Page 1 of 4 CREDIT BUBBLE BULLETIN Speculation heaven
Commentary and weekly watch by Doug Noland
For the five quarters ended September 30, 2009, combined growth of federal
government (Treasury) borrowings and outstanding government-sponsored
enterprise-guaranteed mortgage-backed securities (MBS) jumped to an
unprecedented US$2.810 trillion. This massive growth/inflation of "federal"
finance was arguably one of history's great credit splurges. No discussion of
2009 is near complete without examining the government's momentous role in
stabilizing the US credit system and economy.
The Treasury was certainly not acting alone. Throughout the year - and despite
global market and economic recoveries - the Federal Reserve held short-term
interest rates down at near zero. Importantly, Fed holdings of mortgage-backed
ballooned from nothing to end the year approaching $1 trillion. This
unprecedented monetization reliquefied markets, pushed mortgage borrowing costs
to record lows, fueled a refinancing boom, and worked surreptitiously to
transform hundreds of billions of problematic "private-label" mortgages into
(market-appealing) government-backed securities.
When final year-2009 data is tallied, I would not be surprised to see combined
Fannie Mae, Freddie Mac, Federal Housing Administration and Ginnie Mae
government mortgage guarantees to have expanded as much as $600 billion to $700
billion (in a year of flat to down total mortgage debt growth). This massive
government intervention/nationalization coupled with zero rates stabilized the
securitization marketplace and stemmed the decline in national home prices.
The US economy notably lagged in spite of massive fiscal and monetary stimulus.
Even with the meaningful boost from "cash for clunkers", the best our
maladjusted economy could muster was a 2.2% third-quarter growth rate (preceded
by four straight quarters of negative growth). Third quarter nominal gross
domestic product (GDP) was still down 2.1% year on year. After beginning the
year at 7.2%, unemployment jumped to as high as 10.2% in October (before
declining to 10.0% in November).
The year 2008 saw the collapse of the Wall Street/mortgage finance bubble; last
year marked the full-fledged emergence of the global government finance bubble
and attendant global reflation. I have expected this reflation to be altogether
different from those of the past. The bursting of the Wall Street/mortgage
bubble brought an abrupt end to our housing mania and discredit to US
private-sector credit instruments - in the processes quashing powerful
inflationary biases so easily in the past manipulated by our central bank. It
is the nature of post-bubble reflations to neglect the burst bubble, fueling
instead new and increasingly unwieldy ones.
No longer will Fed rate cuts rapidly transmit into a cycle of huge home equity
extraction, a surge in real estate transactions, inflating home prices, surging
household net worth and spending, and self-reinforcing credit expansion. It is
worth noting that during the five quarters (ended September 30) of
unprecedented federal borrowings and policy-induced reflation household net
worth actually declined $6.6 trillion.
Moreover, the massive expansion of non-productive US credit further weakened
global confidence in the dollar. As we witnessed throughout 2009, the new
reflationary backdrop has liquidity inundating non-dollar asset classes,
certainly including the emerging markets and commodities. Not surprisingly,
foreign central banks began to more aggressively diversify away from US
financial assets and into hard assets.
I will suggest that 2009 marked a historic inflection point in global finance.
I have argued that years of policy mismanagement led to the breakdown in the
dollar reserve "system" - that for more than 60 years worked (with varying
success) to restrain global credit expansion. This year saw key
inflationary/reflationary biases move decidedly from the "core" (the US) to the
"periphery" (notably China, Asia, Brazil, India and the "emerging" markets).
Importantly, a discredited dollar and the prospect of ongoing US policy-induced
currency devaluation created a backdrop of extraordinary market accommodation
for "periphery" credit systems.
To an extent never before imagined, economies around the globe could partake in
aggressive fiscal and monetary stimulus, rapidly expand credit, reflate markets
and economies - and have little worry about currency vulnerability or an
outflow of speculative finance (a far cry from the 1990s). The world had
changed, and global asset prices were revalued based on a backdrop of expected
ongoing dollar devaluation and newfound resiliencies in credit systems and
financial flows to ("undollar") "periphery" economies and non-dollar asset
Chinese equities (the Shanghai Composite) ended the year with a gain of 80.0%.
While impressive, Chinese stocks finished last in the "BRIC" (Brazil, Russia,
India, China) sweepstakes. Russian (RTS Index) stocks surged 128.6% in 2009,
followed by Brazil's (Bovespa) 82.7% and India's (Sensex) 81.0% advances. Other
notable gains included Taiwan's 78.3%, Thailand's 63.3%, South Korea's 49.7%,
Indonesia's 87.0%, Argentina's 115.0%, Peru's 99.0%, Chile's 50.7%, Mexico's
45%, Turkey's 95.9%, Israel's 88.9%, Ukraine's 90.1%, Hungary's 73.4%, and
Emerging debt markets enjoyed a huge year. JPMorgan's Emerging Market Bond
Index ended the year with a 28% gain. After trading as high as 750, emerging
market debt spreads to Treasuries ended the year at 290 bps - the low since
pre-Lehman collapse. Mexico's dollar bond yields ended the year at 5.16% and
Brazil at 5.05%. Brazil, in particular, found itself in the unusual position of
being able to enjoy extravagant credit expansion simultaneously with low
interest rates and a robust currency. Credit systems around the globe have been
But it is China that resides at the very epicenter of global reflationary
forces. A $600 billion stimulus package and an incredible $1 trillion
first-half expansion of bank lending propelled a remarkable economic turnabout.
After slowing modestly to 6.1% annualized in Q1, GDP jumped back to almost 9%
by the third quarter. Some are now forecasting a return to double-digit growth
in 2010. For the first time, 2009 saw Chinese vehicle sales surpass those of
the US. Record credit growth also stoked the reemergence of real estate
inflation and rampant asset speculation.
It's my view that 2009 marked the onset of China's terminal phase of credit
bubble excess. The China bubble is enormous and it is historic. It's poised to
make Japan's late-eighties bubble era appear rather petite - and to perhaps
even rival the scope of the US credit bubble. Importantly, terminal phases of
excess notoriously create acute financial and economic fragilities. They tend
to foment perilous asset-market distortions; distribute wealth
poorly/inequitably; foster systemic malinvestment and structural impairment;
and create a financial/economic structure dependent upon unrelenting credit
expansion and speculation. Only determined policymaking - with a willingness to
pierce bubbles and live with the consequences - can stem what evolves into
powerful bubble momentum and an expanding constituency supporting uninterrupted
Chinese foreign reserve holdings jumped almost 20% this year to a staggering
$2.273 trillion. Overall, total global official foreign reserves inflated
almost $900 billion during 2009 to a record $7.732 trillion (a five-year gain
of 90%!). The Chinese, in particular, rummaged the world in search of
commodities and resource assets. Global reflationary forces certainly fueled a
spectacular 2009 for the traded commodities markets. The Goldman Sachs
Commodities Index surged 50.3%. Gold jumped 24.2% and silver surged 49.4%.
Crude oil jumped about 78% and gasoline surged around 93%. Copper gained 137%.
The so-called "commodity currencies" posted big gains this year. The Brazilian
real gained 32.7%, the South African rand 28.5%, the Australian dollar 27.6%,
the New Zealand dollar 25.1%, the Norwegian krone 20.0%, and the Canadian
Here at home, the Fed's zero interest-rate policy coerced US savers out of
money market funds, CDs and Treasuries and stoked a spectacular return to risk
markets. Stocks excelled and the riskiest stocks really excelled; junk
excelled; collateralized debt obligations excelled; leveraged loans excelled;
virtually everything excelled. It was a year of record flows into the emerging
markets. It was a record year of junk bond issuance. After trading as high as
1300 basis points (bps), junk debt spreads ended the year at a 2009 low of 536
bps. Investment-grade spreads dropped from 290 bps in March to end the year at
A stock market revival emboldened bullish analysis. Many speak of sound US
corporate balance sheets, disregarding the reality that this "strength" is a
direct consequence of the massive expansion of household and, more recently,
public sector debt. Many optimistically talk of de-leveraging, while the
government borrowing binge pushes total system debt further into uncharted
territory. With bank lending stagnant at best, US reflation is being fueled by
massive issuance of Treasury, corporate and municipal marketable debt
The year saw four million jobs lost. Yet there was little in the way of
readjustment to an economy that invests and produces more, consumes less, and
operates on a reasonable amount of credit. Indeed, the shift in (fiscal and
monetary) policymaker objectives from system stabilization to one of inciting
rapid market and economic recovery created an impediment to fundamental
This year was pivotal from the perspective of the "moneyness of credit." The
year 2008 saw the breakdown of "moneyness" for Wall Street credit instruments.
No longer did the marketplace trust this credit as a highly liquid store of
nominal value ("money"). This change in fortunes had a profound impact on the
capacity of this ("Ponzi finance") credit mechanism to expand sufficiently to
sustain both inflated asset prices and the underlying US bubble economy.