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4 CREDIT BUBBLE
BULLETIN Cliff drama
approaches Commentary and weekly watch
by Doug Noland
It's imperative to constantly
test one's thesis - in my case, an unconventional
view of the world of finance, the markets and the
global economy. Does one's analytical framework
help explain system behavior? Of course, various
perspectives come replete with biases, blurry
vision and potentially perilous blind spots. Often
it is too easy to simply see what one wants to
see. At the same time, a sound framework and
proper perspective create the opportunity for more
objective analysis. I'll add that history has
shown that this all becomes keenly relevant during
manias.
The US stock market has more
than doubled from 2009 lows. Financial conditions
seemingly couldn't be looser. November saw a
record US$165 billion of US corporate debt
issuance. This year will see near record corporate
debt sales. Junk bond issuance will
be a
new all-time high. System credit growth will be
the strongest since 2008. Recently, consumer
confidence has jumped to a four-year high. The
nation's housing markets are showing signs of
life. Gross domestic product (GDP) would be
generally OK, except for the matter of the
unprecedented fiscal and monetary excess necessary
to generate such limited economic expansion.
The
conventional bullish view holds that 2008 was the
proverbial "100-year flood". A new secular bullish
cycle has commenced that will, again, prove the
naysayers wrong. The bullish view holds that
Federal Reserve chairman Ben Bernanke's
unrelenting monetary stimulus in high regard. And
while most would claim they prefer an end to
fiscal profligacy, most also hold to the notion
that actual fiscal tightening should be done
gradually so as to not impinge the fledgling
recovery. There will be a more opportune time to
address fiscal issues later. Ongoing fiscal and
monetary stimuli are viewed as essential for
bolstering a post-bubble economy buffeted by
various headwinds from home and abroad.
The
bearish thesis perspective sees things altogether
differently. Fundamentally, I disagree with the
post-bubble backdrop premise - and not for the
first time. When Bernanke emerged onto the scene
back in 2002 to fight so-called post-bubble
deflation, it was clear to me that aggressive
monetary stimulus would inflate the incipient
mortgage finance bubble. It became clear in
early-2009 that even more incredible fiscal and
monetary stimulus would inflate the fledgling
"government finance bubble". With today's
confluence of years of trillion-dollar deficits
and historically inflated bond prices, the benefit
of the doubt belongs with the bubble thesis.
It
was another eventful week in the realm of the
global government finance bubble. Here at home,
we're now less than 31 short days (counting
holidays!) from dropping off the "fiscal cliff".
This predicament has been on the horizon for many
months, though it's obvious that Washington has
not been dealing seriously with this issue. While
pundits have been quick to explain that both sides
are merely posturing, it appears that last-minute
negotiations are beginning with both sides somehow
miles apart.
The Democrats are emboldened,
while the Republicans are no less determined. One
side is focused on increasing taxes on the
wealthy, the other on spending cuts. In a world of
deep philosophical and irreconcilable differences,
it has all the makings of a tense year-end drama.
From my distant vantage
point, I ("master of the obvious") see a low
likelihood of meaningful spending restraint. The
serious entitlement spending issue will, not
unexpectedly, be left for another day - and then
another. Even Republican proposals have most
so-called "savings" occurring a decade out.
Not
surprisingly, at least from the "government
finance bubble" perspective, the previous huge
inflationary surge in federal outlays has
essentially become today's new baseline. Off the
table. Non-negotiable. Instead, "cuts" are
basically commitments to somehow - and in some
undetermined ways - reduce future (generally 10-20
years) expenditure growth.
Not
coincidently, dysfunctional fiscal policy was
conjoined last week with dysfunctional monetary
policy. Clearly, serious fiscal restraint will not
be forthcoming until the markets forcibly squeeze
it out of Washington. The bond and stock markets
should today be pressuring the administration and
congress - yet that's not in the cards with the
Fed talking $85 billion of monthly quantitative
easing starting in January.
Last
week, Bill Dudley, president of the Federal
Reserve Bank of New York, joined the ranks of Fed
policymakers signaling support for greater
monetary stimulus. At the same time, Dudley
confidently stated that "we will absolutely take
away the punchbowl when the time is right". Well,
I can state with confidence that the Fed
absolutely won't. Factually, the Federal Reserve
repeatedly hasn't (ie 1988, 1993, 1999, 2005/06).
Tuesday from Paul Volcker
(CNBC interview): "It's [when to remove stimulus]
a very hard judgment to make. Sometimes you'll be
wrong. But you've got to - I think that is the
chronic problem of any central bank because the
implication is you have to begin tightening before
the excess demand, before the bubbles, before the
inflationary process is under way because it's
more difficult if you're too late. But if you do
it, by definition, people are going to complain.
'Why are you removing the proverbial punch bowl
before the party's really gotten drunken?' But
that's what a responsible host does. He waters the
punch bowl in time.'"
I respect former Fed chairman
Paul Volcker. He is among a select very few with
real inflation-fighting credentials. Yet I also
don't believe he recognizes the nature of current
inflationary manifestations. Volcker warns of the
need for reducing stimulus before the
"inflationary process" commences, without
appreciating the monetary bubble already unleashed
by profligate Federal spending coupled with
profligate Federal Reserve monetary policy.
Dudley, Volcker and others
can surmise a timely removal of the punchbowl, yet
I recall Henry Kaufman arguing convincingly back
in 1999 that there would be severe consequences
associated with the Fed having badly missed its
timing. Little did we know at the time...
My
thesis remains that we are at the late-stage of a
historic multi-decade global credit bubble. At its
core, this monetary fiasco is about a failed
experiment with unconstrained global
electronic-based finance. Using history as a
guide, credit bubbles and associated manias tend
to turn highly unstable near a cycle's end. From
an inflationary cycle perspective, one can expect
increasingly desperate policy measures in a
fateful effort to sustain the unwieldy credit
boom. One would also hope to see more vocal
dissent from those opposing a further ratcheting
up of monetary inflation.
A
week ago, I profiled a refreshingly hawkish view
espoused by Jeffrey Lacker, president of the
Richmond Fed. I was encouraged further by similar
thinking last week from another prominent Federal
Reserve official.
On Tuesday from Bloomberg
(Stefan Riecher and Aki Ito):
Federal Reserve
Bank of Dallas President Richard Fisher said he
advocates putting limits on US quantitative
easing. The Fed could announce "a limit as to
how much we are going to acquire of treasuries
and mortgage-backed securities, say up to a
limit of X, up to a point where our balance
sheet reaches that," Fisher said... "It is my
personal preference to do it sooner than later,
perhaps at the next meeting." Fed officials plan
to meet Dec 11-12 to assess whether record
accommodation is fueling economic growth and
reducing 7.9% unemployment, and to debate
whether to extend the Operation Twist stimulus
plan, which expires next month. Fisher... has
been among the most vocal Fed officials against
more easing. Fisher said there are lessons to be
drawn from Germany's experience of
hyperinflation during the 1920s. While today's
situation is different and he wasn't suggesting
accommodative monetary policies would lead to
inflation, Fisher said they can't be left in
place forever. "There is no such thing as QE
infinity," he said. "QE infinity gets you into
trouble.'"
One can hope that perhaps
the more responsible Federal Reserve officials
have seen just about enough. Despite loose
financial conditions, booming debt markets,
strong/speculative risk markets, massive federal
deficits and robust system-wide credit growth -
the dovish contingent is nonetheless hell-bent on
significantly boosting its "money printing"
operations.
After Lacker's speech and
Fisher's comments, I was hopeful that the December
11-12 meeting of the Federal Open Market Committee
might provide the venue for the hawks to finally
take a stand. This hope was crushed (like a bug)
at 3:24 pm on Wednesday with the posting of Jon
Hilsenrath's "Fed Stimulus Likely in 2013" article
on WSJ.com: "Three months after launching an
aggressive push to restart the lumbering US
economy, Federal Reserve officials are nearing a
decision to continue those efforts into 2013 as
the US faces threats from the fiscal cliff at home
and fragile economies elsewhere in the world."
Hilsenrath's article
generously quotes ultra-doves John Williams (San
Francisco Fed president) and Charles Evans
(Chicago Fed president). It mentions the views of
Bernanke, Janet Yellen (vice chair of the Fed
board of governors) and Lockhart (Atlanta Fed
president). Curiously absent, however, was any
reference to Lacker or Fisher. Not a peep of any
internal debate regarding the size of the Fed's
balance sheet.
The article instead implied
the decision to loosen further had all but been
made: additional QE begins in January, with total
bond/MBS (mortgage-backed securities) purchases in
the neighborhood of $85 billion a month. After
trading down 100 points in the morning, the Dow
Jones Industrial Average closed Wednesday's
session up 107. The dollar, having seemed to catch
a Lacker/Fisher bid, reversed sharply lower. "Risk
on, Risk off" pivoted back toward risk on,
confident as ever in the policy-based liquidity
backstop. "Fiscal cliff" worries? Well, once
again, worry ensures more QE. It's become a bad
habit.
From my perspective, there's
ample confirmation that we're at the wild
"blow-off" phase of speculative market excess.
Whether we're late in the party - with markets
rather numb to the punchbowl - or whether there's
still more of the manic endgame to endure, only
time will tell. But it has reached the point where
monetary stimulus has much more impact on the
markets than it does on real economies.
From
a global perspective, the dismal economic news out
of Europe is unrelenting. From China comes more
stories and anecdotes of corruption and financial
rot. It is also worth noting that both India and
Brazil posted disappointing growth numbers last
week, even more notable since both economies have
stagnated in the face of ongoing rampant credit
expansion.
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