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3 CREDIT BUBBLE
BULLETIN Sandy, Bernanke and
money Commentary and weekly
watch by Doug Noland
October 30, from Dr
Jeff Masters of Weather Underground:
In a stunning spectacle of
atmospheric violence, Superstorm Sandy roared
ashore in New Jersey last night with sustained
winds of 90 mph and a devastating storm surge
that crippled coastal New Jersey and New York.
Sandy's record size allowed the historic storm
to bring extreme weather to over 100 million
Americans, from Chicago to Maine and from
Michigan to Florida. Sandy's barometric pressure
at landfall was 946 mb, tying the Great Long
Island Express Hurricane of 1938 as the most
powerful storm ever to hit the Northeast US
north of
Cape Hatteras, NC. New
York City experienced its worst hurricane since
its founding in 1624, as Sandy's 9-foot storm
surge rode in on top of a high tide to bring
water levels to 13.88 feet at The Battery,
smashing the record 11.2-foot water level
recorded during the great hurricane of 1821.
The
Financial Times (Stephen Foley) Friday reported
that
Trillions of dollars of stock
certificates are feared ruined after Hurricane
Sandy flooded a vault at the Depository Trust
& Clearing Corp, the Wall Street-owned
organization that manages important parts of the
US trading infrastructure ... As businesses in
the affected areas continued efforts to pump out
flooded basements, the DTCC admitted on Thursday
that its vault remained underwater and officials
had still not been able to assess the
damage.
Of course, with loss
of life and such destruction, stock certificates
are the least of our worries. And the world
somehow survived with US equities markets
inoperable for a couple days. But, really, why not
a little forward thinking here? Today, millions in
the northeast wait for electricity, and the New
York area struggles with incredibly long gas
lines, widespread fuel shortages and emptying
grocery shelves. Phone service is intermittent,
while millions wait for subway and train service
to resume. In the past few days, estimates of the
economic damage from Sandy have doubled to as much
as US$50 billion. I'm no expert, but the scope of
devastation and associated economic costs would
appear to just dwarf Katrina.
In the face
of human hardship, the big debate seems to be
whether Sandy will be a positive or negative for
gross domestic product (GDP). Will rebuilding
provide a needed boost to the US economy? Is it
good for stock prices? In the end, does a
(Frederic Bastiat) "broken window" lead to wealth
creation? Keynes, of course, argued that in
desperate times the government should simply pay
workers to dig and fill holes. We have instead
incredible amounts of sand, debris and water.
My work focuses on risk. Sandy has been
called a "once in a lifetime storm", "a storm of
unprecedented proportions". It is worth noting
that of the top ten costliest storms (prior to
Sandy) to hit the US, eight (Katrina, Ike, Wilma,
Ivan, Charley, Rita, Frances and Jeanne) have come
over the past eight years. Allison hit in 2001 and
Andrew slammed Florida as a Cat 5 back in 1992. At
$108 billion, record Katrina (2005) costs are more
than triple those of runner-up Ike (2008).
As for size, at 945 miles (1,520
kilometers) of tropical force winds, Sandy is said
to be the largest ever to hit the US. Sandy is
followed by Igor's (2010) 920 miles, Olga's (2001)
865 miles, Lili's (1996) 805 miles, and Karl's
(2004) at 780 miles.
Storms have become
much bigger and the big storms much more frequent
and atypical. The associated costs have grown
exponentially. A decade or so ago, I would use my
fictionalized "little town on the river" parable.
I highlighted how a speculative bubble in flood
insurance led to a huge building boom along the
riverfront. From both financial and economic
perspectives, the boom distorted risk perceptions
and, in the process, momentously increased
systemic exposure to the inevitable devastating
flood.
I'll avoid the politics of climate
change. I just believe it has become a reality and
will profoundly impact our future. From my
perspective, global warming adds an important
additional layer of systemic risk upon already
historic global financial and economic risks. I am
amazed at how the world remains in this remarkable
mode of disregarding risks of all kinds.
I
admit to a fascination for weather and the issue
of global climate change. Perhaps it dates back to
my youth and love for watching how a big Pacific
storm system would unleash crashing waves on the
beautiful Oregon coastline. From my reading, a
major North Atlantic storm was inevitable - the
classic "when and not if". And the probabilities
were increasing by the year.
Hurricane
Irene (sixth most costly hurricane!) last year was
a warning unheeded. Some years back I casually
studied the flood maps for the New York region and
was quick to revisit them last week when the
National Weather Service warned of "Frankenstorm".
The vulnerability was well-understood, as were the
fragile levees in New Orleans prior to Katrina.
I'll let others explain why the northeast was not
better prepared. For me, it's part of a national
affliction.
From a market perspective,
Sandy was a so-called "tail" event - or "black
swan". Similar to the 2008 crisis, conventional
wisdom would claim it as both an unpredictable and
low probability occurrence. A "100-year" financial
crisis followed by a "100-year" storm - what are
the odds of that? Not worth worrying about - at
least beforehand. Yet I've argued that the 2008
crisis was predictable. Indeed, a catastrophic
bursting of the mortgage finance bubble was
inevitable; it was just the timing that was
unknown.
While the true long-term odds of
a Sandy or a bursting mortgage bubble scenario
were alarmingly high, the near-term probabilities
were viewed as quite low. And we live in a world
where the overwhelming focus is on the near-term.
Like the focus of financial market professionals,
it's imperative to keep one's eye on the ball:
what's going to happen next week or, for
politicians, the next election cycle? Endemic
short-sightedness comes with huge associated
costs, some visible right now on cable news.
After beginning 1990 at $12.8 trillion,
Total System Marketable Debt ended June 2012 at
$55.0 trillion. And Washington politicians and
central bankers are now doing everything they can
to sustain the credit boom and avert the downside
of an historic credit cycle. Similar efforts are
afoot globally. In Europe, we are witnessing the
dire consequences unleashed when the markets
resist buying suspect credit instruments. And,
importantly, when the credit spigot is inevitably
tightened, economic revelations soon follow.
Suddenly, economic structure matters. Is the
system generally robust or fragile? And if the
economy proves fragile, the systemic predicament
will soon be compounded by huge debt and
confidence issues.
From a credit bubble
and economic structure perspective, Sandy and
climate change are very relevant. The prolonged
credit boom has had a particularly profound effect
on the northeast. From beachfront homes and
mansions, to automobiles, marinas, boats, and
recreation and related businesses, the boom
greatly increased the potential for catastrophic
storm losses. This is in addition to the inflated
economy-wide cost structure that will see repair
and rebuilding costs profoundly higher than would
have been the case in the past.
I would
further argue that exorbitant costs are an
important reason why more was not done to protect
against a major Atlantic storm. The piper will now
require payment. Our economy's entire resource
allocation system has been so distorted for too
long. Finance flowed way too easily into home
building, recreation and consumption. Our nation's
infrastructure has been badly underfinanced and
neglected. This was made sadly clear with Katrina
and again with Sandy. Our nation's power grid is a
bad joke.
Insurance companies will take a
hit. From an economic perspective, a much greater
cost will be borne by the millions of individuals
and businesses impacted by Sandy and its
aftermath. There will be enormous uninsured losses
that will push many individuals, families and
businesses to - or past - the edge. The impact on
cash-strapped municipal governments is unclear,
although most analysts seem to assume that
Washington will be there with open checkbook in
hand. In the grand scheme of things, the
associated costs will barely impact the massive
federal debt load. Along with recession or, even,
subpar growth, Sandy will provide politicians
another reason to defer fiscal restraint.
But let's get back to climate change.
Unfortunately, the issue gets bogged down on
whether warming and associated extreme weather is
a manmade or natural phenomenon. As such, most
would surely argue that global warming and the
prolonged/increasingly vulnerable global credit
bubble are mere coincidental phenomena.
In
particular, my trips to China have left me fearing
an unfolding environmental catastrophe. In a sad
way, it doesn't really matter if global warming is
a human phenomenon or not. It's pretty clear that
no one is going to meaningfully confront the issue
anyway. Politicians, central bankers and
governments are trapped in "do whatever it takes"
late-cycle reflationary measures. You can bet on
it. Many have. And the global credit bubble
dynamic will ensure that the world remains
short-sided and blind to myriad serious risks
until it's too late.
We're today in the
midst of the manic financial bubble phase.
Especially here in the US, the markets will
finance virtually anything. There's hardly a junk
bond the market doesn't love. collateralized debt
obligations are back. Relatively higher-yielding
municipal debt induces salivation. There are,
then, no worries regarding the ability to finance
Sandy recovery and rebuilding efforts. Costs
really don't matter. Wealth destruction is
basically irrelevant. If it's "money" that's
needed, well, we've got the Ben Bernanke Fed.
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