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The Straw that Broke the Camel's Back


Central banks are spinning their wheels in a desperate attempt to keep financial institutions from freezing up.

World-wide central banks injected $383 billion in credit to the world's banks just in August. That is just an amazing number. It is unprecedented.

Yes, we are in a new world, but not the world you think.

Central banks are now taking risky collateral for that "credit". This is because that is what is left in a world where all the risk-less assets have been eaten up and only the more and more risky remain. If central banks did not accept this collateral there is no way they could get that "liquidity" into the market. Imagine what markets would look like then. So it's a good thing right?

All that new credit is doing is propping up markets right now. But it is not making things better: that credit is not creating new production, it is only servicing (rolling) the existing debt and keeping things afloat. Central banks are spinning their wheels in a desperate attempt to keep financial institutions from freezing up. It is also doing two very bad things. It is increasing the debt to be serviced by markets, which is the problem in the first place. It is also nationalizing markets: governments taking on more and more risky debt means they gaining more and more influence over markets. Remember, if you can't pay off your debt, your debtor gets to take your assets. There is really no difference from Chavez declaring that his government owns XYZ Company and central banks lending money and then taking the assets as collateral.

So why aren't stocks plummeting? My friend Mr. Cents, who is more of a trader than I am, tells me that there is a persistent and unshakeable bid in futures every day all day. That stocks themselves are heavy from selling, but then they are dragged up by index futures eventually by the end of the day. He tells me to notice how in market rallies stocks seem always to end at the highs of the day. These are "artificial" patterns.

It is impossible to prove this but it makes sense. If central banks are willing to take risky assets onto their balance sheets why not risky assets like stocks? Stocks are very important to the fragile psychology that permeates markets today. Reports of real estate, including commercial real estate now, and debt paper imploding are one thing, but they are once removed from the public's eye. The damage here is spreading and it is certainly real, but it is once removed psychologically.

But if stocks went down that is very visible and would directly affect risk-taking psychology. That would break the camel's back and central banks know it.

So maybe, just maybe they are not letting them go down. But in the end unless central banks are willing to buy vast portions of risky assets (communism), they cannot stop markets from adjusting risk.

If they are willing to go that far, we will be very sorry.
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