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4 CREDIT BUBBLE
BULLETIN QE
forever Commentary and weekly watch by Doug
Noland
"Congratulations Mr Bernanke. I'm
happy, my assets' values go up. But as a
responsible citizen I have to say the monetary
policies of the US will destroy the world." -
Marc Faber, investor, analyst and writer
extraordinaire, September 14, 2012, Bloomberg
Television
The S&P 400 Mid-cap Index
enjoyed a two-week gain of 5.7%, closing on Friday
at a record high. The small cap Russell 2000
gained 6.5% in nine sessions, with the Nasdaq
composite up 3.8%. Notable sector gains included
the 16.1% two-week surge by the S&P 500
Homebuilding index (up 99% year-to-date). The KWB
Bank index jumped 9.4% in two weeks, increasing
2012 gains to 31%. The Morgan Stanley Cyclical
index rose 8.1% over the past nine sessions. The
Morgan Stanley Retail Index gained
6.2% in two weeks and
closed the week at a record high (up 23.5% y-t-d).
Gains have certainly not been limited to the US.
Spain's IBEX 35 index has gained 14.7% in 10
sessions, outgained by the 14.9% rise in Italy's
MIB index. Germany's DAX has gained 10.9% in two
weeks to increase y-t-d gains to 25.7%. India's
Sensex enjoyed a two-week gain of 8.8%, with South
Korea's Kospi up 7.0%, Brazil's Bovespa up 9.4%
and Mexico's Bolsa up 7.2%.
On Thursday
morning, as markets waited anxiously for the
release of the rate-setting Federal Open Market
Committee policy statement, a CNBC anchor noted
that a Twitter "Bernanke" imposter had tweeted
something along these lines: "I put my pants on in
the morning just like anyone else, one leg at a
time. And when I have my pants on - I print
money!"
If I can chuckle perhaps it will
hold back the tears. It's difficult not to be
reflective - to ponder how things could ever have
come to this.
Thursday was another
historic day for policymaking, for markets and for
the perpetuation of history's most spectacular
financial mania. In the past I've noted that, in
comparable circumstances, I have viewed my 14-year
weekly chronicle of history's greatest credit
bubble as pretty much a great waste of effort. I
have tried to warn of the dangers of an unanchored
global financial "system". I've done my best to
illuminate the dangerous interplay between an
unwieldy global pool of speculative finance and
aggressive "activist" central bankers. I have
forewarned of the perils of discretionary (as
opposed to rules-based) policymaking - in
particular highlighting the (long ago appreciated)
fear that too much discretion ensures that
monetary policy mistakes will only be followed by
yet greater mistakes. I took strong objection to
Bernanke's doctrine and framework when he arrived
at the Federal Reserve in 2002 and protested in
vein when he was appointed its chairman in
early-2006.
In my initial Credit Bubble
Bulletin back in 1999, I tried to explain how an
unfettered explosion of non-bank liabilities was
fueling a dangerous credit bubble. Back then, the
consensus view held that "only banks created
credit". What little bubble analysis that existed
at the time focused chiefly on Internet stocks. I
was arguing that a radically changing financial
landscape called for a new "Contemporary Theory of
Money and Credit". I also warned that new finance
beckoned for judicious monetary management. Some
years later (2007) Pimco's Paul McCulley
introduced the world to the phrase "shadow
banking".
I've never been fond of the term
"shadow banking", believing that the entire line
of analysis was missing (avoiding) the most
critical aspects of contemporary finance. From my
analytical perspective, the issue was not so much
that there were financial entities and
institutions operating outside traditional banking
channels and regulation. Rather, the momentous
transformation of financial sector liabilities
from ("staid") bank loans/deposits to ("dynamic")
marketable debt instruments/obligations was
altering traditional relationship between finance,
the financial markets, asset prices and real
economies.
Importantly, unfettered credit
expansion was being driven by an explosion of
securities and instruments changing hands - at, I
might add, ever higher prices - in increasingly
over-liquefied and ebullient markets. Certainly
not coincidentally, this was unfolding
concurrently with the unprecedented proliferation
of hedge funds, proprietary trading operations,
derivatives and so forth. Our central bank was
oblivious.
The confluence of
proliferations in marketable debt and leveraged
speculation profoundly altered the financial
landscape. Fundamentally, there were no longer any
restraints on Credit expansion. The old
"fractional reserve banking" "deposit multiplier"
was supplanted by the "infinite multiplier"
associated with contemporary marketable credit.
Essentially, speculative financial
leveraging created an unlimited supply of
credit/marketplace liquidity. Unlimited supply,
then, led to a wholesale mispricing
(under-pricing) of finance. This was particularly
problematic for asset markets, where the
over-abundance of cheap credit fueled asset price
inflation. Higher asset prices, then, created
heightened demand for additional credit, which was
satisfied at ongoing low borrowing costs.
As credit will do if not restrained, it
all became self-reinforcing - or "recursive". And
as the quantity of unlimited, mispriced and
asset-centric credit exploded, resources
throughout the entire economy were badly
misallocated. A decade or so ago I explained the
dangers of "financial arbitrage capitalism".
Somehow, the notion that our system needs only
greater quantities of mispriced and misallocated
finance has yet to be discredited.
It was
apparent by 1999 that the Alan Greenspan Federal
Reserve needed to respond aggressively to the
changed financial landscape. The non-bank lenders,
especially the government-sponsored enterprises
(such as Fannie Mae and Freddie Mac), Wall Street
firms and hedge funds, needed to come under more
intensive regulation. Either that or Fed monetary
management had to tighten significantly as part of
a policy of "leaning against the wind" of rampant
credit expansion and associated asset inflation
and bubbles.
Mounting systemic excesses
were beckoning for tough love - but the Fed became
comfortable doling out candy. It was always my
hope that the Federal Reserve would eventually
appreciate and respond to the increasingly obvious
dangers associated with contemporary unfettered
credit and financial leveraging. As of
approximately 12:30 pm Thursday, the little sliver
of remaining hope was officially pronounced dead.
Instead of moving prudently to rein in
egregious credit and speculative excess, the
Greenspan/Bernanke Fed's went in the opposite
direction and repeatedly provided extraordinary
accommodation. Amazingly, each bursting bubble led
to only more aggressive monetary largess and more
power for dysfunctional (bubble-prone) markets.
Thursday's policy move by the Bernanke Fed
essentially indicates full capitulation to what
has become a highly speculative global
marketplace. There is at this point no doubt in my
mind that we are witnessing the greatest monetary
fiasco ever.
In early-2009 I pleaded,
"While I understand the necessity of stemming
financial collapse, please don't go down the
policy path of fueling a Treasury and government
finance bubble - one at the very heart of our
credit system." Never at the time could I have
imagined the extent to which the Bernanke Fed
would be willing to inflate history's greatest
bubble.
Chairman Bernanke has gone from
resorting to radical policies during a period of
acute financial crisis to one of imposing only
more radical policymaking three years into
recovery. He has gone from trying to stem credit
contraction to aggressively promoting rapid
(non-productive) credit expansion. Bernanke has
evolved from radical liquidity injections meant to
reverse marketplace illiquidity, to pre-committing
to years of open-ended money printing in the midst
of heightened inflationary pressures and
dangerously speculative financial markets. Of
course, justification and rationalization are
everywhere. History will be unkind.
I have
no reason to doubt the commonly held view that
Bernanke is a decent and honorable man. I wish he
was a scoundrel - then perhaps someone would do
something to rein him in. Many of our nation's
leading economist lavish praise on Bernanke latest
move, while some, amazingly, say he still hasn't
done enough. Quite regrettably, it will require a
terrible crisis for the establishment to change
policy doctrine, along with economic analysis more
generally.
There's no reasonable
justification for Bernanke taking such extreme
risks with financial and economic stability. And I
struggle to understand how he doesn't see the
likely consequences. After the cult of Greenspan,
I thought we had learned a lesson from having one
individual exert such power and influence. Indeed,
the Federal Reserve has now grossly overstepped
its role.
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