More crosscurrents… For the week, the Dow declined 0.4%, and the S&P500 dipped 0.2%. The Transports jumped 1.7%, increasing 2006 gains to 7.5%. The Utilities dipped 0.2%. The Morgan Stanley Cyclical index declined 0.3%, and the Morgan Stanley Consumer index slipped 0.1%. The small cap Russell 2000 added 0.25%, increasing y-d-t gains to 9.7%. The S&P400 Mid-cap index dipped 0.1%. The NASDAQ100 added 0.5%. Technology stocks generally outperformed. The Morgan Stanley High Tech index jumped 1.75%, and the Semiconductors surged 2.5% (up 12.2% y-t-d). The Street.com Internet Index added 0.3%. The NASDAQ Telecommunications index jumped 3.6%, increasing 2006 gains to 16%. The Biotechs added 0.2% (up 9.5% y-t-d). The Broker/Dealers rose 0.5%, increasing y-t-d gains to 15%. The Banks fell 1.6%. With bullion up $6.35 to $565.40, the HUI gold index declined 0.5%.
March 2 – Dow Jones (Christine Richard): “A flood of foreign capital into U.S. dollar-denominated debt has some in the corporate bond market worried that the market's aversion to risk is getting washed away. Risk premiums over Treasurys on investment-grade bonds have been grinding tighter in recent months with the average spread on Lehman’s U.S. Corporate Investment Grade Index closing out February at 85 basis points over Treasurys, down from 95 basis points over Treasurys at the end of November. These skimpy risk premiums are being blamed, at least in part, on steady buying by foreign central banks and other overseas investors.”
February 27 – Bloomberg (Darrell Hassler and Prashant Rao): “U.S. Treasury investors are more complacent about the prospect of an economic shock causing volatility in the $4.2 trillion market than at any time in at least 17 years.”
Global yields on the move… For the week, two-year US Treasury yields added 3 bps to 4.75%. Five-year government yields rose 7 bps to 4.71%, and bellwether 10-year Treasury yields jumped 10 bps to 4.68% (high since June ’04). Long-bond yields surged 13 bps to 4.66%. The curved flattened 7 bps this week, leaving the spread between 2 and 10-year yields at a negative 7 bps. Benchmark Fannie Mae MBS yields rose 10 bps to 5.89%, this week outperforming Treasuries. The spread on Fannie’s 4 5/8% 2014 note widened one basis point to 34.5, and the spread on Freddie’s 5% 2014 note widened 1.5 bps to 36.5. The 10-year dollar swap spread increased 2.3 to 54.8. Investment-grade spreads narrowed slightly, and junk spreads narrowed to 6-month lows. The implied yield on 3-month December ’06 Eurodollars jumped 4 bps to 5.155%.
Investment grade issuers included United Healthcare $3.0 billion, Credit Suisse $2.25 billion, Comcast $2.25 billion, CIT Group $500 million, KeyBank $500 million, American Express $400 million, John Deere $350 million and GATX $200 million.
Junk issuers included Bon-Ton $510 million, Commonwealth Edison $325 million and Dave & Busters $175 million.
Convertible issuers included Arvinmeritor $260 million, Conexant Systems $200 million and Mentor Graphic $200 million.
Foreign dollar debt issuers included Mexico $3.0 billion, Indonesia $2.6 billion and Quebecor World $450 million.
March 2 – Bloomberg (Netty Ismail): “Indonesia raised $2 billion in its biggest overseas debt sale, taking advantage of falling borrowing costs after the government halted the rupiah’s decline. The yield the government will pay on the 10-year portion of the sale is almost 94 basis points less than what it cost in October to sell debt of similar maturity. Borrowing costs on emerging-market debt relative to U.S. Treasuries this week fell to the lowest ever.”
Japanese 10-year JGB yields added 3.5 bps this week to 1.62% (high since August 2004), as the Nikkei 225 index fell 2.7% (down 2.8% y-t-d). Emerging debt and equity markets generally diverged this week. Brazil’s benchmark dollar bond yields jumped 18 bps to 6.30%. Brazil’s Bovespa equity index rose 2.6% (up 17.3% y-t-d). The Mexican Bolsa added 0.5%, with y-t-d gains of 7.8%. Mexican 10-year govt. yields surged 23 bps to 5.60%. Russian 10-year dollar Eurobond yields gained 7 bps to 6.67%. The Russian RTS index added 1.5%, increasing 2006 gains to 32% (one-yr. gain of 112%). India’s major equity index jumped 3.9% this week, increasing y-t-d gains to 12.7%.
Freddie Mac posted 30-year fixed mortgage rates dipped 2 bps to 6.24%, up 45 basis points from one year ago. Fifteen-year fixed mortgage rates were unchanged at 5.89% (up 66 bps in a year). One-year adjustable rates rose 2 bps to 5.34%, an increase of 120 basis points from one year ago. The Mortgage Bankers Association Purchase Applications Index dipped 1.9% last week. Purchase Applications were down 2.6% from one year ago, with dollar volume 2.4% lower. Refi applications were about unchanged. The average new Purchase mortgage jumped to $230,900, while the average ARM was little changed at $337,900.
Broad money supply (M3) surged $54.1 billion to a record $10.335 Trillion (week of Feb. 20). Year-to-date, M3 has expanded at an 8.0% annualized rate. Over 52 weeks, M3 grew 8.5%, with M3-less Money Funds up 8.8%. For the week, Currency slipped $0.6 billion. Demand & Checkable Deposits jumped $20.5 billion. Savings Deposits gained $14.5 billion, and Small Denominated Deposits rose $4.3 billion. Retail Money Fund deposits added $0.9 billion, while Institutional Money Fund deposits fell $5.5 billion. Large Denominated Deposits increased $4.3 billion. Over the past 52 weeks, Large Deposits were up $271 billion, or 23.8%. For the week, Repurchase Agreements jumped $16.4 billion. Eurodollar deposits dipped $2.1 billion.
Bank Credit expanded $4.8 billion last week to a record $7.636 Trillion, with a y-t-d gain of $129 billion, or 11.2% annualized. Over the past year, Bank Credit inflated $665 billion, or 9.5%. For the week, Securities Credit increased $10.4 billion. Loans & Leases were up 11.6% over the past 52 weeks, with Commercial & Industrial (C&I) Loans up 14.3%. For the week, C&I loans added $3.9 billion, while Real Estate loans jumped $11.9 billion. Real Estate loans have expanded at a 12.0% rate y-t-d and 13.8% during the past 52 weeks. For the week, Consumer loans declined $2.0 billion, while Securities loans dropped $18.8 billion. Other loans slipped $0.5 billion.
Total Commercial Paper surged $22.9 billion last week to a record $1.704 Trillion. Total CP is up $55 billion y-t-d (9wks), or 19.2% annualized, while having expanded $270 billion over the past 52 weeks, or 18.8%. Last week, Financial Sector CP borrowings surged $20.3 billion to $1.566 Trillion (up $57.3bn y-t-d), with a 52-week gain of $275 billion, or 21.3%. Non-financial CP gained $2.6 billion to $138.6 billion, with a 52-week decline of 3.8%.
Asset-backed Securities (ABS) issuance increased to $16 billion (from JPMorgan), with Home Equity Loan (HEL) ABS issuance at about $8.0 billion. Year-to-date total ABS issuance of $127 billion is running 17% ahead of 2005’s record pace, and y-t-d HEL issuance of $85 billion is 22% ahead of last year’s record boom.
Fed Foreign Holdings of Treasury, Agency Debt (“US marketable securities held by the NY Fed in custody foreign official and international accounts”) jumped $7.5 billion to a record $1.580 Trillion for the week ended March 1. “Custody” holdings are up $60.8 billion y-t-d, or 23.1% annualized, and $201 billion (14.6%) over the past 52 weeks. Federal Reserve Credit gained $5.0 billion last week. Fed Credit has declined $5.6 billion y-t-d, or 3.9% annualized, to $820.8 billion. Fed Credit has expanded 4.6% over the past 52 weeks.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $465 billion, or 12.5%, over the past 12 months to a record $4.193 Trillion.
March 2 – Bloomberg (Halia Pavliva): “Russia’s foreign currency and gold reserves, the world’s fifth biggest, rose to a record $195.6 billion as of Feb. 24 as revenue from oil and gas exports increased, the central bank said…”
The dollar index dropped 1% this week. On the upside, the Norwegian krone gained 2.0%, the Philippines peso 2.0%, the Swiss franc 1.6%, and the Euro 1.4%. On the downside, the Peruvian new sol fell 1.1%, the Chilean peso 1.1%, the South African rand 1.1%, and the Mexican peso 1.0%.
This week silver traded to a 22-year high. April crude oil gained 76 cents to $63.67. April Unleaded Gasoline jumped 8.4%, while April Natural Gas fell 7.2%. For the week, the CRB index gained 0.7%, putting the index almost back to breakeven y-t-d. The Goldman Sachs Commodities index rose 1.4% this week, with the 2006 decline reduced to 0.5%.
March 3 – Bloomberg (Rob Delaney): “China should cut its foreign exchange reserves by more than two-thirds to reduce vulnerability to declines in the currencies comprising the holdings, China Securities Times reported, citing an economist. China needs $250 billion worth of foreign exchange reserves at most, compared with the $819 billion in government coffers as of the end of 2005…citing Xiao Zhuoji, a Beijing University professor and member of the China People’s Political Consultative Congress, a government advisory body.”
March 2 – Bloomberg (Clare Cheung and Nipa Piboontanasawat): “Hong Kong’s retail sales growth picked up in January as the city received more mainland Chinese tourists during the Lunar New Year holidays. Retail sales grew 11.6 percent from a year earlier to… ($2.73 billion) after climbing a revised 6.8 percent in December…”
Asia Boom Watch:
February 28 – Bloomberg (Cherian Thomas and Anand Krishnamoorthy): “India’s government said it will increase investment in power plants, roads and ports to help boost annual economic growth to 10 percent and challenge China as the world’s fastest-growing major economy. Stocks rose to a record. Spending will rise 11 percent to 5.64 trillion rupees ($127 billion) in the year starting April 1, Finance Minister Palaniappan Chidambaram said…”
February 27 – Bloomberg (Theresa Tang): “Taiwan’s unemployment rate fell to a five-year low in January as companies such as AU Optronics Corp. increased investment to meet rising overseas demand for laptops and televisions. The seasonally adjusted jobless rate dropped to 3.97 percent…”
March 1– Bloomberg (William Sim): “South Korea’s exports grew at a faster pace in February as companies shipped more goods after the Lunar New Year holidays in January. Shipments rose 17.4 percent from a year ago to $239.6 billion after rising a revised 3.8 percent in January…”
February 28 – Bloomberg (Seyoon Kim): “South Korea’s industrial production gained 6.1 percent in January, the most in more than seven years, as companies produced more mobile phones and cars to meet rising demand at home and abroad.”
February 27 – Bloomberg (Anuchit Nguyen): “Thailand’s economic growth will accelerate this year due to rising exports, company investments and domestic spending, the finance ministry said. The country’s gross domestic product may expand 5 percent this year from an estimate of 4.5 percent in 2005…”
March 1– Bloomberg (Aloysius Unditu and Arijit Ghosh): “Indonesia’s inflation accelerated more than economists expected in February, increasing pressure on the central bank to raise its benchmark interest rate. Consumer prices in Southeast Asia's biggest economy rose 17.9 percent from a year earlier…”
Unbalanced Global Economy Watch:
February 27 – Bloomberg (Theophilos Argitis): “Canada’s current-account surplus widened to a record in the last three months of 2005 on more exports of natural gas and cars. The surplus on the current account…widened to C$13.3 billion ($11.6 billion) from C$7.76 billion in the third quarter… The surplus for all of 2005 rose to a record C$30.2 billion.”
February 27 – Bloomberg (Laura Humble): “U.K. home loans approved by banks rose 32 percent in January from a year earlier as the country’s $6 trillion property market strengthens.”
February 28 – Financial Times (Ralph Atkins): “Lending to eurozone consumers and to businesses is growing at the fastest rate since the start of the decade, supporting a European Central Bank interest rate rise this week, and possibly again later this year. Loans to households in January grew at an annual rate of 9.4 per cent - the fastest since the first quarter of 2000, according to ECB data… Lending for house purchases grew at a rate of 11.7 per cent. Lending to businesses - or ‘non-financial corporations’ - also accelerated, increasing at an annual rate of 8.5 per cent, the fastest since the second quarter of 2001. The pick-up in business borrowing almost certainly reflected the surge in corporate takeovers led by private equity groups and more recent intercompany merger and acquisition activity.”
February 27 – Bloomberg (Simone Meier): “Money supply growth in the economy of the dozen euro nations accelerated in January for the first month in four as the European Central Bank prepares to raise interest rates this week. M3, the ECB’s preferred measure of money supply, rose 7.6 percent from a year earlier, up from a 7.3 percent gain in December…”
March 1– Bloomberg (Matthew Brockett): “Inflation in the dozen nations using the euro stayed above the European Central Bank’s ceiling for a 13th month in February, supporting the bank’s case to raise interest rates. Consumer prices rose 2.3 percent from a year ago after gaining 2.4 percent in January…”
March 3 – Bloomberg (John Fraher and Jeffrey T. Lewis): “The economy of the dozen euro nations will grow at the fastest pace since 2000 in the first three quarters of this year, the European Commission said.”
March 1– Bloomberg (Simone Meier): “Manufacturing in the dozen nations sharing the euro grew in February at the fastest pace in 19 months as the European Central Bank prepares to raise interest rates. Bonds fell, and stocks and the currency climbed. An index based on a survey of about 3,000 purchasing managers rose to 54.5, the highest since July 2004, from 53.5 in January…”
February 28 – Bloomberg (Gabi Thesing): “Confidence among European executives and consumers increased to the highest in almost five years in February as economic growth in the region accelerated.”
March 2 – Bloomberg (John Fraher): “German retail sales rose the most in more than a year in January and orders for plant and machinery surged, adding to evidence that growth in Europe’s largest economy is gathering pace.”
February 28 – Bloomberg (Ben Sills): “Inflation in Spain, Europe’s fifth-largest economy, held near a nine-year high in February even as oil prices fell. Consumer prices rose 4.1 percent from a year ago…”
March 1– Bloomberg (Jacob Greber): “Manufacturing in Switzerland grew at the fastest pace in almost two years in February, supporting the Swiss central bank’s view that Europe’s eighth-largest economy is strong enough to absorb higher interest rates.”
February 28 – Bloomberg (Fergal O’Brien): “Irish mortgage lending growth accelerated in January, suggesting the European Central Bank’s first interest rate increase in five years didn’t slow property demand in the euro area’s fastest growing economy. Mortgage lending rose a record annual 28.8 percent in January…”
February 28 – Bloomberg (Trygve Meyer): “The pace of borrowing by Norwegian households and businesses in January advanced, adding pressure on the Nordic country’s central bank to raise interest rates for a third time since June. Credit growth for households, companies and municipalities accelerated to an annual 13.4 percent, from a revised 13.2 percent in December…”
March 2 – Bloomberg (Trygve Meyer): “Norway’s unemployment rate in February dropped for the first time since November as college graduates who joined the ranks of jobseekers at the start of the year found jobs. The unemployment rate fell to 3 percent from 3.3 percent in January…”
February 27 – Bloomberg (Tracy Withers): “New Zealand consumers borrowed 15.1 percent more in January for housing and consumption than a year earlier, according to figures from the Reserve Bank.”
Latin America Watch:
February 28 – Bloomberg (Alex Emery): “Peru’s economy expanded 7.7 percent in the fourth quarter as gold, silver and natural gas production surged. The figure marked 18 straight quarters of growth…”
Bubble Economy Watch:
January Personal Income was up 5.8% y-o-y, with Compensation up 5.5%. Personal Spending was up 6.8% y-o-y, led by a 9.6% gain in Non-Durables spending. The Personal Consumption Expenditures (PCE) Price Index was up 3.1% y-o-y in January. For comparison, the PCE Price Index was up 2.7% y-o-y in January 2005, 2.0% y-o-y in January 2004 and 2.1% in Jan. 2003. The February ISM index rose 1.9 to a stronger-than-expected 56.7. The ISM New Orders component jumped almost four points to 61.9, the strongest reading since December 2004. The ISM Non-Manufacturing index increased 3.3 to an impressive 60.1, led by a 7 point jump in the Employment component.
Total January Home Sales (New and Existing) were down 4% from a year earlier to a seasonally-adjusted annualized pace of 7.793 million units. This was 8% above the January 2004 level. Existing Home Sales were down 5.2% from January 2005, although Average Prices were up 9.1% to $261,200 (“calculated annualized transaction value” (CTV) up 3.4% y-o-y). New Home Sales were up 3.3% from the year ago period to an annualized 1.233 million (up 7% from Jan. 2004). Average Prices were up 3.0% y-o-y to $291,600. New Homes CTV was up 6.4% from January 2004. The Inventory of Unsold New Homes jumped 13,000 to a record 528,000, a whopping 21% increase from one year ago and up 40% from January 2004.
And speaking of rising home inventories, from the California Association of Realtors (C.A.R.): “C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in January 2006 was 6 months, compared with 3.2 months for the same period a year ago.” January home sales in the Golden State were down a notable 24% from the year earlier period. Interestingly, at $551,300, California Median Prices were second only to Augusts record $568,730. Prices were up 13.8% ($66,720) over the past year, with a two-year gain of 36% ($146,840). Condo Median Prices were up 14.6% ($54,810) y-o-y to $430,610, with a two-year gain of 42% ($127,550).
Financial Sphere Bubble Watch:
March 2 – Dow Jones: “U.S. bank earnings rose 9.6% in 2005 to a record $134.2 billion, even as earnings in the fourth quarter declined from the record level of the third quarter, the Federal Deposit Insurance Corp. said… Bank earnings last quarter were $32.9 billion, down 5% from the previous quarter… The average return on assets fell to 1.22% from 1.25% a year earlier. The FDIC said fourth quarter profits reflected slowing growth in residential mortgages, continued low net interest margins and a sharp increase in net charge-offs of credit card loans.”
Mortgage Finance Bubble Watch:
February 28 – Dow Jones: “Average U.S. home prices increased 12.95% from the fourth quarter of 2004 through the fourth quarter of 2005, the Office of Federal Housing Enterprise Oversight reported… OFHEO, the agency responsible for overseeing the financial safety and soundness of Fannie Mae and Freddie Mac, said appreciation for the most recent quarter was 2.86%, or an annualized rate of 11.4%. The increase during 2005 is similar to the revised increase of 12.55% for the year ended with the third quarter of 2005, showing no evidence of a slowdown, OFHEO said. ‘Despite recent indications that a slowdown may be forthcoming, house price appreciation during 2005 continued to hover at near-record levels’ said Patrick Lawler, OFHEO’s chief economist.”
February 28 – Wall Street Journal (Robert Guy Matthews): “The Congressional Budget Office said capital-gains tax receipts in 2004 were significantly higher than it expected, and its early projections indicate the trend continued last year. The reason, the CBO said, is that taxpayers realized larger-than-expected capital gains in 2004 and 2005. The revised estimates indicate that taxpayers realized $479 billion in capital gains in 2004, compared with the $381 billion predicted by the CBO. Capital gains are taxed at a top rate of 15%; government receipts were $60 billion, compared with an estimate of $48 billion. For 2005, the CBO said, capital-gains realizations are likely to total about $539 billion. The government, as a result, is likely to reap about $75 billion in receipts, a 25% increase over 2004.”
March 1– Bloomberg (Kevin Orland): “U.S. companies’ earnings rose by an average of 15 percent in the fourth quarter as near-record oil prices bolstered energy producers. The performance marked the 14th consecutive quarter that profit at companies in the Standard & Poor’s 500 Index rose more than 10 percent, matching a streak that ended in 1996… Earnings at energy companies… rose 49 percent. The growth was the fastest among the S&P 500’s 10 main industry categories. A group including retailers, carmakers and homebuilders gained 1.4 percent, the smallest increase, as General Motors Corp. posted a loss. Sales for S&P 500 members rose 9.6 percent.”
Energy and Crude Liquidity Watch:
February 27 – Bloomberg (Adam L. Freeman and Armorel Kenna): “Eni SpA, Europe’s fourth-largest oil company, will raise investment in exploration and production to 25.3 billion euros ($30.2 billion) in the next four years as its output growth slows. The spending figure compares with a budget of 17.4 billion euros given a year ago for the four years through 2008.”
March 2 – Bloomberg (Halia Pavliva): “Russia, the world’s second-largest oil producer, will collect more budget revenue than planned through 2008 because of higher-than-expected crude oil prices, the Finance Ministry said. The government expects an extra 560 billion rubles ($20 billion) in revenue this year, bringing the estimated total for the year to 5.6 trillion rubles…”
March 3 – Bloomberg (Hector Forster): “Sumitomo Chemical Co., Japan’s third-largest chemicals producer, said costs to develop its Saudi Arabian project increased to $9.8 billion, more than double an initial estimate.”
Financial Sphere Watch:
February 27 – Bloomberg (Gregory Cresci): “Merrill Lynch & Co., the world’s biggest securities firm by market value, authorized the purchase of as much as $6 billion of its own stock.”
February 28 – MarketNews International (Steven K. Beckner): “Although the proliferation of credit derivatives has enabled financial institutions to manage risk ‘much more effectively’ and generally strengthened the financial system, they could potentially destabilize the system in the event of a major failure or default, New York Federal Reserve Bank President Timothy Geithner said. Geithner…said ‘progress’ has been made in improving the "infrastructure" of the credit derivatives market, but said there is still a large ‘gap’ between the growth of the market and the ability of firms to manage the business effectively. Geithner suggested that the favorable economic and financial conditions of recent years may have masked the scope of the potential problems that could arise in a time of stress.”
March 1– Bloomberg (John Dooley): “Senior bankers from Goldman Sachs Group Inc., Citigroup Inc. and JPMorgan Chase & Co. are meeting today for a second time in eight months to resolve a backlog of unconfirmed trades and settlement problems in the $270 trillion derivatives market. The group, led by Goldman managing director E. Gerald Corrigan, in July issued a 300-page report demanding ‘urgent’ effort to improve controls in the expanding market for credit derivatives, contracts based on debt. New York Federal Reserve Bank President Timothy Geithner, who leads regulators at today’s forum, yesterday said settlement is ‘still quite weak’ and the backlog remains ‘large.’”
February 28 – Financial Times (Paul Sullivan): “High-net-worth investors will be putting more money into hedge funds and cash and shying away from the US stock market this year. According to a survey released today by Northern Trust, 70 per cent of the 1,014 people polled, with more than $1m in investable assets, already have a portion of their portfolio in hedge funds, private equity and real estate in the hope of getting higher returns. Younger millionaires - those under 35 - have a greater interest in alternative assets with 27 per cent of their portfolios allocated to them. They also have the largest cash positions of any group, with 19 per cent. Similarly, investors with more than $5m have 26 per cent of their assets in alternative assets and 16 per cent in cash. The group average was 18 per cent and 13 per cent, respectively.”
Global Asset Inflation and Lessons to be Learned:
We are in the midst of the Greatest Global Asset Inflation Ever. Contrary to the entrenched conventional view, this development is the manifestation of extraordinary underlying Monetary Disorder and as such has profound ramifications. All the same, surging perceived wealth stokes the delusion that we live in The Golden Age of Free-Market Global Capitalism. These are especially precarious times, in particular with respect to the confluence of Bubbling asset markets, inflated expectations, an epidemic of leveraged speculation, and wide-open global Credit. In tandem with excesses, New Paradigm notions become only more outlandish.
“We have to recognize that the very reason capitalism exists is to have asset price increases. That is the point of capitalism, so we shouldn’t bemoan the fact that asset prices are increasing.” Louis-Vincent Gave, in a December interview with the estimable Kate Welling (Dec. 15, Welling@Weeden, “Brave New World or Bust”).
Well, we definitely should bemoan it. Not only is asset inflation certainly not “the very reason capitalism exists,” the recent Global Asset Bubble Affliction poses a very serious clear and present danger. The essence of Capitalism is the free market interplay of supply and demand to determine a structure of relative prices that create favorable incentives and just rewards – positive impetus for individual economic agents that in aggregate nurture behavior that is best for the system as a whole.
Economic Sphere profits should drive the process, not the circumstance today where a wildly inflating Financial Sphere completely dominates the creation and dissemination of perceived wealth and resources. Systemic Asset inflation and Bubbles nurture price distortions and patently unsound incentives. The essence of robust and dynamic Capitalism is a market system that adjusts and self-corrects, rewards and disciplines. Asset inflation and Bubbles have a powerful propensity to avoid self-correction, while meandering to dangerous and self-reinforcing extremes.
I find it rather ironic that the most outspoken contemporary proponents of free market Capitalism seem to have the least appreciation for its pressing vulnerabilities. In this regard, I will forever pin blame on the flawed analysis of the circumstances and developments that culminated with financial collapse and The Great Depression, analysis championed by Milton Friedman and, later, by his “disciples” including our new Fed Chairman.
It was too expedient (by the early 1960s) to paint the Roaring Twenties as the “golden age” of free market Capitalism and Federal Reserve monetary management, casting blame instead on post-boom Federal Reserve incompetence. Such a perspective conveniently whitewashed Credit system and speculative market dynamics that had fueled myriad financial market Bubbles (acute financial fragilities) and fashioned fateful Global Economic Bubble Vulnerabilities. Invaluable lessons learned at deplorable social cost were simply Wiped Away with a Wanton Stroke of Historical Revisionism. And it remains these days too easy for the ideologues to intransigently deride the notion of inherent Credit system and private sector instabilities, a circumstance not all too conducive to either sound analysis or enlightened policymaking. Especially in an era of unchecked private-sector “money” and Credit (the reality in which we must analyze and operate), along with momentous financial and technological developments, there is great risk in dismissing Capitalism’s vulnerabilities.
Regrettably, it seems to have been long forgotten that the very foundation of a stable free market system rests (at certain junctures tenuously) upon sound money and Credit. That such a notion sounds so antiquated is an indication of how far analysis has drifted off course. And, with regard to today’s unsound money and Credit, there has been ample failure in both the public (gross mismanagement and deficits) and private sector (reckless speculative excess, gross over-issuance of suspect Credits, and attendant malfeasance) domains. Such an unsound monetary backdrop, as we have witnessed, will foment unwieldy booms with a propensity for increasingly deleterious incentives, asset inflation, financial and real resource misallocation, destabilizing speculation, escalating non-productive debt expansion, unjust wealth redistribution, and progressive structural economic maladjustment. Sure, government policies – including untenable future obligations and derelict monetary management – have been prominent factors in fostering the boom. But Credit system dynamics will invariably play the prevailing role in shaping the financial and economic landscape. To disregard the structure and character of the Credit-creating mechanism – the Financial Sphere generally, is to do injustice to the analysis.
Even analysts that I respect too frequently point blame for the current state of affairs on the government “printing press.” If I could convince readers of one aspect of my less-than-conventional analysis it would be to appreciate that the vast majority of contemporary (electronic) “money” and Credit is created outside of the domain of the Federal Reserve and resides largely beyond its control. Most zealous free markets proponents stubbornly adhere to archaic analysis with a narrow fixation on Fed controlled “money.” In reality, unchecked non-productive Credit expansion is the nucleus of contemporary monetary inflation. It is also, most disconcertingly, The Bane of Free Market Capitalism.
The essence of our contemporary Credit mechanism – the fountainhead for how, where and to what purpose liquidity/incremental purchasing power is introduced into the system - is asset-based lending and speculating (as opposed to financing real economic investment). The character of the Capitalistic system cultivated by this financial apparatus would be quite alien to Adam Smith. He would undoubtedly protest the quality of contemporary “money” and rebuke the nature of present-day market-based incentives. The root of the problem is, as I see it, that the preponderance of contemporary Credit inflation (and resulting price/incentive distortions) emanates from the expansion of asset and securities-based finance. Such a system is fundamentally and irreversibly unsound. An unconstrained monetary system that is principally backed by the market values of speculative assets is inherently unstable and predisposed to boom and bust dynamics. There is simply no getting around this fundamental dilemma.
I have for some time lamented the myriad risks associated with the aggressive expansion of “Wall Street Finance,” in particular the evolution to “Financial Arbitrage Capitalism” and the attendant preeminence of global leveraged speculation. Wall Street - their powerful leveraging mechanisms, “structured finance” and “risk management” capabilities, and their prospering clients - now command the Credit apparatus. Importantly, they largely govern monetary (“money” and Credit) issuance, hence system rewards and incentives. What an incredible and – for them - absolutely wonderful arrangement. This dangerous reality receives zero attention, although it obviously has monumental ramifications.
I have also repeatedly blasted the Fed for its (pandering) “transparent baby-step” monetary management, stating that it graciously afforded a dysfunctional system way too much leeway to adjust, inflate, further capitalize and in the process attain only greater power and influence. It’s now been about two years since Greenspan telegraphed to the marketplace his intention to cautiously raise rates. A couple of years provided ample opportunity for Wall Street to position itself to thrive mightily from the current Global Credit and Asset Inflation.
The Securities Broker/Dealer index is up 16% y-t-d, 52% over the past year and 80% since the Fed reversed course and raised rates to 1.25% in June of 2004. There is ample additional evidence that financial conditions have loosened measurably in the face of rising short-term rates. Manifestly, the expansive asset-based Wall Street “money” and Credit-creating mechanism was more than left unchastened; it was profoundly buttressed and emboldened. Timid “baby-steps” garnered sufficient time for The Street and its client base to adjust their interest-rate arbitrages (i.e. switch to variable rate financing and instruments) and myriad carry trade positions (i.e. borrow in yen, Euros, or Swiss francs). At least as consequential, it provided everyone the opportunity to gear up for a huge (“blow-off”) Global Inflation Trade.
This (once in a lifetime?) play is providing an unprecedented litany of inflating assets and markets to (borrow and) speculate on: private equity and LBOs; global equities; emerging equities and bonds; high-yield and variable-rate debt, MBS and “structured instruments;” global real estate; crude oil and energy properties the world over; and precious and industrial metals and commodities generally. Since essentially all of these prices have been rising at a faster clip than global funding costs, there should be no surprise that liquidity conditions have refused to tighten.
The Fed has a big problem; global central bankers have a big problem. Now that “Global Wall Street Finance” is fully positioned to profit from all aspects of the Great Global Inflation Trade, it has every incentive to sustain rampant over-issuance (Credit inflation). So what if the Fed ratchets up borrowing costs a little; bond portfolio losses pale in comparison to the ongoing hefty returns being generated from inflating asset values almost across the board. Chairman Greenspan was masterful in manipulating leveraged speculating community returns to achieve his desired goals. Lowering short-term rates provided an immediate incentive for speculators to boost leveraged bond bets, in the process lowering bond yields, stimulating borrowing and risk-taking, and increasing system liquidity. It was all too magical – the most powerful and abused monetary transmission mechanisms ever.
I’ll conjecture that the (overconfident) Fed fully expected that it would retain the power to simply reverse this manipulation – cautiously raising rates, reducing speculator returns on the margin, and judiciously managing excesses. Think again. To accommodate mature Credit and Asset Bubbles is to guarantee that they expand, disperse and morph. Expectations that rising rates and restrained U.S. mortgage lending would tighten financial conditions generally, temper consumption and the U.S. Current Account Deficit, and work to impinge global liquidity excess are not coming to fruition.
Increasingly, the Fed and global central bankers must be observing the myriad avenues for rampant Credit and speculative excess (associated with The Global Inflation Trade) that have blossomed of late and wonder what the heck it will now take to rein things in. The Fed and global central bankers fell so far behind the curve. The ECB did move again this week and, more importantly, indicated that there was likely more on the way. And when, probably in the near future, Japan joins in, we’ll have the first concerted global “tightening” in quite some time. Little wonder global bond markets are on edge and currency markets are unsettled. Not surprisingly, frothy global equity markets were generally oblivious.
It is certainly not uncommon for highly speculative markets to spite major fundamental developments until it is too late. Indeed, this is the very nature of Credit-induced booms and Asset Inflations: system incentives and rewards become totally defective. It is well-known to speculators that the greatest potential returns often present themselves in a final “blow-off” frenzy. If such a dislocation does unfold throughout global equity markets, it would be very bad news for central bankers and an unwelcome development for international bonds, not to mention setting equity markets up for an unavoidable drubbing.
Milton Friedman was in the past fond of claiming that there was no such thing as destabilizing speculation. He was wrong. We continue to have a ringside seat for the reprehensible consequences of unsound money and Credit and the resulting Asset Inflations and Bubbles. My only consolation will be if lessons are learned and forever retained from the experience.