Page 1 of 3 CREDIT BUBBLE BULLETIN Abormal times Commentary and weekly watch by Doug Noland
The US Federal Reserve's balance sheet has expanded almost US$225 billion over
the past 16 weeks. International (global central bank) "reserve assets" have
jumped $1.5 trillion in 12 months. In just two years, "reserve assets" have
ballooned an incredible $2.6 trillion, or about 40%, to $9.3 trillion (reserves
were about $3.0 trillion to begin 2004).
There's been nothing comparable to this in the history of central banking - in
the history of "money". The resulting liquidity
onslaught has inflated global securities and commodity prices, distorted market
perceptions of risk and liquidity, depressed global yields and fomented
speculative excess in any market that trades. I have referred to this backdrop
as one of "monetary disorder".
Monetary disorder can certainly fester for some time under the facade of a
seemingly healthy environment. As we have witnessed, global equities prices
have been a prime beneficiary of global reflationary dynamics. And there is
nothing like the tonic of inflating stock prices to bolster confidence and
embolden the risk-takers. Ebullient markets, then, lead economic expansion and
provide seeming confirmation of the bullish point of view. Yet there is no
escaping the instability lurking just beneath the fragile surface.
It is said that hedge fund assets (and leverage!) have returned to pre-crisis
levels. Surely, global sovereign wealth funds have grown only more gigantic.
And it is worth noting that China's "reserve assets" have jumped 46% in only
two years to an incredible $2.847 trillion. The world is awash in
liquidity/"purchasing power" like never before. This is all worth keeping in
mind as we contemplate the likelihood of ongoing unrest in the Middle East and
potential supply and price shocks. The Goldman Sachs Commodities Index ended
last Friday at the highest level since August 2008.
The global liquidity and speculation backdrop ensures that any important
commodity facing potential supply constraint enjoys a propensity for
spectacular price inflation - a dynamic now appreciated by companies,
speculators and policymakers alike. This inflationary manifestation was really
taking hold back in 2008 before the onset of the global credit crisis. Of late,
it has returned with a vengeance throughout the agriculture commodities and
food complex. Yet, with stock markets booming and confidence running high, most
have been content to disregard this troubling inflation dynamic. The markets
last week abruptly turned somewhat less complacent (at least for a few
sessions).
The Middle East crisis took a decided turn for the worst last week, with the
eruption of violence and chaos throughout Libya. The markets now confront great
uncertainty as to how developments will unfold throughout the region. Recent
events certainly increase the probability for potentially problematic energy
supply disruptions and resulting price shocks. A fragile global recovery and
inflated markets create a susceptible backdrop, especially with optimism and
speculative zeal having become so prominent throughout global markets.
With crude (West Texas Intermediate) surpassing $100 - and with prospects high
that Middle East instability won't dissipate anytime soon - analysts are
scurrying to fashion views as to the impact surging energy prices will have on
corporate profits, consumer spending, inflation and global growth. To say that
unfolding circumstances create extreme uncertainty is no overstatement.
Last week, Saudi Arabia's King Abdullah announced plans to increase social
spending by $36 billion, including a 15% pay increase for government employees
and $10 billion for low-income housing. At the top of the list of oil exporters
(and with $440 billion of international reserves), Saudi Arabia enjoys unusual
capacity to ameliorate its underclass. The markets are watching Saudi Arabia
with keen interest, at this point confident that the kingdom has the capacity
both to hold social unrest at bay and to pump additional barrels.
To be a fly on the wall in Beijing ... Chinese policymakers must be intensively
analyzing developments throughout the Middle East. I'll assume they are taking
great interest in the House of Saud's approach to placating the masses. And
while China is definitely no Saudi Arabia or Egypt, there is simmering social
tension that provides authorities constant worry. China may not have a huge
unemployed youth problem, yet inflation and bubble economy dynamics have
engendered huge wealth disparities and attendant social instability.
To this point, policymaking has been straddling a fence. There has been a
certain determination to dampen home price appreciation and other bubble
effects in urban locations, while at the same time moving to significantly
increase minimum wages and boost construction of low-income housing. There has
been a focus on addressing real estate excesses, with the expectation that
adept economic management will allow this "tightening" to be accomplished
without sacrificing ongoing strong growth. This is the type of complex economic
management that nurtures a high risk of monetary mismanagement.
On Friday from Bloomberg News: "China may slow the pace of tightening
'significantly' in coming months as policy makers are likely to need time to
access the impact of the 'intensive and aggressive tightening' measures
introduced the past five months, Daiwa Securities Capital Markets Co. said ...
The political turmoil in some African countries and increased uncertainty about
the global economy should make China 'more cautious' about implementing further
tightening measures, according to the report by Mingchun Sun, analyst at
Daiwa."
First of all, the notion of what amounts to "intensive and aggressive
tightening" has evolved considerably since Paul Volcker manned the helm of the
Federal Reserve. With borrowing rates at about 6% and January bank loan growth
of $180 billion, China remains some distance away from tight "money". At the
same time, the view that recent events might provide the impetus for Chinese
authorities to take a more cautious approach to further "tightening" does
resonate.
From the perspective of my analytical framework, China is in the midst of its
"terminal phase" of credit bubble excess. I have posited that China, with the
extraordinary dimensions of its population, its underdeveloped north, and the
nation's $2.8 trillion hoard of reserves, has perhaps a unique capacity to
prolong its historic boom. I have also noted that it is generally typical for
policymakers to turn increasingly timid as the risks of bursting bubbles
compound. China has reached the point where it must move forcefully in order to
rein in excess or risk things running completely out of control. I have feared
that policymakers would along the way find reason to lose their nerve.
The recent surge in food and energy prices comes at a critical juncture for
global policymakers. The inflationary backdrop beckons for meaningful
synchronized monetary tightening. The seriousness of unfolding inflationary
risks is becoming difficult to downplay. Yet the Federal Reserve, the guardian
of the world's reserve currency, won't even slow its pace of quantitative
easing, let alone reverse course and tighten. Incredibly, global inflationary
dynamics do not factor into the Fed's policy framework. The Europeans have
begun to prepare the markets for an increase in rates, although when this does
occur it will hardly qualify as monetary restraint. The Bank of Japan won't be
raising rates anytime soon, and I wouldn't be surprised if other Asian central
banks actually step back a bit from their baby-step approach to rate hikes.
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