I'll cut to
the chase somewhat and highlight three of the
major themes for what will surely be a tumultuous
and historic 2008: An ongoing bust in "Wall
Street-backed" finance; mounting recessionary
forces imperiling the US bubble economy; and
worsening global monetary disorder.
It is
a confluence of extraordinary developments that
will keep policymakers discombobulated and
impotent, with financial market participants
increasingly aghast at what they perceive as
ineffectual policymaking. This year will
fundamentally change the
Greenspan/Bernanke Fed's
(fallacious) doctrine that bubbles are to be
ignored because of the confidence in the
effectiveness of post-bubble "mopping up"
measures. Going forward, an appropriate "risk
management" approach to central banking will give
much greater weight to restraining credit and
speculative excess.
Last year was a
watershed year for both US and global finance.
Spectacular breakdowns in the gigantic markets for
Wall Street's "private label" mortgage
securitizations and mortgage-related derivatives
fundamentally and profoundly altered the financial
and economic landscape - for years to come. The
loss of trust in structured credit products'
ratings, pricing, leveraging, financial
guarantees, counterparties and marketplace
liquidity is an ongoing saga that will for some
time significantly restrain both credit
availability and marketplace liquidity.
US
risk asset market (financing and speculating)
dynamics have been altered and myriad bubbles are
in now jeopardy. Resulting recessionary forces are
so powerful I am confounded as to why the vast
majority of analysts and strategists maintain
ridiculously low probabilities for recession for
2008. It's on us. And a key economic Issue 2008 is
how rapidly and deeply the bubble economy falters,
a dynamic that will be greatly influenced by the
performance of the financial markets.
As
we begin 2008, I believe the US bubble economy is
unusually susceptible to stock market weakness.
Consumer confidence has waned right along with
home prices, yet I'll suggest that equities market
resiliency worked to support the general view that
US economic fundamentals remained sound.
Prolonging the equities market bubble also played
a role in cushioning the Credit market crisis.
Faltering stock prices will now batter fragile
consumer and debt market sentiment, creating a
spiral of market weakness begetting and
reinforcing economic weakness. Moreover, I expect
negative sentiment to be reinforced by what will
soon be a steady stream of headline-grabbing job
cuts, especially in the financial and retail
sectors. I would argue that, in the case of both
the stock market and corporate America, last
year's disregard for the true ramifications of the
bursting credit bubble will make for a more
problematic 2008 in the markets and otherwise.
Consumer spirits are certainly not being
heartened by headlines of US$100 crude oil. And
while the bloated consumer sector of the economy
will initially suffer the brunt of recessionary
headwinds, other dimensions of economic activity
(ie energy, alternative energy, agriculture, metal
and mining, and exports in general) will be
governed by powerful inflationary dynamics. Wall
Street is keen to ridicule the Fed's (or at least
a faction at the Fed Open Market Committee)
attention to inflation risk. The reality of the
situation is that global inflationary pressures
have become the most robust in decades. In 2008,
economies with weak currencies, huge trade
deficits and large imported energy requirements
will face outsized inflationary risks.
Attempting to illuminate dynamics
associated with today's problematic Global
Monetary Disorder, I'll use an analogy to the
mortgage finance bubble. The GSEs
(government-sponsored enterprises such as mortgage
finance institutions Fannie Mai and Freddie Mac)
with their quasi-government status, hence market
perceptions of superior debt quality, were for
years instrumental in nurturing market distortions
and powerful inflationary biases throughout
American housing markets (homes and mortgages).
By the time GSE accounting irregularities
brought an abrupt halt to their ballooning credit
expansion back in 2004, inflationary biases had
become more than sufficiently powerful to
accommodate the shift to massive issuance of Wall
Street-backed "private-label" MBS (mortgage-backed
securities). This credit onslaught was, at least
for awhile, sufficient to sustain the bubble. I
have discussed how Wall Street grabbed the
mortgage finance bubble "baton" from the GSEs (and
ran like crazed lunatics).
Well, US credit
bubble excesses - manifesting into asset bubbles,
unprecedented spending and "investment"
distortions, massive current account deficits, and
highly leveraged speculation - over a period of
years nurtured increasingly robust global credit
bubble dynamics. And just as mortgage/housing
inflationary biases invited wild and destabilizing
("blow-off") credit excesses from an emboldened
Wall Street, US bubble-induced global inflationary
forces (ie securities markets, energy,
commodities, and economies) have encouraged
domestic credit systems around the globe to
partake in an unparalleled global credit boom.
With few exceptions, double-digit credit
growth has become the global norm, with "BRIC"
(Brazil, Russia, India, and China) credit
expansion likely in the 20% to 30% range. To be
sure, "Wall Street" monetary disorder evolved into
an even more unwieldy strain of global monetary
disorder. Wall Street today wishes desperately
that the Fed would completely disregard global
issues and aggressively reflate. It is the nature
of bubbles that such easy-money policies would
work to exacerbate bubble excess, with minimal
impact on those that had already burst.
There are today great - and apparently
unappreciated - risks associated with aggressive
Fed rates cuts further aggravating global
liquidity, financial flows, and currency market
excesses and instabilities. This is not 2001/02 or
1998, and the current backdrop is the antithesis
of the early-nineties global "disinflationary"
backdrop that provided the Greenspan Federal
Reserve the flexibility to orchestrate a historic
banking system recapitalization and economic
reflation.
For one, the Fed today risks
inciting a crisis of confidence for our degraded
dollar and currency market dislocation more
generally. Second, there are the enormous
financial, economic and geopolitical risks
associated with the continuation of rampant energy
and commodities inflation. Third, aggressive Fed
rate cuts risk exacerbating increasingly
destabilizing financial flows (teaming with now
rampant domestically induced excesses) to Asia and
the emerging markets (Brazil, Russia, India and
China - in particular). The last thing an
increasingly unstable Chinese bubble needs is
another year of massive financial inflows. Fourth,
with monetary disorder and general inflationary
pressures mounting rapidly across the globe,
reflationary policies here at home today have a
much greater propensity for feeding into
traditional measures of consumer price inflation
than they’ve had in decades.
Returning to
my credit bubble baton analogy, it is instructive
to contemplate how precarious it became when Wall
Street-backed credit supplanted (quasi-govt) GSE
credit at the ("terminal") blow-off phase of
mortgage finance bubble excess. This period of
acute monetary disorder was fueled by unfettered
inflation (issuance) of Wall Street
securitizations conjoining with manic speculative
impulses. Inflating home prices, market euphoria
and accompanying economic distortions masked the
fundamental fragility of the underlying credit
instruments, debt structures and asset prices.
Today, similar dynamics enshroud acute
asset market, credit system and economic
vulnerabilities on a global basis. The US credit
system handed the global credit bubble baton to
domestic financial systems in the likes of China,
Russia, India, Brazil, the oil/commodity producing
economies, and the emerging markets more
generally. These immature and unsound
"contemporary" financial systems are today
perpetrating a credit fiasco paralleling US
subprime but on a much grander scale.
Keep
in mind that only deep-seated underlying US
systemic weakness (manifesting into massive
financial outflows and a depreciating currency)
could have engendered the profligate backdrop
where (fundamentally deficient) credit systems
across the globe could inflate with such reckless
abandon. The bottom line is that credit bubble and
"Ponzi" dynamics are working their seductive and
disastrous effects now on an unprecedented
international scale.
To those arguing that
aggressive Fed rates cuts pose inconsequential
risk, I have the following retort: "Only if you
exclude the risk of global financial and economic
collapse."
Analysts of the bullish
persuasion have been trumpeting the US economy's
resilience in the face of the "subprime" crisis.
As I have addressed over the past few months, our
bubble economy has been bolstered by significant
ongoing credit creation - even in the face of the
bust in Wall Street-backed finance. Importantly,
the liabilities of some key sectors have retained
their "moneyness" throughout the crisis, spurring
a rapid expansion of the thus far immune debt
instruments. Bank credit has expanded at a 16.1%
rate over the past 23 weeks and finished 2007 with
one-year growth of a record US$964 billion, or
11.6% (2-yr growth of 23.4%!). Money fund assets
ballooned at a 46% rate over this same 23-week
period (to $3.1 trillion), with one-year growth of
30.2%. Fannie and Freddie’s combined books of
business (BofB) expanded on average almost $55
billion monthly between March and November, in
what will be a record year of BofB growth. The
Federal Home Loan Bank System likely expanded
credit at a 30% to 40% annualized rate during the
second half, capping off what will also be record
annual growth.
The ongoing bust in Wall
Street-backed finance will undoubtedly be a major
Issue for 2008. No amount of Fed rate cutting can
reverse this spectacular debt collapse. The
fallacies of so many aspects of ''contemporary
finance'' have been exposed. Going forward, the
viability of many firms involved in Wall Street
risk intermediation will be in doubt. The
financial guarantors are in serious trouble. The
credit default marketplace will attempt to
forestall implosion. Problems that will beset the
colossal
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