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June 09, 2005

Who's on First?
by Rob Kirby

How many of you haven't ever listened to the classic comedy skit by famed American funnymen Bud Abbott and Lou Costello - the one entitled, Who's On First? I must admit, the hilarity of this craftily polished and well rehearsed he said - he said never fails to bring a tear to my eye through all the laughter. I never thought I'd live to see the day that ole' Bud and Lou would have to make room 'at the top of the heap', so to speak, for a funnier group of clowns with an act more rehearsed than an elaborate Siegfried and Roy stage show extravaganza - that is until this past week.

On Wednesday June 1, 2005 CNBC's senior economics commentator Steve Liesman conducted an 'exclusive' interview with Dallas Fed. President Richard W. Fisher. Mr. Fisher just happens to be the newest addition to the powerful FOMC [Fed Open Market Committee] group at the Federal Reserve [A Private Corporation that serves as America's Central Bank] which sets interest rate policy for the United States of America. What was so interesting about this interview was Mr. Fisher's pronouncement that the current rate tightening cycle was in its eighth inning [there having been 8 successive quarter point rate increases already over the past year or so] with the ninth inning coming up at the end of this month - the next time the FOMC meets. For those of you who are not particularly knowledgeable about baseball - the American version of the game generally has nine innings - save of course, the game is tied at it's natural conclusion, meaning extra innings. Prior to this pronouncement, a clear message had been consistently transmitted by Fed stalwarts strongly suggesting that 'measured' rate hikes would indeed continue for the foreseeable future. To suggest that Mr. Fisher's comments regarding the likely future course of interest rates 'caught the market by surprise' is a gross understatement - an immediate 100+ point rally ensued in the DOW Jones Industrial averages in new found optimism that the Fed may be near an end of its current rate hiking posture. In fact, the markets were so enthused with Fisher's comments; they even prompted CNBC commentators to opine that Mr. Fisher may not be speaking for the all powerful FOMC interest rate group which he is now its newest member - and he may have committed a 'rookie/greenhorn' mistake in articulating his views. Looking at Mr. Fisher's bio, we can see that Mr. Fisher has served his country as a deputy U.S. trade representative with a rank of ambassador. He was an assistant to the Secretary of the Treasury in the Carter Administration. He founded his own fund management firm. He is a former vice chairman of Kissinger McLarty Associates, an advisory firm chaired by former Secretary of State, Henry Kissinger. So, let's just say there is no grass growing under Mr. Fisher's feet - shall we?

That got me thinking. In the 20+ years that I've worked in and been around financial markets, I have never known the Fed to leave ANYTHING to chance. I feel that it's a fair assessment to characterize their actions as extremely well planned and rehearsed. These are not people who any rational thinker would characterize as leaving anything to chance. Given these realities, I choose to believe that Mr. Fisher's utterances were premeditated and planned as part of what's become colloquially referred to as the "Open Mouth Committee". There is no doubt in my mind that they were intended to achieve exactly the result they produced - namely, a more favorable [higher] equity market and a rally in bonds [lower interest rates] and perhaps to even take a little bit of starch out of the recent dramatic rise in the U.S. dollar - particularly in Euro terms.

Fast forward, if you will, two whole days to Friday June 3, 2005 and consider the commentary of Fed Reserve Governor [outgoing] and current FOMC member Mr. Edward Gramlich. When questioned by reporters about Fisher's baseball analogy comments on Friday, Gramlich responded,

"I don't know what inning we're in."

Now I don't know about you, dear reader, but these two gentlemen allegedly play for the same team. Did one of them simply forget to bring his mitt to the ball park? Were Gramlich's comments [casting a pall of doubt over the notion that the Fed may soon be finished raising rates] intended to be dollar friendly? Were these comments intended to allay fears on behalf of foreigners who fund American profligacy that the Fed will remain 'tough on inflation'? Who knows? But for now, 'tough on inflation' is the second baseman, and he's on the 15 day disabled list.

Speaking of disabled and baseball, I wrote a piece a couple of weeks ago about the Pirates - no - not the ones who work in Pittsburg [a great steel town]. The other ones who steal in the Caribbean in an article entitled, Pirates Reprise. The long and short of the story outlines how the U.S. Treasury's numbers don't add up. I received assistance with this story from a Dutch journalist named Willem Middelkoop - who was first to recognize the inconsistency of the Treasury's reporting based on an earlier article I had written. It's my understanding that Mr. Middelkoop primarily works in television. The discrepancy in the numbers prompted him to contact the U.S. Treasury, citing my article, and query them on the numbers. He received a reply from none other than Mr. Tony Fratto , a fellow who apparently works in a capacity of public relations for the U.S. Treasury. He forwarded Mr. Fratto's comments about my article to me as a FYI [for your information] - or journalistic pleasantry. Mr. Fratto suggested that the author [that would be me] "succumbed to a bit of hyperbole" in suggesting that anything was amiss at the good ole' U.S. Treasury and their reporting of numbers. In fact, he said that there was nothing unusual or brazen at all with the reporting of the subject numbers.

Well, I must admit that I'm very flattered that Mr. Fratto has taken the time to read my article. It's perhaps the nearest thing to the truth the man has seen in quite some time. Since I've got his attention I would like to point out that, thanks to alert readers, we have found even more that appears to be egregiously wrong with the same set of numbers in the Pirates Reprise article. In the first data set, Norway is omitted. In the second data set, Norway is retro inserted to the tune of 35 billion dollars alone in the subject month of Jan. 05. With a show of hands please, does this appear normal to any of you?

Mr. Fratto was not the only person who should have an informed opinion who passed judgment on this article. I heard from a former high ranking official [who shall remain nameless for now] of the New York Fed who had this to say,

Dear Rob

Re- Pirates Reprise

I enjoyed your article on the Fed data. I was once chief of a division at the NY Fed that complies a good deal of this data for treasury.

A few points:

I noticed these discrepancies the minute they were out since I track this data set and must update it by hand. I agree that the revisions are large. Several facts may explain the changes although I have not placed calls to find out why. For now, it's a survey break...

But rest assured that having 'financial reporters' blame the problems and the risks of the world on HEDGE FUNDS gets us no closer to understanding the facts. It just gives the devil a name- and maybe the wrong one. In this case I think they were stabbing in the dark...

Some of the revisions may be pure error. Here I agree that I'd be shocked to know that the US treasury could not get straight numbers from other foreign governments. Or that the registration system has failed that badly. But there are myriad technical issues as well. Its not as simple as you might think...Maybe it is a result of getting the date of ownership wrong since treasuries are traded widely. It might also reflect some confusion over who owns a security for the purpose of the survey if it is OUT on repo...

However, there may be some discrepancy between book and market value if someone has changed their method of evaluating holdings - (unlikely but possible).

There is also the possibility of instrument mishandling. For example in the US FNMA securities are not treasuries but to foreign governments they are often treated with almost the same respect as investments in US governments (implicit government guarantee and all...). Were they improperly tabulated for a time as 'treasury holdings'? It's possible.

As for Caribbean hedge funds, well the new investor of de-merit is the hedge fund. We no longer have nameless speculators we can call them hedge funds and SEEM more authoritative.

Another problem with the treasury holder by location data is just that these data are by location HELD. These data DO NOT trace holdings back to the ultimate beneficial owner. For example the Japanese securities firms (...and I was once chief economist at the US offices of one the Big Four firms) sometimes have bought and sold US treasuries in a subsidiary in the Caribbean (NOTE - NOT a hedge fund) the purchase in this case is attributable to the Caribbean not to the Japanese. When Merrill Lynch UK buys bonds it is a holding by a UK resident, etc...

So for data on US treasury holdings by nonofficial holders the geographical reporting is not very clear. Large institutional and investment fund buying occurs in Switzerland Luxembourg, the UK, the Netherlands and Germany, as well. We have no idea who the ultimate beneficial owner of these investments are or where they really reside.

So look at the data and think about them. I am not opposed to your ire in this matter- indeed I share it but for the simpler reason that these huge revisions were released hidden- if you will- without comment.... oh they called a 'series break'... never mind. It's the sort of thing US authorities are not supposed to do. They are supposed to be above all this.

Guess they aren't.

Notice that the official holdings data were revised but holdings were made higher there.

Perhaps Mr. Fratto should instead busy himself reading the Treasury's numbers prior to publishing rather than commenting on my hyperbolic efforts, ehhh? Hyperbolic efforts, last I heard, just happens to play third base.

Now Batting Clean Up

Because this piece has a baseball theme running through it, I would now like to draw your attention to none other than Alan "Fingers" Greenspan, warming up in the bull pen. To complete this little ditty, we will feature an archived exchange between Rep. Ron Paul of Texas and Alan Greenspan [under oath I presume] at the formerly known as, Humphrey Hawkins Testimony up on Capitol Hill in 1999,

2/24/1999

Dr. PAUL. "Thank you, Mr. Chairman.

Mr. Greenspan, a lot of economists look to the price of gold as an indicator and as a monetary tool. It has been reported that you might even look at the price of gold on occasion.

Last summer on a couple of occasions here when you were talking before the committees on securities and on derivatives you mentioned something that was interesting. You said that central banks stand ready to sell gold in increasing quantities should the price rise, which I thought was rather interesting.

Then I followed up with a letter to you to ask you whether or not our central bank might not be involved in something like that, in the gold market. And you did answer me and stated that since the 1930's the Federal Reserve has had no authority to be involved with the gold markets.

I am quite confident that the Treasury has authority to be in gold markets, but you stated that the Federal Reserve did not. But this contradicts some reports that have been made by some Federal Reserve officials that said that the New York Fed was very much involved in the London gold pool from 1961 to 1971. But your answer implied that the Fed has never been involved since the 1930's, which I think is interesting......"

Mr. Greenspan's verbatim response to this direct line of questioning was,

Mr. GREENSPAN. "I think the price of gold has, over the decades, been a generally usable indicator of what the level of inflation has been. Obviously, during the period of an active gold standard, which was really prior to World War I, the price level pretty much locked itself in to the gold price. In fact, by definition it did.

The issue of buying and selling gold as the price changes is indeed exactly what we used to do. We used to, at a certain thing called the gold points, which was the price of gold plus the transportation cost differentials, we, that is, the United States Treasury, stood ready to buy and sell gold at a spread, as indeed all other participants in the gold standard did. So in that regard that was exactly what was happening.

But, needless to say, since we have gone off the gold standard, and especially since 1973, there has been basically a general float of the dollar vis-à-vis gold, which means that the gold price is like another commodity's price.

Nonetheless, like a lot of commodity prices, and perhaps better than most, it has been useful, in my judgment, in trying to get some sense of what inflationary pressures have evolved in this country."

Now folks, I would like to draw your attention to this piece of archived communication between officials at the Vatican Bank and Mr. Paul Volcker, then President of the New York Federal Reserve:

After reading this piece of correspondence, dated Oct. 6 in the year of our lord 1975, can anyone tell me if they truly believe that the Fed has not been involved in the gold market since the 1930's? If Mr. Fratto over at Treasury really wants to read some good hyperbole, all he needs to do is get Sir Alan's take on inflation or the BLS's take on the employment situation. Better yet, thanks to the Montreal Expos, he can go watch real baseball now!

I'll ask the question again; does anyone really feel that ignoring and refusing to report the facts outlined above are going to make this situation better or worse? We may sidestep the issues here if we collectively so choose - then our kids and grand children get to deal with it, ehhh?

That, by the way, was Strike Three. You're out!

I'm now teaching my daughter the meaning of Caveat Emptor - I think I owe it to her.

Rob Kirby
Kirby Analytics

Copyright © 2004 - 2006 Rob Kirby

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