status surrounding Mr. Greenspan, commentators have oft ignored or are unaware of the modus operandi of the Federal Reserve—price stability.

The implementation of “Inflation Targeting” (something Dr. Bernanke has repeatedly advocated in policy addresses and speeches), while not a given; could be argued that it is more congruent with the intent of the 1913 inception of the body than the present approach. At any rate, a shift to this guiding principle is unlikely. It is also rather inflexible—as situations which land in the grey area would wind up tying the hands of policy-makers.

In addition, all indications point toward Bernanke following in the footsteps of Greenspan as a “consensus builder.” Votes under Greenspan were overwhelmingly unanimous. Difficult issues would bring out a dissenter or two on occasion, but that was the exception—not the norm. In the past decade I cannot recall a time when there was a tie breaker cast or a slim majority on any issue, regardless how contentious the debate may have been.

Bernanke also seems eager to continue making the Fed and the monetary policy process more transparent. The Fed did not release minutes prior to Greenspan. The Fed did not “tip its hand” as to the direction and/or risks facing the economy and rates prior to Greenspan. Greenspan transformed the Federal Reserve to a pro-active body, something Bernanke has written extensively on and is likely to maintain.

While Bernanke is unlikely to become a carbon-copy of his predecessor, he is likely to adopt and build upon his legacy. I view this as a huge positive for business and monetary policy.



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It’s a Mad, Mad World

The global economy is strong. The U.S. remains robust, Japan is on the mend and business confidence in Europe continues to show improvement. The so-called “developing countries” have also been experiencing rapid growth as more nations take advantage of global trade to move their manufacturing operations abroad. China and India remain powerhouses as Western nations have been able to gain entry in markets typically thought to have high barriers to entry. They have also became lead consumers of commodities virtually overnight, building out infrastructure at a frenetic pace to keep up with overwhelming demand in construction and real estate.

The Middle East continues to be riddled with problems. While Iran has spelled trouble for the west since the day they overran the U.S. embassy some 25 years ago, there are other nations emerging that pose a similar risk to international stability. While the Palestinian election that put Hamas in power over Fatah shouldn’t come as a surprise to international observers or their neighbors—but will have the unintended consequence of emboldening the Iranian regime.

Attacks on oil platforms in Nigeria have also escalated in the past few weeks as militants have become more daring and brazen. This week several employees of Agip were murdered and kidnapped.

President Hugo Chavez is also a graduate of the crash course on how not to join the international community. Despite his socialist agenda which his hampering foreign investment (except for the energy industry—that I might add could be faced with a threat of nationalization) and threatens a repeat of Jacobo Arbenz vs. United Fruit.

As discussed previously, Russia is precipitously teetering on the brink of socialism or authoritarian rule. Failure to deliver gas at market prices to its neighbors is simply unacceptable, and really nothing more than the latest example of its flagrant disregard for global protocol.

On a positive note, the U.S. and Korea formed a free-trade agreement that may someday rival NAFTA. This should demonstrably improve the quality and quantity of high end consumer products and more palatably, the quality of life.

Despite all the negativity, global markets have trudged higher and will most likely continue to do so. Remember, sometimes the trend is a trend until it isn’t anymore.

Corporate Corruption or an Unlikely Trailblazer?

Over the past few weeks the financial media has been having a field day with the evolving Livedoor story and its embattled founder Takafumi Horie (and former CEO, whom resigned today). Mr. Horie was the face of the new Japan—shunning suits, untarnished by nepotism and a rejection of the samurai/corporate culture that escalated Japan in the 1990’s, which inevitably led to its downfall in the 1990’s.

While the media feeding frenzy’s coverage would infer that Livedoor’s financial health mirrors that of a pre-collapse Enron or Worldcom; there may be a different story here altogether.

Mr. Horie made a name for himself with his brazen disregard for the homogenizied Japanese business establishment. His outspoken disdain of the “Iron Triangle” (the close relationship between Parliament, MITI and corporations) and his foray into politics clearly did not endear him to the old standard-bearers of society. In fact, PM Koizumi encouraged Mr. Horie to run for parliament as part of his reform agenda, designed to breathe life into a struggling economy.

Reports of last week’s suicide of a banker with close ties to Livedoor may intimate that some wrong doing has occurred—but many in the general population feel the charges against Mr. Horie are trumped-up; designed to defame and deter those from breaking with culture.

One thing to be sure of is that we are still very early in this story. Right now, prosecutors seem to be qualifying every statement with “suspicion of” which tells me that they have an idea or a concept of what has occurred, but lack material proof, or “a smoking gun” if you will. Because of the complex nature of many of the transactions, forensic accountants should have their hands full for the time being. Unfortunately, only a detailed examination of Livedoor’s financials can shed light on what really happened, but even that may remain elusive for the time being.



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Give it a Year

There is no question that Iran’s President has been treading on thin ice since taking office. His comments on the Holocaust and the fate of Israel have done little to bolster Iran’s image abroad and will most likely only further the divisions between the radical government, the general population and the international community.

Most recently, Iran has played the role of global opportunist, seizing upon the tumult in Iraq and the health of Prime Minister Sharon to move its nuclear agenda. After breaking the UN/IAEA seals, Iran had the audacity to virtually threaten UN Security Council membership by withholding energy in the face of any sanctions; in the event they are referred.

I think we can be reasonably sure these are not hollow threats—President Ahmadinejad strikes most (including myself) as a man of his word and would gladly destroy his country’s economy by withholding oil to acquire WMD’s.

I am also confident that he may have miscalculated his odds in terms of the Chinese and Russian responses. Increasingly Tehran has had much friendlier and profitable trade relations with these nations—but it is unlikely even Vladimir Putin (who recently sold Iran missiles) would go along on this ride. Also, for the first time this century it appears the French and Germans are galvanized (perhaps mainly because they are within range) and while they may only be prepared to initiate sanctions at this juncture, it’s a start.

The reason I say “give it a year” is two fold. The first scenario is the UN Security Council backed initiative that is likely to form over the next few weeks. The possibility of a referral, combined with any economic penalties will surely take months, especially as back-channel negotiations through our European allies will progress and fail. It will also surely take time to bring Russia and China on board for any specific proposal, as the wording often becomes more important than the concept behind any draft. One year may actually be considered fast, come to think of it.

The second scenario is the military option. At this point it would seem likely that our options are confined to a targeted operation, something along the lines of a “surgical air strike” destined to incapacitate their nuclear ambitions. Technically, we could do this tomorrow. But we won’t, and for good reason.

It would behoove us to wait a year and let Iran actively build their atomic infrastructure. In fact, the closer they are to completion, the more ideal the time. This can be one of the most demoralizing tactics, as it has been used countless times—most notably Israel’s elimination of Iraq’s nuclear plant in the 1980’s.

At any rate, don’t look for quick resolution (or a quick resolution)—escalation is probably more likely in the near term.

Day of Reckoning

Japan’s TSE was shut down for the first time ever today as a result of the system not being able to handle an influx in sell volume. Over the past few months the TSE has encountered a stream of new problems—ranging from bad trade entries to the dwindling financial health of Livedoor Co. Ltd. At any rate, the recent run up and subsequent sell off in the NIKKEI should add to our domestic woes today.

Yesterday the U.S. had a trifecta—Yahoo, Intel and IBM all reported earnings that fell short of analysts expectations. While on the face of it they were solid (YHOO reported bottom line growth of 83%), the recent rally in share prices made valuations look expensive, leading to wildly negative after-hours session in New York.

At this point it looks like the pain will creep from the technology sector into others as bears seek to capitalize on any bad news, regardless of its scope and size. NASDAQ futures are down roughly 30 pts vs. fair value at 5am EST, so look for heavy selling at the NY open.



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Conduct Unbecoming

Conduct Unbecoming This was the gentle way in which Secretary of State Rice described the current G-8 (and Russian) President Putin’s handling of his nation’s energy dispute within the Ukraine and the whole of the European continent. His refusal to supply natural gas to Ukraine at market rates over the weekend propelled prices up to the U.S. equivalent of $230/cf and sent many other neighboring countries into a frenzy trying to shore up their reserves, stretching as far as France.

Unfortunately, this is not an isolated incident, but fits nicely into a pattern of recent behavior by the Russian President. Since taking office democratically in 2000, Mr. Putin has clearly taken steps to move Russia toward an equal participant in the global community. Regrettably, many of these positive developments have been accompanied by aggression, suppression of dissent and a general indifference toward international law.

Many Kremlin watchers fear a gradual usurpation of power has already begun destined to end with hegemony of power centered in the hands of the president. Putin has only served to further this fear with offhand comments about “running again”—something currently forbidden under Russian law and deposing, imprisoning and virtually exiling those who oppose his vision. The head of Russian oil giant Yukos, Mikhail Khodorkovsky was arrested in 2003 on what many feel to be “trumped up” charges designed to penalize and warn the class of business oligarchs that swept into Russia in the 1990’s and threatened his re-election.

Russia’s latest military exploit involved a sale of missiles to Iran, at the same time delegates from the EU and US have been attempting to broker a deal keeping Iran from acquiring nuclear weapons. Russia had also been rumored to be providing assistance to Saddam Hussein’s regime, selling night vision goggles, sig-int. gathering equipment and other arms related items while ignoring UN sanctions on such contraband.

It is difficult to look at President Putin’s latest ordeal with the Ukraine with anything but skepticism. In fact, this prompted the resignation of a senior economic advisor that remarked that Russia “was not free” upon his departure. These are all clues as to what may lie ahead for Russia, and their role as an international player.

Two Inversions

At the end of last year the inevitable finally arrived, the yield curve inverted. Essentially the “bread and butter” of any financial institution involved in lending will be affected as typically banks borrow money at lower, short-term rates and lend them out at higher, long-term rates; profiting from the difference in the two, or “spread.”

When the yield on the two year note is greater than the yield on the ten year treasury, the yield curve becomes “inverted.” This does not allow lenders to engage in the simple process described above, as doing so would invariably yield a loss. Because the U.S. economy is so dependent upon the capital and credit markets for liquidity, this poses a problem for all parties involved: the banks that lend money, the businesses/entities dependent upon borrowing and the Federal Reserve.

The Federal Reserve is affected as pressure is put upon them to cut the fed funds rate to return the yield curve to a normal state. Because the FOMC is overly concerned with inflation, they are forced into a bind: cut rates, return the yield curve to normal and risk stoking inflation or allow the inversion to remain, continue their campaign and threaten economic growth and the solvency of banks.

The other complication is the use of derivatives by lenders to protect themselves from adverse conditions (i.e. inverted yield curve) encourages them to offset risk—creating an entirely new breed of risk as Hedge Funds, LBO’s and other investment vehicles will become deeply intertwined.