Econ Brew

October 11th
1035 - 1815

Over the past 72 hours, I've had over 300 or so messages
asking me so many questions and expressing much concern
about the health of portfolios. While I cannot and will
not tell u what to do specifically (I'm not a Registered
Financial Advisor) about your portfolio I can point out
some things for you to think about.

Since these are complex times, I consulted with my brother
that's an economic fiend. This message echoes his thoughts
more than mine, with mine interspersed with his. In
spirit, this is all his. After all, I'm a simple minded
trader. My personal truth vacillating somewhere between
"Last Trade" and "Bid Price"....

- The crisis has gone from housing to the financial system.
The linkage between them expressed through the deflation
and the mass exodus of risk. Nobody know how long this will
take. Liquidation en-masse does not necessarily mean that the
trading volumes are high. They could also be characterized
by spreads that are wide and a sustained move downwards.
One other fingerprint is reversal of markets during the last
few minutes of trading.

- Liquidation patterns can be seen easily - the best performing
sectors on Friday were the banks, real estate and financials
in general. The worst were healthcare and utilities (supposedly
recession proof). My futures trading fiend of a brother points
out that "everything" was on sale esppecially longer dated
government bonds of all varieties. Only thing that was going
up was short dated government bills.

- Money is coming back home if you are American or Japanese.
Japan and the USA are the biggest investors in risky assets.
Asia (ex Japan) are typically holders of safer assets. Sales
of risky assets outlined above is leading to money being
repatriated back home. Basically, the Yen is equivalent to
Gold. Japan is the biggest saver in the world and is generally
the biggest creditor.

- We are witnessing the biggest deflation of asset values in
decades. The dollar is still the reserve currency and the Fed
is the MOST important player. We (courtesy Past Fed) caused
the asset bubbles of the past and we will pay for it, too. The
current deflation of assets is causing a liquidity squeeze
(shortage) in dollars. The Fed will fight the deflation in
asset prices by creating policy that is inflationary in nature.
Interest rates in the United States will go to ZERO. Yes, ZERO!
Welcome, Helicopter Ben!!!

- Every banking crisis has found a solution through monetary
and fiscal policy. The recovery won't happen quickly but will
with remarkable speed. In the USA it will be expressed through
the economy on "LIFE SUPPORT" and in "ICU" through massive
fiscal spending over the next few years. Perhaps, this will
what Obama will do with the "New Deal 2.0". We'd rather not
talk about the alternative in McCain+Palin. If that happens,
I'm giving up my passport and moving elsewhere.

- Here are some things that are important :

1) Injections of capital into banks is a necessary but not
sufficient condition for recovery. We have to prevent any runs
on banks to guarantee the savings of depositors.

2) The Weak players in the financial industry are being weeded
out either by the destruction of equity or by mergers. This
is a healthy process. As with public companies, some players
in the hedge fund complex will be the next to go.

3) The guarantee of bank balance sheets and inter bank lending
is fraught with danger. It created moral hazard.

- This correction of asset prices is destroying money on
a scale that is truly gargantuan. Equity market wealth
in the world has gone from 54 Trillion dollars to 28
Trillion dollars as of the end of day on Thursday.
Real estate losses amount to probably 10-12 Trillion
in the US and another 20 across the world.

- The pre-conditions for consolidation and recovery are
here OR are in the process of being put into place.
Previous recoveries were "V shaped", thanks to engineered
actions of Greenspan & Co. This recovery will resemble
Japan but will likely be much shorter in time. There
will be a war between demand destruction (by private
sector) and demand expansion (government led). Broad
market action will be dictated by ebbs and flows in
these two wars.

- Economic growth in the US will take a BIG BIG hit.
This is necessary to correct the imbalances. I think
US retailers still have a way to go down.

- Volatility is running at 5-7 times its normal rate
so size your bets correctly. For those of you that bet
big, realize that 10 units of risk when volatility is
at X is similar to 5 units of risk when volatility is
at 2X when the world is linear in nature. BUT the
world is not linear. With the multitude of shocks to
the system happening right now, you might have to go
down to 2 units of risk on your books. ie., if you
cannot stand the swings in your portfolio cut down risk
on rallies. The markets will always be there and you
can always trade and invest.

- What might the future hold? Will the US look like
Japan or will it look like Sweden/South Korea after their
respective crisis? Korea and Sweden were smaller economies
that benefited from devaluations and the economic pull
from cross border growth. In the case of the USA, it is
not possible. Contrary to what the IDIOTS on CNBC say we
cannot export out way out of this slowdown. Any export
growth has been in low value added commodity exports and
will disappear with plummeting commodity prices and
falling global demand. Hence we'll end up more like Japan.

- THE CRISIS is characterized by the symptoms we see all
around us. The end is marked by violent selloffs we are
now witnessing. Every risky asset is being sold.

- THE RECOVERY is characterized by policies being put in
place, regulatory reform etc., Financials and other problem
sectors outperforming the markets, imbalances being
corrected in a violent manner ie., long term personal
consumption in the US will be the first to go. A 5-8%
fall in GDP will bring US deficit down. The unhealthy US
consumption being paid for by Asian investment in US
fixed income will change. The US dollar will go down as
a re-inflation of the system is necessary. The Fed will
accomplish this by massive liquidity measures. Watch
the dollar start to fall as a sign of health.

THOSE WHO THINK THAT THE DOLLAR IS GOING UP BECAUSE WE
ARE SO MUCH BETTER SHAPE THAN THE REST OFF THE WORLD
ARE DEAD WRONG. WE HAVE CROSSED THAT STAGE. THIS IS A
DEFLATIONARY DOLLAR RALLY. THE US IS THE LIQUIDITY
PROVIDER TO THE REST OF THE WORLD. THE FED WILL RESUME
THAT ROLE.

- Changes in US policy will cause seismic shifts off
shore. We are already witness to this (Europe). As
there is demand adjustment in the US, Asia will have
to play ball, too. China will chart a new course in its
development as the US dollar will depreciate alongwith
lack of demand in goods. Europe will cut rates and the
Euro will come under pressure as fiscal expansion is
less flexible in Europe than the US. Likely major
interest rates cut in UK and less in Europe.

- Asia is the big unknown. What will China do when the
biggest consumer of their goods is going downhill and
FAST?

- VO and aLV