Conspicuous global liquidity excess. For the week, the Dow jumped 2.2%, and the S&P500 rose 2.9%. The Utilities gained 2.2%, and the Transports added 0.4%. The Morgan Stanley Cyclical index jumped 2.9%, and the Morgan Stanley Consumer index advanced 1.4%. The broader market was exceptionally strong. The small cap Russell 2000 jumped 3.7% and the S&P400 Mid-cap index gained 3.2%. Technology stocks were on fire. The NASDAQ100 surged 5.2%, and the Morgan Stanley High Tech index jumped 5.6%. The Semiconductors surged 7.7%, the Street.com Internet Index jumped 5.4%, and the NASDAQ Telecommunications index surged 6.8%. The Biotechs gained 3.6%. The Broker/Dealers rose 3.5%, and the Banks gained 2%. With bullion surging $23, the HUI gold index surged 9.2%.
For the week, two-year Treasury yields declined 4.5bps to 4.35%. Five-year government yields fell 3.5bps to 4.32%. Bellwether 10-year Treasury yields dipped 2bps for the week to 4.37%. Long-bond yields gained 2bps to 4.60%. The spread between 2 and 10-year government yields reverted 3 to a positive 2 bps. Benchmark Fannie Mae MBS yields dropped 9 bps to 5.66%, this week significantly outperforming Treasuries. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note declined 2 to 36, and the spread on Freddie’s 5% 2014 note declined 2 to 37. The 10-year dollar swap spread narrowed 3.5 to 51.5. Junk bond spreads were little changed. The implied yield on 3-month December ’06 Eurodollars dropped 8.5bps to 4.71%.
January 4 – Bloomberg (Caroline Salas): “The $5 trillion corporate bond market is becoming more perilous for investors, according to Wall Street’s biggest underwriters. U.S. companies are reversing a four-year trend of reducing debt that contributed to the lowest default rate since 1997, prompting warnings from analysts that companies…may penalize bondholders by squandering cash on stock buybacks and dividends or through debt-financed takeovers.”
The corporate bond market commenced the New Year with strong issuance of $21 billion (from Bloomberg). First quarter corporate debt sales are expected to be quite strong. For the week, investment grade issuers included HSBC $3.0 billion, Wellpoint $2.7 billion, Wells Fargo $2.4 billion, GE Capital $2.0 billion, Morgan Stanley $2.0 billion, Fortune Brands $2.0 billion, Monumental Global $500 million, TIAA Global Markets $500 million, Avon Products $500 million, John Deere $350 million, International Lease Finance $300 million, Oklahoma Gas & Electric $220 million and First Industrial $200 million.
January 4 – Bloomberg (Walden Siew and Francisco Alcuaz Jr.): “The Philippine government, the biggest overseas debt seller in Asia, sold a record $2.1 billion in dollar- and euro-denominated bonds today to fund its budget deficit… It exceeded the $1.5 billion of 25-year global bonds sold in January 2005. The government priced the 7.75 percent dollar bonds, which will mature in January 2031, to yield about 7.875 percent… The yield compares with 9.5 percent when the government last sold 25-year bonds a year ago.”
Foreign dollar debt issuers included Iraq $2.7 billion, Northern Rock PLC $2.0 billion, Turkey $1.5 billion, Philippines $1.5 billion and Vale Overseas $1.0 billion.
Japanese 10-year JGB yields dipped 3bps this week to 1.44%. Emerging debt and equity markets began the year just where they left off 2005. Brazil’s benchmark dollar bond yields sank 35bps to an astounding 6.55%. Brazil’s Bovespa equity index surged 6%, with a 52-week gain of 46%. The Mexican Bolsa jumped 5%, increasing 52-week gains to 47%. Mexican govt. yields added 2bps to 5.33%. Russian 10-year dollar Eurobond yields declined 6bps to 6.40%.
Freddie Mac posted 30-year fixed mortgage rates dipped one basis point to 6.21%, a 10-week low but up 44 bps from one year ago. Fifteen-year fixed mortgage rates were unchanged at 5.76%, and were up 55 bps in a year. One-year adjustable rates added one basis point to 5.16%, an increase of 106 basis points from one year ago. The Mortgage Bankers Association Purchase Applications Index declined 3.4% last week. Purchase Applications were down 1% from one year ago, with dollar volume up 1%. Refi applications jumped 8.3%. The average new Purchase mortgage dropped to $211,800, while the average ARM fell to $321,100. The percentage of ARMs declined to 28.8% of total applications.
Broad money supply (M3) surged $56.3 billion (week of 12/26) to a record $10.240 Trillion. Over the past 32 weeks, M3 has inflated $615 billion, or 10.4% annualized. Over the past year, M3 expanded 8.0%, with M3-less Money Funds growing 8.8%. For the week, Currency rose $2.8 billion. Demand & Checkable Deposits jumped $20.8 billion. Savings Deposits fell $15.5 billion. Small Denominated Deposits added $1.2 billion. Retail Money Fund deposits increased $10.5 billion, and Institutional Money Fund deposits jumped $11.9 billion (up $30.3bn in 3 wks). Large Denominated Deposits surged $29.4 billion. Over the past 52 weeks, Large Deposits were up $293.4 billion, or 27.2% annualized. For the week, Repurchase Agreements fell $5.2 billion, while Eurodollar deposits added $0.5 billion.
Bank Credit rose $10.1 billion last week to a record $7.505 Trillion (up $68.7bn in four weeks). Over the past 52 weeks, Bank Credit has inflated $741 billion, or 11.0%. Securities Credit declined $9.2 billion during the week. Loans & Leases expanded 13.0% over the past year, with Commercial & Industrial (C&I) Loans up 15.3%. For the week, C&I loans added $3.2 billion, and Real Estate loans gained $2.4 billion. Real Estate loans have expanded 14.2% during the past 52 weeks to $2.903 Trillion. For the week, Consumer loans rose $1.5 billion, and Securities loans jumped $14.0 billion. Other loans slipped $1.8 billion.
Total Commercial Paper jumped $11.7 billion last week to $1.660 Trillion. Total CP expanded $263.1 billion over the past 52 weeks, or 18.8%. Financial CP rose $10.9 billion to $1.519 Trillion, with a 52-week gain of $255 billion, or 20.2%. Non-financial CP added $0.8 billion to $141.7 billion, with a 52-week rise of 6.0%.
Total ABS issuance ended 2005 at $787 billion, up 25% from 2004’s record (from JPMorgan). Home Equity Loan ABS issuance of $516 billion was 23% above 2004.
Fed Foreign Holdings of Treasury, Agency Debt increased $4.5 billion to $1.523 Trillion for the week ended January 4. “Custody” holdings were up $179.3 billion over the past 52-weeks, or 13.3%. Federal Reserve Credit jumped $6.4 billion ($21.2bn in 3 wks) to a record $832.8 billion. Fed Credit was up 5.2% over the past 52 weeks.
The dollar index commenced 2006 with a 2.6% drubbing. On the upside, the South African rand jumped 4.2%, the Iceland krona 3.8%, the Polish zloty 3.6%, the Norwegian krone 3.5%, the Swedish krona 3.5%, and the Swiss franc 3.4%. On the downside, the Chilean peso fell 2.0%, the Argentine peso 1.0%, and the Israeli shekel 0.8%.
Commodities started the year with a bang, as the CRB Commodities index closed today at an all-time high. Copper this week traded to a new record high, gold a 25-year high, and sugar to an 11-year high. February crude oil jumped $3.17 to a 3-month high $64.21. February Unleaded Gasoline jumped 6.2% this week, while February Natural Gas sank 14.2%. For the week, the CRB index jumped 2.3%, with a 52-week gain of 21.7%. The Goldman Sachs Commodities index added 1.4% this week, with a 52-week rise of 38.2%.
January 3 – Bloomberg (Janet Ong): “China’s tax revenue rose 20 percent last year to a record 3.1 trillion yuan ($382 billion) as economic growth boosted corporate profits and spurred trade.”
January 5 – Bloomberg (Janet Ong): “China plans to optimize the structure’ of its record $769 billion foreign-exchange reserves as it seeks higher returns, the country's currency regulator said. The State Administration of Foreign Exchange plans ‘to actively explore ways of investing foreign exchange more efficiently,’ Hu Xiaolian, director of the agency, said…”
January 5 – Bloomberg (Janet Ong): “China’s central bank eased its target for growth in the amount of money circulating in the world’s fastest-growing major economy… The People’s Bank of China plans to restrict growth in M2, the broadest measure of money supply, to 16 percent this year… The 2005 target was 15 percent.”
Asia Boom Watch:
January 4 – Financial Times (Anna Fifield): “South Korea’s strengthening economy, a soaring stock market and a population increasingly keen on new investment products have coincided to make it the world’s busiest market for equity derivatives. Only a few years after stock index derivative products were introduced to Asia’s fourth largest economy, Korea has overtaken the US to record the highest turnover volumes globally, on the back of a stock market that repeatedly hit all-time highs last year. ‘While the world has been focusing on the strong growth in China and India, 2005 has turned out to be the year of Korea,’ says Andy Xie, chief Asia-Pacific economist at Morgan Stanley.”
January 3 – Bloomberg (Seyoon Kim): “South Korea’s exports are likely to rise 11.7 percent this year from 2005, the fourth straight year of double-digit growth, the Ministry of Commerce, Industry and Energy said. Exports are expected to rise to $318 billion, while imports will probably increase 13 percent to $295 billion…”
January 3 – Bloomberg (Shamim Adam and Chen Shiyin): “Singapore’s economy expanded at a faster-than-expected 9.7 percent annualized pace in the fourth quarter as rising global demand for digital-music players and video-game consoles spurred electronics exports. Growth accelerated from a revised 8.6 percent in the third quarter…”
January 4 – Bloomberg (Stephanie Phang): “Malaysia’s exports grew in November at a slower-than-expected pace as a week-long holiday disrupted shipments… Exports rose 11.9 percent from a year earlier…”
January 3 – Bloomberg (Jason Folkmanis): “Vietnam’s economy expanded last year at the fastest pace in almost a decade, led by gains in construction, tourism and telecommunications. Gross domestic product grew 8.4 percent in 2005… The figure is up from a 7.8 percent expansion in 2004…”
Unbalanced Global Economy Watch:
January 4 – Bloomberg (Craig Stirling): “Home-loan approvals by U.K. mortgage lenders reached the highest level in 18 months in November, the Bank of England said, as a pickup in Britain’s $6 trillion property market strengthened.”
January 5 – Bloomberg (Craig Stirling): “U.K. services such as information technology and communications grew at the fastest pace in 20 months in December, an industry report showed, suggesting Europe’s second-biggest economy may strengthen this year.”
January 4 – Market News: “German plant and equipment orders surged a real 21% in November from their level of a year earlier on much stronger foreign and domestic demand, the German machinery manufacturers’ association reported…Domestic orders were up 15% on the year, while foreign orders jumped 25%, VDMA said.”
January 5 – Bloomberg (Tasneem Brogger): “Denmark’s jobless rate in November unexpectedly dropped to the lowest since August 2002 as companies filled vacancies to meet demand. The jobless rate fell to 5.2 percent from 5.4 percent in October…”
January 3 – Bloomberg (Marta Srnic): “Russia’s manufacturing industries rose in December at the fastest pace in 18 months, paced by new orders as the economy grew for a seventh consecutive year…”
Latin America Watch:
January 2 – Bloomberg (Carlos Caminada and Andrew J. Barden): “Brazil’s trade surplus widened in December to its highest in five months, the government said. The surplus climbed to $4.35 billion in December from $4.09 billion in November…”
January 4 – Bloomberg (Eliana Raszewski): “Argentina’s annual inflation rate jumped to a 31-month high in December as a pickup in government spending and an increase in the money supply led companies to raise prices. Annual inflation accelerated to 12.3 percent compared with a 6.1 percent in 2004…”
January 2 – Bloomberg (Daniel Helft): “Argentina’s December tax collection surged 41.4 percent from a year ago led by soaring receipts from income taxes as the country's economy expanded for a third straight year.”
January 5 – Bloomberg (Matthew Walter): “Chile’s economy grew 6.1 percent in November from a year earlier as prices for copper, the country’s top export, rose to records and industrial production increased more than expected.”
January 4 – Bloomberg (Alex Kennedy): “Venezuela plans to spend $7.5 billion of international reserves this year on infrastructure projects such as subways, highways and electricity plants, Finance Minister Nelson Merentes said…”
Bubble Economy Watch:
January 3 – Reuters (Joan Gralla): “U.S. municipal bond issuance set a record in 2005, soaring to $405 billion despite rising interest rates, Thomson Financial said… This was more than 13 percent higher than in 2004, when sales totaled $357.1 billion. Last year’s debt sales by states, counties, cities and towns topped the record of $379.3 billion set in 2003.”
January 4 – Financial Times (Doug Cameron): “The world’s largest derivatives exchanges ended the year with record volumes. The all-electronic Eurex exchange retained its leadership by yesterday reporting a 17 per cent annualised rise to 1.25bn contracts in 2005. The Chicago Mercantile Exchange narrowed the gap with its German-Swiss rival, reporting a 34 per cent rise in annual volumes to 1.05bn contracts, buoyed by its core interest-rate futures and options and the expansion of foreign exchange products. Volumes at the Chicago Board of Trade, which went public in September, climbed 12 per cent to 675m contracts…”
January 4 – Financial Times (Amy Yee): “Sales of luxury condominiums fuelled New York’s housing boom in 2005, pushing up average prices for flats by 28 per cent to $1.2m, according to figures released today by the Corcoran Group… Buyers paid an average of $1.5m for condominiums in Manhattan in 2005 and $998,000 for co-operative apartments, representing increases of 25 per cent and 23 per cent, respectively, compared with 2004… New York’s notoriously pricey and competitive real estate market is expected to stay strong but will become more ‘normalised’ this year even as big Wall Street bonuses are spent during the first quarter. ‘Volume in 2005 was off the charts but the double-digit price increases will take a bit of a pause,’ said Pamela Liebman, chief executive of Corcoran. ‘Buyers are armed with cheque books but are not going into a buying frenzy. Anything perceived as overpriced is not going to sell.’”
January 4 – The Wall Street Journal (Michael Corkery): “Sale prices of condominiums and co-ops in Manhattan continued to rise last year, but there was a sizable decrease in the number of sales, according to reports by two of the city’s largest real-estate brokers. Corcoran Group reported the number of sales of Manhattan condos and co-ops dropped by about one-third from 2004 to 2005. Similarly, Prudential Douglas Elliman said sales slipped 27.2% in the fourth quarter compared with a year earlier.”
California Bubble Watch:
January 4 – “California’s housing production is expected to drop slightly in 2006 compared to the robust construction activity in 2004 and 2005, but still remain near 200,000 homes and apartments, the California Building Industry Association reported… The forecast, authored by CBIA Chief Economist Alan Nevin, projects that between 185,000 and 205,000 homes, condominiums and apartments will be built in 2006 - down from about 212,000 in each of the previous two years.”
Financial Sphere Bubble Watch:
January 4 – Dow Jones: “The Chicago Board Options Exchange saw a 30% increase in trading volume for 2005, its busiest year ever. In a press release Tuesday, the CBOE said trading volume rose to 468.2 million contracts from 361.1 million in 2004, which was the previous record.”
“Project Energy” Watch:
January 3 – Bloomberg (Alison Fitzgerald): “Rising prices for imported oil haven’t grounded the U.S. economy because many of the dollars flying out of the country have a return ticket. International investors, flush with petrodollars, have boosted their holdings of U.S. stocks and bonds by record amounts for two-straight months, according to U.S. Treasury Department figures. Members of the Organization of Petroleum Exporting Countries have increased their purchases of Treasury securities by 50 percent since the end of 2003, according to official figures that reflect only part of the oil cartel's holdings.”
January 4 – Bloomberg (Harris Rubinroit): “NRG Energy Inc. is seeking $8.8 billion of debt financing to help fund its purchase of electricity producer Texas Genco Holdings LLC, the fourth biggest utility takeover in the past year.”
Mortgage Finance Bubble Watch:
January 4 – Dow Jones (Janet Morrissey): “Manhattan’s commercial real-estate market wrapped up 2005 with its lowest vacancy rate in five years. However, asking rents continue to lag. A report, released this week by real-estate brokerage firm Colliers ABR, showed the vacancy rate stood at 8.7% at the end of 2005, the lowest level since December 2000…”
Global markets and economies enter 2006 buoyed by intense optimism. The tonic of abundant global liquidity has worked its magic. Almost across the board, economies are either booming or in upswings. Booming global equity markets are out of the blocks with a flurry, with emerging markets sprinting to new record highs. The great commodities bull market also shows little sign of waning (CRB index ends at all-time high today!); ditto for the global M&A boom and the global onslaught of Wall Street “structured finance.” Crude prices are defying all the talk of ample global supplies. Meanwhile, international interest-rate markets remain extraordinarily sanguine. In short, the Global Liquidity Glut continues to foster unparalleled loose financial conditions both at home and abroad – and securities markets are relishing it.
Not surprisingly, there is today keen analytical focus directed at Federal Reserve policy, the U.S. housing market, bond yields and the shape of the Treasury yield curve. A popular consensus view has taken shape that inflation and the Fed are both well under control, while housing is poised to cool significantly. Beloved Goldilocks has returned. Bond yields are said to have peaked (apparently concluding the most merciful of bear markets), and the lagged effect of restrictive Fed policies is working just as prescribed. While not necessarily arguing that all facets of consensus thinking are misguided, I do suggest that a Credit Bubble analytical framework offers a more fruitful perspective for what will surely be a most extraordinary year.
Last year was a seminal period for the U.S. Credit Bubble. Prudent Federal Reserve policy would have implemented sufficient rate increases to engender a much needed tightening of financial conditions and a commencement of an imbalance-rectifying adjustment processes. The soon-to-depart Fed chairman had other plans. Ongoing telegraphed baby-steps provided no impediment whatsoever to an overheated Financial Sphere; blow-off excesses were further accommodated. Mortgage Credit excesses went to only greater extremes; already unparalleled trade deficits ballooned; the global pool of speculative finance became only more massive; over-liquefied global markets became much more so; energy and commodities prices surged; and myriad Credit and speculative Bubbles took firm hold throughout. Bubble dynamics enveloped scores of markets, economies and financial systems, and this remarkable circumstance must now play a prominent role in how we analyze prospects for 2006.
As they say, “There is a thin line between love and hate.” Late-cycle excesses are as powerfully alluring and intoxicating as bursting Bubbles are devastating. Always, it is the euphoric indulgence associated with intense highs that set the stage for heart-breaking disappointment and revulsion. Major Bubbles surely can – and, let’s face it, have a propensity to - last for years. Forecasting the duration, pattern of evolution or the circumstance of their demise is too close to an exercise in futility. This, however, in no way detracts from the validity and utility of Macro Credit and Bubble Analyses. And it is a given that Macro Credit Analysis will be of greatest value when it is held in complete disrepute by the manic crowd.
As we look ahead to 2006, there are key aspects with respect to this most atypical financial backdrop that we understand with a high degree of confidence. For one, the U.S. Credit system is very much immersed in “blow-off” excesses. The extreme nature of asset inflation and leveraged speculation preclude the financial sector from safely turning back. We should instead anticipate great enthusiasm to justify, rationalize and perpetuate the boom. To be sure, the Credit system is primed for continued massive mortgage Credit growth (perhaps marginally below 2005’s record), robust corporate borrowings, and large government (Federal and S&L) deficits. We have, as well, a freshman Fed chairman openly inimical to reining in Bubbles; the marketplace is gaga.
The backdrop ensures extraordinary developments, although there is great uncertainty as to whether circumstances will be dictated by ongoing rampant Credit, liquidity and speculative excess, or the inevitable bursting of Bubbles. The best we can do is to diligently study developments on a daily and weekly basis. We should remain analytically open to 2006 scenarios that include intense market euphoria, stunning disappointment or a combination of both. We should certainly be prepared for much greater volatility across all markets, and I will not back away from the unfortunate proposition that financial crisis will be necessary to commence the inevitable adjustment process.
These days, the optimists have reasons for being as overly confident as they convey. They have been consistently rewarded with a resilient economy, rising asset prices (“wealth creation”), seemingly insatiable foreign appetite for U.S. securities, and financial markets impervious to the Fed’s “tightening” cycle. Besides, the bigger the Bubble the more cautious the policymaker. In a year that appeared unusually susceptible to financial dislocation (a highly leveraged and speculative Credit system - with a faltering currency and untenable Current Account Deficits - facing the specter of significantly higher rates), 2005 was about as financially tranquil as one could have imagined. Emboldened - and with happy visions of “gentle Ben” Bernanke positioned permanently next to the monetary spigot emergency release lever - the bulls can be excused for blind faith that the future is exceptionally colorful and bright. There is at this point hardened conviction that the pig-headed pessimists simply don’t appreciate the underlying soundness of the U.S. economy and financial system.
Well, the optimists remain contently oblivious to the fact that so-called “sound” fundamentals are acutely Credit excess dependent, interest-rate dependent, global leveraged speculating community dependent, and global central bank dependent. It is a shallow and fragile prosperity. The loathsome reality that we have sacrificed our self-sufficiency and destiny to prolonging this fateful boom is lost in The Muddle of Bubble Distortions and Disinformation. The story of 2005 was one of unparalleled U.S. and global Credit and liquidity creation that lifted most boats, while keeping ours inflated. This was not a scenario outside of the purview of Credit Bubble Analysis.
Contrarily, the sanguine consensus view for 2006 is one of slowing housing markets, tempered economic growth, and minimal inflation – one of a suddenly meek Credit Bubble, accommodating asset markets and an amenable Bubble Economy. Here, it is difficult to reconcile the bullish scenario with Late-Cycle Dysfunctional Monetary Process, Monetary Disorder and Bubble Dynamics. More likely, Credit growth again surprises on the upside; inflationary pressures continue to accelerate and expand; asset markets become increasingly disjointed and unwieldy; and the U.S. Bubble economy demonstrates more problematic distortions and imbalances.
The most intractable and parlous imbalance is the $800 billion U.S. Current Account Deficit. With bond yields remaining low and with the dollar rallying over the past year, the new paradigm view of an irrelevant U.S. Current Account has been emboldened. Yes, 2005 did give foreign central banks somewhat of a breather in their heavy-lifting accumulation of dollar claims. I expect this to be short-lived. If, as I suspect, considerable demand for dollars during 2005 was related to short covering, the unwinding of currency hedges and speculative directional trading - highly unstable supply/demand dynamics now leave the dollar susceptible to abrupt reversal. Has it already begun? Yield differentials may continue to lend some support to the greenback in the near-term, but the ongoing scope of U.S. Current Account Deficits combined with international bound investment/speculative flows are simply staggering (approaching $1 Trillion annually). Last year’s market developments only increase the risk of global currency crisis.
I hold in low regard the thesis that the symbiotic relationship between the U.S. consumption-based economy and (chiefly) Asian manufacturing economies ensures a stable recycling of U.S. dollar flows. There will come a point when foreign central banks question the advantages and prudence of further massive accumulation of dollar financial claims. Clearly, “emerging” economies have, from the extended boom, gained considerable confidence, suggesting that a large reserve war chest available to battle financial crisis is a much less pressing issue these days. It is also reasonable to assume that last year’s dollar rally temporarily relaxed the resolve to cap dollar exposure, setting the stage for some serious central banker soul-searching come the next leg down in the dollar bear market. The U.S. bond market assumes dollar weakness is bullish, although such a view becomes immediately suspect the day foreign central banks shy away from their dollar “buyer of last resort” role.
The Chinese are again indicating their determination to diversify (at least at the margin) their massive reserve holdings away U.S. securities. Not only will the Chinese now have the largest amassment of official holdings in the world, they operate within a unique set of economic, financial, social and political dynamics that will dictate a growing aversion to stockpiling dollar claims. First of all, their growth dynamics are increasingly directed inward (domestic consumption) and toward inter-Asian trade, with relatively less dependence on the U.S. Moreover, sustaining their economic growth engine (viewed as vital for national stability) will require ever larger supplies of crude oil and commodities in an increasingly supply-constrained world. Quite simply, there is compelling justification today for the Chinese to cash in some of their U.S. chips for things of real economic value, to be used in support of accomplishing ambitious national economic goals. I will also suggest that any creative theorizing with respect to the ongoing stability of the current global dollar recycling mechanism should today differentiate between the determined Chinese and our deferential allies, led by the Japanese.
Importantly, the massive pool of speculative finance and the general Global Liquidity Glut (foremost emanating from years of enormous U.S. current account deficits) ensure that anything on the Chinese shopping list will be immediately vulnerable to aggressive speculator “front running” and anxious hording by competing users. This, then, engenders the dynamic of ongoing robust inflation of energy and commodities, along with self-reinforcing relative out-performance versus the depreciating economic value of (inflating quantities of) dollar-denominated debt securities. The Chinese are surely cognizant of this dynamic. We should expect a more contentious China operating with keen determination in a broad spectrum of markets.
I will conjecture a bit with my view that the Chinese may have retreated somewhat from the energy markets during the second-half of last year, after crude prices had spiked higher. Perhaps they are back or are anticipated to return to ensure progress toward their goal of building a strategic petroleum reserve. Certainly, Europe and the rest of Asia are also today quite keen to accumulate crude inventories and procure secure future energy sources. Energy insecurity and the determination to rectify it will certainly be a major Issue 2006 and global theme for years to come. As such, I fully expect the fanciful notion of the “win-win” Bretton Wood’s II (stable dollar claims recycling) monetary regime will loose sway to the “zero-sum game” proposition of excess dollar claims as purchasing power to procure increasingly constrained crude oil and industrial metals supplies. The trend toward energy investment and precious metals holdings as a preferred store of value (to inflating quantities of specious financial claims) will only gain momentum. Indeed, the dilemma posed by the volatile interplay between accelerating energy and hard commodity shortages and the Global Liquidity Glut could easily unfold as A Critical Issue of 2006.
Considering the unparalleled liquidity backdrop and the powerful inflationary forces that abound, I find the continued fixations on “core CPI” as a measure of “actual inflation” and the yield curve as an economic barometer as rather dubious propositions. The story of 2005 in the U.S. was a Bubble Economy demonstrating steadfast and expanding inflationary biases. As we look to 2006, I expect the preponderance of local housing markets to remain resilient as long as interest-rates remain low. The most overheated markets are cooling, and there should be some tightening of Credit Availability at the fringe. Yet sales in the vast majority of local markets remain strong and price inflation significant, while the general financial backdrop is quite constructive. Job and income growth are clearly supportive. The energy boom will continue to support economic expansion, as will the booming export sector and hurricane-related rebuilding. All indications suggest continued Service sector expansion.
I will be surprised if there is much of a consumer pull-back in the near-term. And if financial markets cooperate, the economic surprise for 2006 could very well be the re-emergence of the technology investment boom/Bubble. It is a fundamental tenet of Macro Credit Theory that if the Financial Sphere is determined to expand Credit and sustain abundant marketplace liquidity – create purchasing power – the Economic Sphere will gladly find ways to spend it. It’s guaranteed! Barring market tumult, I see a significant probability that economic growth initially surprises on the upside.
It is today an analytical stretch to argue that the Fed has removed accommodation. It is a leap of faith to claim that previous “tightenings” will demonstrate a lagged effect. It is nonsense to invoke the analysis that the Fed has reached some “neutral” rate. But it is indisputable that financial conditions today remain exceptionally accommodative – perhaps the loosest ever both at home and abroad. Global Risk Embracement is extraordinary. Furthermore, the Financial Sphere’s proclivity for and capacity to intermediate risky loans into safe/“moneylike” instruments has never been stronger. Speculative impulses in the markets and "animal spirits" in the economy are both running exceptionally hot.
It is the nature of economic Bubbles to advance to a fateful state of exuberance; for market Bubbles to conclude with a destabilizing terminal “blow-off” phase. Distressingly, we are today faced with the reality that the norm would consummate the worst-case scenario for both the U.S. financial system and economy. As an analyst of Bubble Processes and Dynamics – as well as a student of financial history - I fear the worst-case is anything but a low-probability proposition. I never believed the tech Bubble was The Bubble. It is now clear that it was but a harbinger of things to come – a forewarning recklessly disregarded. More importantly, the technology Bubble served as a prerequisite for the policymaking, financial and economic backdrops capable of fomenting History’s Greatest Bubble.
I hope the “optimists” are right, but they won’t be. There are too many ways things can go wrong. The Bubble economy is unstable and will likely boom until it busts. The California housing market is a disaster in the making, although its initial weakness could very well foster lower general mortgage rates, spreading the inflationary scourge to other markets. The dollar is unsound and a disaster in the making, although – once again – dollar trouble could again manifest initially with lower market interest rates (ballooning central bank holdings coupled with speculator “front running” of Treasury purchases) and further marketplace distortions. I fear emerging markets have become a main target of the global leveraged speculating community, exacerbating global system fragility. I fear the geopolitical backdrop and the unfolding clash for energy and commodity resources. I also worry about, of all things, the weather.
It is the nature of bull markets (asset inflation) to create their own liquidity, as it is for impetuous bears to savagely destroy it. Generally, inflation creates its own demand for Credit and - in this strange new world of contemporary finance – completely unrestrained Credit systems create their own (limitless) supply of new liquidity. There are today unprecedented avenues for Credit creation and few impediments. The upshots are today’s Global Liquidity Glut and a perpetual motion liquidity and asset inflation machine. Yet, the catch is that as Bubbles expand, disperse and multiply the amount of ongoing Credit and marketplace liquidity required to sustain the systemic Credit inflation expands exponentially. The now global U.S. Credit Bubble will be sustained only by enormous ongoing Credit and speculative excess. And it is also the case that Credit booms turn most fragile when they appear most powerful. Seemingly endless liquidity can vanish as quickly as a speculator’s nerve.
Euphoria, greed, confidence, and marketplace liquidity are notoriously flaky and fleeting things. You certainly would never wager the world on them. I have warned repeatedly of the great dangers associated with leveraged speculation evolving into the key source of liquidity for the financial markets and economy. Well, this dynamic has enveloped the globe – the entire world! Our policymakers have done the unthinkable; they’ve kept betting over and over - double-or-nothings - until they bet – yes – the entire world. What a stunning, extraordinary and distressing development. It’s going to be a wild, exciting and, likely, historic 2006. To my loyal readers, I promise to do my best when following, analyzing and commenting on developments. As a Macro Credit and Bubble analyst, I am a kid in a candy store and more than willing to endure stomach aches and a mouthful of cavities.