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3 CREDIT BUBBLE
BULLETIN You can intimidate
everyone Commentary and weekly
watch by Doug Noland
I used to think if
there was reincarnation, I wanted to come back as
the president or the Pope or a .400 baseball
hitter. But now I want to come back as the bond
market. You can intimidate everyone. -
James Carville, Clinton campaign
strategist, 1993.
Intimidating debt
markets back in 1993? How about nowadays? When
Carville paid reverence to the bond market, US
marketable debt totaled about US$16 trillion.
Non-financial debt was at $13.1 trillion, with
households on the hook for $4.2 trillion,
corporations $3.8 trillion, state and local
governments $1.1 trillion and the federal
government $3.3 trillion. The Fed's balance sheet
ended in 1993 at $424 billion.
Fast-forward to June 30, 2012. Total US
marketable debt ended
Q2 at about $55
trillion, an increase of 238% since 1993.
Non-financial debt increased 212% to $38.9
trillion. From 1993 levels, household debt jumped
207% to $12.9 trillion. corporations have boosted
borrowings to $12.0 trillion, an increase of 215%.
State and local government debt of $3.0 trillion
was up "only" 159%. Federal marketable debt ended
Q2 at $11.1 trillion, up 231% since 1993.
Total financial sector credit market
borrowings increased from 1993's $3.3 trillion to
$13.8 trillion, with asset-backed securities up
298% to $1.86 trillion,
Agency/government-sponsored enterprise securities
up 295% to $7.54 trillion, broker/dealer
borrowings up 437% to $2.05 trillion, and Wall
Street "funding corps" up 593% to $2.29 trillion.
Total outstanding corporate and foreign bonds
jumped from $2.05 trillion to $11.96 trillion (up
483%). The value of corporate equities rose 285%
from $6.30 trillion to $24.22 trillion. The Fed's
balance sheet inflated 580% to $2.88 trillion.
Since 1993, private pension fund assets
have grown 180% to $6.39 trillion. State and local
pensions were up 187% to $1.04 trillion. Nothing,
however, compares to the growth experienced by the
hedge fund community, which grew from about $50
billion in 1993 to recent estimates approaching
$2.2 trillion (growth of 4,300%). And,
importantly, the explosion in debt and financial
assets management has been a global phenomenon.
I have argued that economic structure
matters. I have further posited that a defining
feature of contemporary economies (especially with
respect to the consumption and services-based US
structure) is the capacity to absorb enormous
amounts of credit expansion/purchasing power with
little impact on traditional measures of consumer
price inflation. Moreover, I have attempted to
explain how, when credit expands, this finance
flows into the economy before much of it finds its
way out into the "global pool of speculative
finance". I have further argued that this
ever-expanding pool of unwieldy finance is this
credit bubble cycle's most dangerous inflationary
manifestation.
The Alan Greenspan Federal
Reserve sold its soul back during the 1998 bailout
of Long-Term Capital Management. Even prior to
1998, mortgage-guarantors Fannie Mae and Freddie
Mac had been playing the critical role as
liquidity backstop to the hedge fund community in
the event of market stress. I wrote some years ago
that speculators could take highly-leveraged
positions in mortgage-backed securities, confident
that the GSEs were at any time willing to pay top
dollar for this paper - especially during bouts of
market tumult.
The Federal Reserve took a
decidedly more "activist" approach to market
interventions during the 2001/2002 corporate debt
crisis and recession. After reading Bernanke's and
others' "inflationists" writings, I recall a
Credit Bubble Bulletin about a decade back where I
suggested that the Fed was determined to have
hedge funds unwind their short positions in Ford
and other corporate bonds - and furthermore entice
them into going (leveraged) long. And, sure
enough, the funds did adjust and made a ton of
money. The Fed was subtler back then, but
they were sowing the seeds for the recent backdrop
where they've essentially guaranteed anyone that
speculates in MBS or Treasury securities
(corporate bonds, municipals debt, equities?)
seemingly risk-free speculative returns.
I
was always impressed that former European Central
Bank (ECB) president Jean-Claude Trichet would
categorically - and repeatedly - state that "the
ECB never pre-commits on interest rates". The Fed
has for years now operated otherwise, believing it
advantageous to signal its intentions specifically
to the marketplace. This has proved quite
advantageous for some, but clearly much to the
disadvantage of system stability. The ECB seemed
to better appreciate that illuminating too much to
the speculator community would simply ensure
destabilizing speculation - and attendant bubbles
- based on the expected course of ECB
policymaking.
Betting on the predictable
path of Federal Reserve policy must by now be one
of the more lucrative endeavors in history. In a
CBB a decade ago, I made a flippant comment about
the financial and economic landscape, writing "The
titans of industry run money." Never did I imagine
back then that hedge fund assets were on their way
to $2.2 trillion, Pimco to $1.7 trillion and
Blackrock to $3.6 trillion.
Betting
successfully on Fed policy has created
billionaires. More importantly, those that have
played this extraordinary policymaking backdrop
most adroitly today control unimaginable sums of
financial assets - in the hundreds of billions and
even trillions. There's been nothing comparable in
terms of the concentration of financial power and
speculation since the late-20s.
Ironically, this historic financial
windfall even accelerated following 2008's near
financial collapse, as policy effects on financial
markets reached only greater dimensions. Those
that played it most successfully amassed only more
incredible fortunes. The stakes over just the past
few months have been enormous, and those with the
best sense - or, more likely, the best information
- of how things were going to play out in
Frankfurt and Washington added further to their
kitties, and, predictably, additional assets to
manage flow to the victors.
ECB President
Mario Draghi is clearly a very intelligent man. He
is an Massachusetts Institute of Technology
trained economist with the most impressive
credentials. He has decades of experience as a
professor, World Bank official and governor of the
Bank of Italy. Draghi was also a vice chairman at
Goldman Sachs for several years (2002-2005).
Clearly, Draghi understands markets and the
dynamics of speculative finance.
When he
warned against betting against the euro and
European bonds the marketplace took notice.
Amazingly, the ECB has gone from being adamantly
opposed to pre-committing on rates to openly
determined to pre-commit to huge open-ended market
interventions and price support operations. After
holding out, the ECB finally sold its soul - and
the speculators have been giddy.
Bill
Gross at Pimco has been rather open about it:
"We're buying what the Fed and ECB are buying."
And Gross and others have been buying Spanish and
Italian bonds, with a brilliant plan to sell them
back to the ECB at higher prices. There's a very
large global contingent keen to place such bets,
after similar trades in US Treasuries and MBS have
made gazillions.
In the face of alarming
economic deterioration, European debt has become a
hot commodity. The euro has become a hot currency.
Reuters reported Thursday that the euro zone is
considering a bond insurance plan. The idea is for
the European Stability Mechanism (ESM) to
"guarantee the first 20 to 30% of each new bond
issued by Spain". Friday from Reuters (Andreas
Framke): "The European Central Bank envisions
buying large volumes of sovereign bonds for a
period of one to two months once its 'OMT'
programme is launched ... "
From those
among us questioning how the euro can trade so
resiliently in the face of potential financial and
economic calamity, I have this thought: The Draghi
Plan has been in the process of transforming
Spanish, Portuguese, Italian and other problematic
debt into possibly the most appealing speculative
asset in the world today. After all, all this
paper provides relatively decent yields
(especially in comparison to bunds, Treasuries, or
securities funding costs), and now at least the
one-to-three year debt enjoys a commitment of
open-ended liquidity/price support from the ECB.
If the Draghi Plan does transform this
debt from a fundamentally attractive short to a
must-have speculative long in the eyes of the
powerful leveraged players, well, then the Draghi
Plan truly has been a "game changer".
There's a lot that will likely go really
wrong in Europe, perhaps even in the short-term.
Greece is an unmitigated disaster, and Spain is
running a close second. There was further dismal
economic news last week, most notably from France.
But that hasn't in the least diminished recent
keen speculative interest in European debt.
Indeed, ever since the Fed sold its soul,
I've often believed that the speculators became
adept at recognizing periods of rising systemic
stress and market vulnerability as opportunities
to load up on Treasuries and MBS. Then it becomes
a game: "OK Federal Reserve, make the value of
these securities (or spread trades) go up or we'll
dump them."
They haven't had to dump. The
ECB has similarly opened itself up to blackmail.
"Be ready with the OMT as promised - or we dump."
"Spanish and Italian politicians, play ball or
we'll dump." "Mr Weidmann and the Bundesbank, fall
in line - or we dump!" "All policymakers
everywhere, play or we dump." At least in Europe,
this is developing into one fascinating
multifaceted game of chicken.
Well, I've
been ranting for awhile now about the "biggest
bubble in the history of mankind". At this point,
things increasingly remind me of 1999 and 2006.
Bubble dynamics eventually reach a degree of
excess that is too conspicuous to deny. Yet the
stakes are so much greater today. The amount of
global debt is so huge and the quality so poor.
It's completely systemic and global. Dangerous
excesses have gravitated to the core of credit and
monetary systems.
Policymakers are now
"all in" in a desperate gambit to hold financial
and economic fragility at bay, and dangerously,
highly speculative markets seem determined to
extend their divergent path from economic
fundamentals. It's frightening how enormous and
enormously powerful dysfunctional global markets
have become.
WEEKLY WATCH The
S&P500 gained 1.4% (up 16.2% y-t-d), and the
Dow rose 1.3% (up 11.4%). The Banks were up 3.7%
(up 30.5%), and the Broker/Dealers were 3.2%
higher (up 2.4%). The Morgan Stanley Cyclicals
jumped 2.3% (up 13.3%), and the Transports rallied
3.1% (up 0.5%). The Morgan Stanley Consumer index
gained 2.0% (up 12.3%), and the Utilities
increased 0.7% (up 0.8%). The S&P 400 Mid-Caps
gained 0.7% (up 13.3%), and the small cap Russell
2000 rose 0.7% (up 13.8%). The Nasdaq100 was up
0.5% (up 23.5%), while the Morgan Stanley High
Tech index ended about unchanged (up 16.3%). The
Semiconductors added 0.3% (up 5.2%). The
InteractiveWeek Internet index gained 1.2% (up
15.4%). The Biotechs jumped 3.0% (up 47.0%).
Although bullion gained $9, the HUI gold index
ended the week unchanged (up 3.1%).
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