THE “LAST WAR”? LET’S HOPE SO….
We might as well buy some marble and hire a good engraver. The Fed and central banks around the world have all but written the epitaph of the next great boom bust period in global history. It will be a liquidity driven “recovery” that pales in comparison to the boom bust cycles we have previously created. The problem this time around is that it’s likely too boom in all the wrong places while the continued bust occurs across the entire consumer spectrum….
In the 90’s & 00’s it was the Yen carry trade that helped so many investors and liquidity junky’s leverage up on what seemed like near risk free returns:
The Federal Reserve compounded the problems that the Bank of Japan created when they too added their own bit of carry to the market via the form of easy monetary policy. Of course, the results have been spectacular (in both good and bad ways). The added liquidity has created some of the greatest bull markets imaginable (not to mention a few memorable bears). Unfortunately, the men wielding the power of this liquidity were unaware of its potency and even less capable of containing it. I fear Ben Bernanke has opened Pandora’s box (or Greenspan’s box) one too many times and though the results have surely been miraculous in the near-term it is unlikely that this liquidity glut will end any differently than the last few. The major difference between this boom and past booms is that central banks around the world are mishandling the power of liquidity (as opposed to one or two).
Deutsche Bank elaborates on the potential outcome:
Will global excess liquidity continue to rise in the wake of expanding central bank balance sheets? Or will global excess liquidity be cut back due to softer lending?
The very recent re-acceleration of narrow money (M1) growth was driven primarily by rapidly expanding central bank balance sheets. This is particularly true of the US. Noticeably, US commercial banks are currently reported to hold deposits at the Fed worth almost 6% of US GDP, a steep increase from an average of 0.3% of GDP over the past two decades. These sizeable excess reserves by US commercial banks with the Federal Reserve suggest that the Fed’s extra-liquidity injections have not (yet) been transformed into new credit and hence money. Rather it has mostly stayed within the US banking sector for now, pointing to frictions in the credit creation process.
Although the central banks’ extra-liquidity injections are at the moment urgently needed to support the banking sector, the credit channel and hence the overall economy, they involve the risk that credit and money could surge at a future point in time to undesired high levels once the economies and hence lending stabilise again. Therefore, central banks need to pull the extra money out of the system when the credit multiplier process normalises eventually and before it starts running hot. Should the CBs exit strategies succeed, then the current extra-liquidity injections might overall be beneficial for the economy because they would support credit at times of financial turmoil without boosting credit and money to unsustainable, excessively high levels over the medium to long term.
Although central banks should be able to withdraw large parts of their (temporary) extra-liquidity programs by simply not rolling them over, the central banks’ commitment as well as timing remains crucial for success. Moreover, some nonstandard central bank measures (such as the Fed’s outright purchases of US Treasuries, agency debt as well as mortgag ebacked securities or the ECB’s outright purchases of covered bonds) might be more difficult to reverse quickly. Although central banks have a wide range of possible instruments to re-absorb today’s extra-liquidity injections whenever this becomes necessary at a later point, only the future will tell whether they started to act in a timely fashion. Given that central banks will try hard to avoid any further setback in economic activity, monetary policies could again turn out to be too accommodative for too long.
There are a number of different outcomes that could occur here. Scenario 1 would involve hyperinflation as central banks around the world fail to rein in excess liquidity. In this scenario precious metals, raw materials and stocks would all explode to the upside. The dollar would crumble, your savings accounts would get obliterated and bonds would deteriorate substantially. Think every gold bug’s dream.
Scenario two is the inverse and would be a deflationary environment where the massive debts built up over the past 20 years continue to crush U.S. consumers, capacity utilization remains low and de-leveraging continues for years. Think Japan redux. The dollar and bonds soar while most other assets crumble. I don’t see either scenario specifically occurring.
What I fear will occur here is scenario three: inflation and deflation. More specifically, inflation in the assets we need (think gasoline, consumer goods) and continued deflation in the assets we own (think housing and stocks). Many investors are arguing over the inflation versus deflation debate without recognizing that both can occur in various asset classes. While the liquidity glut is likely to cause inflation in commodities, the continued de-leveraging in the consumer sector is likely to cause deflation in many other assets.
Further compounding the problems at the central bank is the emergence of a U.S. dollar carry trade. Strategists at various firms have been recommending a carry trade using the U.S. dollar. Investors will effectively short dollars, purchase higher yielding currencies and use the proceeds to speculate on various assets – most likely inverse dollar plays such commodities. This could compound the Fed’s issues as they fight to reflate the assets we own. In essence, we would get inflation in the assets we need while high unemployment, stagnant wages and low capacity utilization keep a lid on the assets we own.
As Anna Schwartz said, the Fed is fighting the “last war”. The Fed has vowed to print our way out of this mess while allowing mistakes to go unpunished. The long-term bulls are dancing in the streets in recent weeks despite stock prices that are still 30% off their highs, 10% unemployment and housing prices that are 30% off their highs. Don’t lose sight of the forest for the trees here. This isn’t a sprint we’re experiencing, it is likely to be a marathon. They say history has a way of repeating itself and this movie looks like one I’ve seen one too many times before….The best thing that might result from all of this is that Ben and company actually are fighting the “last war”. Rather, the “last war” we allow them to so foolishly start….
Amen!
A crowded short the dollar carry trade could result in a snapback, with the dollar rising quite quickly. This of course would result in a commodity sell-off, bringing down stock markets. In the intermediate term, or perhaps more long term, you may be right, that commodities do take off further, as a “play” on a declining dollar. However, with overcapacity and declining demand, the fundamentals certainly do not support increasing prices in commodities – aside from the “fundamentals” of currency speculation. Furthermore, higher commodity prices increase cost not only for consumers but also the cost of production. Higher production input prices rise results in a further squeeze on corporate profits, as higher prices get stuck in the pipeline and can’t be carried over to higher consumer prices due to a lack of demand. A feedback loop then ensues, with demand declining further, pressuring commodity prices down.
We live in a time when various and even contradictory scenarios can be perceived. This reflects the degree of uncertainty and inherent instability, due to deep rooted, structural imbalances that span the globe. Such conditions provide for a degree of unpredictability that leaves us all striving to get a handle on just what is unfolding and where it will take us.
Edward Griffin wrote a book “Creature from Jekell Island”. It talks about the history and the legacy of the Federal Reserve, how it formed after the financial panic of 1907. Very interesting read. Lots of people thinks that the Federal Reserve is a branch of the government. Griffin reveal them as a cartel of bankers.
Didn’t we see exactly this scenario during the spring and summer of last year. Rising commodities, rising consumer prices, falling dollar, stock markets having a hard time deciding which way to go. Emerging markets booming. Then credit collapse, quickly reversed all those trends.
Oil and commodities crashed hard, emerging market stock markets took the biggest fall. But none of these hit real fundamentally low levels. In previous recessions, oil prices adjusted today’s prices using CPI were in the low 20s. Commodities were much lower. Either the weak dollar prevented (and will prevent) further decline or a correction in commodity prices has not yet fully played out. Demand is at multiyear lows and supply at multiyear highs.
I have recently read predictions for oil prices that range from $20 to $95 per barrel.
Last year everyone seemed convinced that oil would not decline below $80 a barrel for a long time. Now even with speculation and dollar hedging oil has struggled to get back above $70.
If the secular trend is credit deflation, won’t that ultimately counteract the current short-term trend to rising commodities prices and rising stock markets? But at the same time, with lots of slack in employment market and very low capacity utilization one would think that there would be little upward wage pressure and therefore consumer price inflation would be muted.
The last? Maybe. But I don’t think so.
This inflation scheme is for alliance of Corporate America, Wall street and government to rob wealth from public, when there is no more place to grow their greed. This game can be played over and over again until 1. there is no more wealth left 2. People rebel to overthrow the alliance. Otherwise, they can reflate 10 more times and dollar lost 95% value, guess what? Most American still have a job and feel so good because they live better than most African.
http://www.youtube.com/watch?v=FXzAFnZvsxI
Perhaps rampant speculation results from having too much cash in the system and no productive use for that cash.
US consumers are in no shape to borrow and spend like they used to due to high unemployment and close to record high consumer indebtedness. Which leaves everyone who has cash without any productive use for that cash. The interest rates are so low that the so called safe investments aren’t worthwhile anymore. And this leaves only the financial markets to gamble in and try to profit from.
Perhaps that’s what all these wild up and down rides in commodities and stock markets are all about. There is too much monetary liquidity in the system. And it’s sloshing around wildly from one market to another, instead of trickling down to consumers and employers and stimulating sustainable economic growth. That drain that goes to consumers is plugged up by too much debt. And no monetary liquidity can go to consumers until they pay off a substantial part of their debts and unplug the drain so to speak.
Hyperinflation can result if the common people all of a sudden lay their hands on a lot of free money. Which isn’t likely to happen. And in absence of that, wild, speculative, up and down rides in various financial markets probably will continue rather than outright inflation that permanently raises prices for some assets.
Asset prices cannot stay high for long, when these assets don’t produce much income for those who own them. In speculative trading, people buy assets in order to sell them at a higher price to someone else. And that’s what makes the speculative markets so unstable. There are no long-term investors to provide stability. Everybody is trading short-term using various technical analysis signals. Which leads to herd behavior. Because everybody uses the same signals to buy all at the same time. And every body uses the same signals to sell all at the same time.
What is so bad about a little deflation? Japan is still a nice place after years of deflation. Not the least bit improverished. (It probably wouldn’t be 20 years if they just let the bubble deflate faster. Just get things over with.) Intel thrives in a world of deflation.
Ben and his central banking buddies should stop printing money and just let the damn bubble deflate once and for all.
Those who took on debt they couldn’t afford and those who irresponsibly underwrote the loans should be the ones who suffer. Instead Ben and his friends are rewarding those responsible for the debt bubble and its bursting and in turn letting the fiscally responsible suffer.
Dean,
Marc Faber doesn’t have a clue where the market is going next. He always hedges both ways. He is the same as everyone else.
The correlation to the dollar is clear, but the direction of the dollar is not.
I have been starting to think that if the unemployment report tomorrow surprises to the downside that it could send the stock market up sharply since it may send the dollar down. I assume the dollar weakness would be based on the assumption that the Fed would extend monetary easing. Both treasuries and stocks might rise. Usually they go in opposite directions. Something similar happened on the day of the Q2 GDP report. (But then the markets seemed confused, good headline number but horrible details.)
A stronger unemployment report might actually have the opposite effect.
Using my logic above if unemployment prints 10%. Dollar goes to 1.50 USD/EUR and the S&P to 1,200. Bizzaro world. If we get to 12% unemployment next year the market might just get back to 1,565.
Rob:
I hear you. My guess is that the unemployment is a positive surprise(the pattern lately) and we continue to trade the channel:
http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3186525&cmd=shows159825753&disp=P
inflation in the assets we need (think gasoline, consumer goods) and continued deflation in the assets we own (think housing and stocks).
There’s a rather deliberate effort to reengineer a bull market for housing, in an effort to fix the banking system’s balance sheet problem and to provide asset stability and a source of credit to the average consumer. (I could editorialize on the alternative that I would have preferred, but I’ll stick to being pragmatic.)
So I would say that housing deflation is highly unlikely over the medium term. Housing is already putting in a bottom in certain markets, and that bottom will take hold throughout most of the country over the next year or so. While skyrocketing prices aren’t in our near future, price stability is being created, and confidence and credit will create more demand in time.
Stocks are another matter. We may be entering a new phase in which recovery means lower GDP growth than what we’ve seen previously, as well as a higher structural unemployment rate. 2% growth and 6% unemployment may become the new normal, and if that occurs, earnings might reflect that in the form of lower growth rates.
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