China, the dollar, and what does Goldman Sachs know that Sec. Paulson doesn’t?

So Goldman’s chief U.S. economist Jan Hatzius is out discussing the “lending shock” to come:

The impact of the U.S. mortgage market crisis on the underlying economy could be “dramatic” as leveraged investors may need to scale back lending by up to $2 trillion, according to investment bank Goldman Sachs.

… unlike stock market losses, which are typically absorbed by “long-only” investors, this mortgage-related hit is mostly borne by leveraged investors such as banks, broker-dealers, hedge funds and government-sponsored enterprises.

And leveraged investors react to losses by actively cutting back lending to keep capital ratios from falling — A bank targeting a constant capital ratio of 10 percent, for example, would need to shrink its balance by $10 for every $1 in losses.

“The macroeconomic consequences could be quite dramatic,” Hatzius said in the note to clients. “If leveraged investors see $200 billion of the $400 billion aggregate credit loss, they might need to scale back their lending by $2 trillion.”

“This is a large shock,” he said, adding the number equates to 7 percent of total debt owed by U.S. non-financial sectors.

Hatzius said such a shock could produce a “substantial recession” if it occurred over one year, or a long period of sluggish growth if it occurred over two-to-four years.

That’s basically the simple deposit multiplier, working backwards (and outwards). Don’t be surprised if, as this becomes a problem, the Fed starts following the lead of the Brits and begins messing with the structure/rules of fractional deposit banking. Given that they’ve bent some very sensible rules already (I should check to see how temporary that change became), I shouldn’t be the least bit surprised. We’re not their friends, after all – Wall Street is.

I realise that I have a bad attitude about Paulson – but this is precisely among the reasons why. He acts, now, as though he was never around when all of this shit was being aimed at the fans in the first place. All he seems to do now is big up the dollar while everyone else can plainly see that (a) it’s sinking, and (b) nothing is being done about it. Quite the opposite.

China has cooked up an answer: trying to re-export our own inflation, are you? Well:

Chinese lunchtime television on Friday gave ordinary people a basic tip on how to play the currency markets: sell the dollar!

A state news program, quoting unnamed “wealth management experts,” told residents with dollar accounts on the mainland to convert their holdings into yuan or a range of other foreign currencies, including the pound and the euro.

The Chinese people, as individuals, hold less than USD200bn of the stuff, we’re told – not a patch on the potential of a USD1.4tr sovereign wealth fund that the Chinese people, as a government, have on hand. That is properly frightening. It is not a good sign, though. For a start, if China is telling its own people to drop dollars, is there something they know that they aren’t telling us?

Not that I blame them (a reference again to Paulson and his – one should say former – cronies). I mean, just who are we, anyway, to lecture anybody on transparency?


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