The market zigged and zagged and most groups ended little changed. For the week, the Dow added 0.4% and the S&P500 was plus 0.3%. The Transports rose 0.4%, while the Utilities slipped 0.6%. The Morgan Stanley Cyclical index added 0.5% and the Morgan Stanley Consumer index advanced 0.6%. The small cap Russell 2000 declined 0.4%, while the S&P400 Mid-cap index increased 0.5%. Although Cisco and Dell disappointed, the NASDAQ100 (down 0.6%) and Morgan Stanley High Tech (down 0.4%) indices held their own. The Semiconductors dropped 1.8%, The Street.com Internet Index fell 1.2%, and the NASDAQ Telecom index declined 1.4%. The Biotechs dipped 0.3%. Financial stocks were mixed. The Broker/Dealers jumped 3%, while the Banks finished largely unchanged. With bullion surging $8.90, the HUI gold index rose 6%.
For the week, two-year Treasury yields declined 8 basis points to 4.03%. Five-year government yields sank 10.5 basis points to 4.125%. Ten-year Treasury yields dropped 11 basis points for the week to 4.27%, and long-bond yields sank 13 basis points to 4.45%. The spread between 2 and 10-year government yields dropped 5 to 24. Benchmark Fannie Mae MBS yields sank 13 basis points, marginally outperforming Treasuries. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note widened one basis point to 30, and the spread on Freddie’s 5% 2014 note widened one to 29. The 10-year dollar swap spread declined one to 44.25. Corporate bond spreads generally widened slightly, with auto bond and CDS spreads moderately wider this week. Junk bond spreads widened this week. The implied yield on 3-month December Eurodollars declined 3.5 basis points to 4.285%, and December ’06 Eurodollar yields sank 14 basis points to 4.495%.
Corporate issuance rose to $17.3 billion. This week’s investment grade issuers included Credit Suisse $4.0 billion, US Bancorp $2.5 billion, Bank of America $1.8 billion, Home Depot $1.0 billion, Skyway Concession $960 million, Wal-Mart $800 million, CIT Group $800 million, Tribune Co $780 million, HSBC Bank $750 million, Chubb $600 million, BB&T $500 million, Premium Asset Trust $400 million, Duquesne Light $320 million, Protective Life $300 million, Lehman Capital Trust $300 million, Kimberly-Clark $300 million, Hershey Foods $250 million, Leggett & Platt $200 million, Consumer Energy $175 million, DTE Energy $170 million, and Platinum Holdings $135 million.
Junk bond fund outflows jumped to $450 million (from AMG). Junk issuers included Chesapeake Energy $1.1 billion, Lamar Media $400 million, CCO Holdings $300 million, National Power $300 million, Sierra Pacific Resources $225 million, Ahern Rentals $200 million, Mac-Gray $150 million, Entergy Louisiana $200 million, Darden Restaurants $300 million, Dollarama $200 million, and Revlon $80 million.
Convert issuance included NII Holdings $300 million and Maxtor $300 million.
Japanese 10-year JGB yields jumped 6 basis points this week to 1.38%, after trading as high as 1.475% yesterday (a 4-month high). Emerging debt markets were mixed. Brazilian benchmark dollar bond yields jumped 10 basis points to 7.95%. Mexican govt. yields sank 10 basis points to 5.48%. Russian 10-year dollar Eurobond yields surged 12 basis points to 6.21%.
Freddie Mac posted 30-year fixed mortgage rates jumped another 7 basis points, rising to 5.89%. Rates are up 36 basis points in six weeks and were actually 4 basis points higher than one year ago. Fifteen-year fixed mortgage rates surged 9 basis points to 5.47%. One-year adjustable rates jumped 10 basis points to 4.57%, up 33 basis points in six weeks and 49 basis points higher than a year earlier. The Mortgage Bankers Association Purchase Applications Index increased 0.9% last week to a five-week high, demonstrating notable resiliency in the face of rising mortgage rates. Purchase applications jumped 13.7% compared to one year ago, with dollar volume up 29%. Refi applications declined 3.3%. The average new Purchase mortgage rose to $243,800. The average ARM jumped to $353,600. The percentage of ARMs rose to 29.7% of total applications.
Broad money supply (M3) rose $12 billion to a record $9.773 Trillion (week of August 1). Year-to-date, M3 has expanded at a 5.2% rate, with M3-less Money Funds expanding at a 6.4% pace. For the week, Currency gained $2.1 billion. Demand & Checkable Deposits declined $12.5 billion. Savings Deposits rose $22.1 billion. Small Denominated Deposits increased $3.9 billion. Retail Money Fund deposits added $0.3 billion, and Institutional Money Fund deposits gained $7.6 billion (2-wk gain of $18.1bn). Large Denominated Deposits declined $3.0 billion. For the week, Repurchase Agreements dropped $8.5 billion, and Eurodollar deposits slipped $0.1 billion.
August 8 – Dow Jones (Tom Sullivan): “Six banks have committed to fund the acquisition of a 60% ($11 billion) stake in the commercial mortgage operation of General Motors Acceptance Corp. by an investor group that includes Kohlberg Kravis Roberts… The banking syndicate includes Citigroup, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, JPMorgan Chase and Royal Bank of Scotland…”
Bank Credit jumped $32.8 billion last week. Year-to-date, Bank Credit has expanded $544.7 billion, or 13.5% annualized. Securities Credit gained $7.3 billion during the week, with a year-to-date gain of $145.6 billion (12.7% ann.). Loans & Leases have expanded at a 14.2% pace so far during 2005, with Commercial & Industrial (C&I) Loans up an annualized 18.8%. For the week, C&I loans dipped $1.3 billion, while Real Estate loans surged $19.7 billion. Real Estate loans have expanded at a 16.7% rate during the first 31 weeks of 2005 to $2.794 Trillion. Real Estate loans were up $382 billion, or 15.8%, over the past 52 weeks. For the week, Consumer loans declined $3.3 billion, while Securities loans increased $6.5 billion. Other loans rose $4.0 billion.
Total Commercial Paper dipped $2.7 billion last week to $1.575 Trillion. Total CP has expanded $160.8 billion y-t-d, a rate of 18.5% (up 16.6% over the past 52 weeks). Financial CP declined $2.1 billion last week to $1.432 Trillion, with a y-t-d gain of $148.1 billion (18.7% ann.). Non-financial CP slipped $0.7 billion to $142.2 billion (up 15.9% ann. y-t-d and 10.7% over 52 wks).
ABS issuance rose this week to $12 billion (from JPMorgan). Year-to-date issuance of $451 billion is 21% ahead of comparable 2004. Home Equity Loan ABS issuance of $286 billion is 24% above 2004's same period.
Fed Foreign Holdings of Treasury, Agency Debt gained $6.2 billion to $1.461 Trillion for the week ended August 10. “Custody” holdings are up $125.5 billion y-t-d, or 15.3% annualized (up $205bn, or 16.3%, over 52 weeks). Federal Reserve Credit declined $7.5 billion to $791.7 billion. Fed Credit has expanded 0.2% annualized y-t-d (up $36.9bn, or 4.9%, over 52 weeks).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi - were up $602.5 billion, or 18.2%, over the past 12 months to $3.908 Trillion. South Korean reserves were up 26% over the past year to $206.38 billion.
Looking increasingly vulnerable, the dollar index slipped 1.3% this week. On the upside, the New Zealand dollar jumped 2.6%, the Japanese yen 2.3%, the British pound 2.0%, the Chilean peso 1.8%, and South African rand 1.7%. On the downside, the Romanian leu dropped 3.0%, the Brazilian real 2.6%, the Turkish lira 2.4%, and Israeli shekel 1.0%.
August 11 – Bloomberg (Loretta Ng and Wing-Gar Cheng): “China’s crude oil imports rose 15 percent in July as refiners bought more of the fuel to process into diesel, gasoline and chemicals. Oil imports climbed to 11.1 million metric tons last month…”
August 11 – Associated Press: “Airports in Arizona, California, Florida and Nevada recently came within a few days - and at times within hours - of running out of jet fuel, according to several airline industry officials. Because of supply bottlenecks, airlines were forced to fly in extra fuel from other markets and scramble for deliveries by truck.”
August 12 – Bloomberg (Pham-Duy Nguyen): “Copper prices in New York surged to a record amid indications that economies in Japan and Europe are recovering, signaling inventories may not meet growing demand for the metal used in homes, cars and appliances.”
The historic commodities boom runs unabated. September crude oil surged $4.55 to a record $66.86. Nymex natural gas jumped to a 4-year high. For the week, the CRB index jumped 2% (high since Dec. 1980), increasing y-t-d gains to 13.7%. The Goldman Sachs Commodities index surged 6.5% to an all-time high, with 2005 gains rising to 42.3%.
August 12 – Bloomberg (Nerys Avery): “China’s retail sales rose to a four-month high in July as higher incomes and tax cuts spurred spending on products including Dell Inc. computers, Adidas shoes and General Motors Corp. cars. Sales in the world’s most-populous nation increased 12.7 percent from a year earlier to 494 billion yuan ($61 billion)…”
August 11 – MarketNews: “Chinese exports rose 28.7% year-on-year in July to $65.58 bln, the Customs Bureau reported… Imports rose 12.7% on the year…to $55.18 bln.”
August 11 – Bloomberg (Nerys Avery): “China had its second-highest trade surplus on record in July, reflecting a surge in exports that has led the U.S. and Europe to threaten sanctions. The surplus widened to $10.3 billion from $1.97 billion a year earlier and $9.68 billion in June…”
August 12 – Bloomberg (Nerys Avery and Yanping Li): “China’s money supply grew in July at the fastest pace in more than a year, exceeding the central bank’s 15 percent target for a second straight month. M2, which includes cash and all deposits, rose 16.3 percent from a year earlier to 27.7 trillion yuan ($3.42 trillion)…”
August 11 – XFN: “China’s power demand growth is expected to reach 13.4% this year with power shortages to ease in the second half, Hu Weiping, director of the Energy Bureau of the National Development and Reform Commission, said. ‘2005 will be another high growth year for power demand. Demand will continue to be strong for a long time.’ Power demand grew 14.8% in 2004.”
Asia Boom Watch:
August 10 – Bloomberg (Kathleen Chu): “Office vacancies in Tokyo fell to their lowest in 3 1/2 years last month as companies expanded and sought more space… Vacancy rates in Tokyo's five main business districts of Chiyoda, Chuo, Minato, Shinjuku and Shibuya declined to 4.76 percent in July…”
August 8 – Bloomberg (Theresa Tang): “Taiwan’s exports grew in July at the fastest pace in three months as overseas demand for the island’s electronics products recovered from a slump caused by higher oil prices. Shipments rose 5.3 percent from a year earlier to $15.4 billion after gaining 3.1 percent in June…”
August 11 – Bloomberg (Yu-huay Sun): “Taiwan’s energy consumption increased at the fastest pace in a year in June as manufacturers…used more power to meet rising demand for electronics products. The island burned the equivalent of 9.56 million kiloliters (60.1 million barrels) of oil in June, up 7.4 percent from a year earlier…”
August 10 – Bloomberg (William Sim): “South Korean bank lending to companies last month grew at its fastest pace in 18 months in July, indicating growth in Asia’s third-largest economy is spurring corporate investment.”
August 10 – Bloomberg (Sara Webb): “Singapore’s economy grew at an annual 18 percent pace in the second quarter, as electronics and drugs production rebounded. The fastest growth in almost two years prompted several economists to raise their 2005 forecasts.”
August 12 – Bloomberg (Sara Webb and Haslinda Amin): “Indonesia’s economy expanded about 6.3 percent in the first half and would probably achieve growth of ‘close to 6 percent’ this year, Trade Minister Mari Pangestu said…”
August 11 – Bloomberg (Soraya Permatasari): “Automobile sales in Indonesia rose 28 percent in July, said PT Astra International, the nation’s biggest auto distributor…”
August 12 – Bloomberg (Cherian Thomas): “India’s industrial production expanded in June at the fastest pace in nine years as rising incomes and cheap credit spurred sales at companies including Tata Motors Ltd. The 11.7 percent increase in production at factories, utilities and mines followed a revised 10.9 percent gain in May…”
August 10 – Bloomberg (Kartik Goyal): “Indian Railways, the state-run monopoly railroad operator, carried 11 percent more freight in the four months ended July 31 from a year ago, as factories increased production.”
Unbalanced Global Economy Watch:
August 11 – Bloomberg (John Fraher): “Growth in Germany’s economy, Europe’s
largest, stalled in the second quarter as oil prices rose to a record and unemployment stayed close to the highest since World War II. Gross domestic product…was unchanged in the three months through June…”
August 11 – Bloomberg (Sheyam Ghieth): “The Italian economy, Europe’s fourth largest, emerged from recession in the second quarter and grew at the fastest pace in more than four years… Gross domestic product expanded 0.7% in the second quarter after contracting 0.5% in the previous three months…”
August 11 – Bloomberg (Alexandra Dawe): “The Dutch economy, the fifth-largest among the 12 nations that share the euro, returned to growth in the second quarter, led by spending on roads and homes. Gross domestic product…rose 1.2 percent from the previous quarter… Economists expected GDP to gain 0.3 percent…”
August 10 – Bloomberg (Tasneem Brogger): “Danish inflation in July accelerated to 2 percent, the fastest since June 2003, led by rising housing and transport prices.”
August 11 – Bloomberg (Trygve Meyer): “Norwegian house prices rose 2.8 percent in the second quarter from the first as the central bank kept borrowing costs at a record low. The seasonally adjusted increase follows a 1.8 percent advance in the first quarter… Prices rose an annual 7.9 percent…”
August 9 – Bloomberg (Bradley Cook): “Russia’s trade surplus grew 49 percent in the first six months of the year as oil prices rose to records and exports of other natural resources surged, Interfax reported, citing the Federal Customs Service. Russia earned $66.4 billion more from exports than it spent on machinery and other foreign goods in the period…”
August 11 – Bloomberg (Victoria Batchelor and Gemma Daley): “Australian employers unexpectedly added workers in July…the longest run of job gains in 10 years means the central bank won’t cut interest rates. Employment rose 12,700 last month and the jobless rate remained at a 29-year-low 5 percent…”
August 9 – Bloomberg (Alexandre Deslongchamps): “The Canadian economy will grow faster over the next 12 months than previously expected, as demand for the country’s goods abroad strengthens, a Bloomberg News survey of economists showed. Canada’s economy, the world’s eighth largest, will expand at a 3.2 percent annual rate this quarter, the most in a year…”
Latin America Watch:
August 12 – Bloomberg (Katia Cortes): “Brazil’s federal tax revenue rose 12 percent in July from a year earlier, the tax and customs agency said.”
August 12 – Bloomberg (Patrick Harrington): “Mexico’s industrial output growth slowed more than expected in June, dragged down by a 0.2 percent decline in manufacturing. Industrial output rose 0.7 percent from the year-earlier period, down from growth rates of 2.9 percent in May and 5.2 percent in April…”
Bubble Economy Watch:
The June Trade Deficit rose $3.4 billion from May to $58.8 billion. Goods Exports were up 13% from one year ago to $74.5 billion, and Goods Imports were up 13% to a record $138.5 billion. Ex-petroleum exports were up 8.6% y-o-y. Goods Exports would need to rise 54% to match Goods Imports. July Import Prices were up 7.7% from a year earlier.
August 9 – Bloomberg (Joe Richter): “U.S. labor costs over the last year rose by the most since 2000, and productivity among workers grew at a slower pace in the second quarter, keeping pressure on the Federal Reserve to raise interest rates. The cost to companies of employing workers was 4.3 percent higher in the second quarter than in the same three months last year, the Labor Department said…”
July Retail Sales were up 8.3% from July 2004. Retail Sales-Ex autos were up 6.7%, the weakest y-o-y comparison since February. By category, Auto Dealer sales were up 13.8% y-o-y, Gasoline Stations 18.8%, General Merchandise 6.8%, Electronic Stores 5.9%, Clothing Stores 4.8%, Eating & Drinking establishments 5.9%, and Building Materials 4.7%. Food & Beverage sales were up only 3.3%, while Furniture sales were down 0.4%.
Mortgage Finance Bubble Watch:
August 12 – The Wall Street Journal (James R. Hagerty and Kemba Dunham): “The number of homes available for sale has increased sharply in some of the nation’s hottest real-estate markets -- one of several recent signs suggesting that air may be seeping out of the frenzied U.S. housing market. Home prices have surged an average of about 50% in the U.S. in the last five years, largely thanks to the lowest mortgage interest rates in more than four decades and what has been a shortage of available homes in many markets. But some economists and housing-industry analysts believe supply is catching up with demand… In San Diego County, for instance, where the median home price has more than doubled in the last five years, the number of homes listed for sale totaled 12,149 on July 8, more than twice the 5,995 available a year earlier…”
Countrywide’s huge June was followed by a huge July. Total Fundings of $44.1 billion were up 48% from July 2004, with the Total Pipeline up 60% to $77.0 billion. At $21.0 billion, Total Purchase Fundings were down from June’s $24.0 billion, although they were up 20% from a year earlier. Non-purchase Fundings were up 90% from July 2004 to $23.1 billion. ARM Fundings were up 37% from one year ago and comprised 53% of total fundings. Home Equity Fundings were up 28% from July 2004 to $3.64 billion, while Non-prime Fundings declined 2% to $3.66 billion. Bank Assets were up $4.1 billion during the month to $69.6 billion (up 143% y-o-y).
Fannie Mae’s CEO Daniel Mudd, from yesterday’s conference call following the company's disclosure that they would not have 2000 to 2004 financial statements prepared prior to mid-2006: “I will pause and ask the question you all want to ask. In fact, the question I ask… Why the hell does this (the restatement process) take so long? In a statement that we issued yesterday, we laid out some of the specific challenges this initiative presents and the substantial resources we are applying against these challenges. For example, we estimate that we will need to record over one million lines of journal entries; determine hundreds of thousands of commitment prices and securities values at various points in time; and verify some 20,000 derivative prices. We expect that over 30% of our employees will spend over half of their time on these or other issues that are related to the restatement. Many more will be involved from time to time as needed. And we’re additionally bringing on 1,500 consultants to assist with our efforts by year-end… All told, this means we anticipate devoting 6 to 8 million labor hours to the restatement [and up to $800 million]…”
August 10 – The Wall Street Journal (Ruth Simon): “As investors flood into the housing market, they are not only pushing up home prices. They are also putting downward pressure on rents. Growing numbers of people are buying real estate as an investment, with the intention of flipping it or moving into it later. That is increasing the supply of rental property. At the same time, low interest rates have pushed many would-be renters into becoming homeowners, thus lowering demand -- and prices -- for rentals.”
August 12 – Bloomberg (Lisa Kassenaar): “In Manhattan, where two-bedroom apartments now average $1.5 million, remodeling costs have jumped at least 50 percent in five years as building managers dictate everything from where to put appliances to when carpenters can play the radio.”
The Global Inflationary Boom Thesis:
Last week’s Bulletin expounded upon the ineffectiveness of Transparent Baby Step Monetary Management. More generally, the Greenspan Fed’s ideologically-based “strategy” of relegating to “the markets” the responsibility to (over time) rectify U.S. and global imbalances is also well on its way to colossal failure. The Credit Bubble analytical framework continues to suggest that uncontrolled U.S. Mortgage Credit Excesses and resultant Current Account Deficits will increasingly foment over-liquefied markets and economies globally – that Credit Inflationary Manifestations will broaden and propagate. This dynamic has been reinforced by the ballooning global leveraged speculating community and their aggressive pursuit of profits. Macro Credit Theory warns us that an historic bout of Global Wildcat Finance has greatly increased the probability for an unfolding Unwieldy Global Inflationary Boom.
Well, there is no better evidence to support the Global Inflationary Boom Thesis than $67 crude. And there was today news from China that July retail sales were up 12.7% from a year earlier (4-month high) and that China’s M2 money supply expanded last month at the fastest pace in a year (16.3%). Also today, India reported a stronger-than-expected 11.7% rise in industrial production. The Wall of Global Liquidity – much emanating from U.S. mortgage borrowings and speculative leveraging - continues to fuel the Chinese boom, as it does to only somewhat lesser degrees throughout Asia, India and elsewhere.
The Asian liquidity backdrop is apparent in regional equity market performance. Japan’s Topix index rose 4.7% this week (up 8.3% y-t-d) to the highest level since July 2001. Hong Kong’s Hang Seng index added 2.7% this week to the highest point since February 2001. The Hang Seng is up 8.6% y-t-d and 24.5% over 12 months. The Korea Composite index closed the week up 3.8% to the highest level since late-1994. The index is up 26.2% y-t-d and sports a 47.4% gain over the past year. India’s Mumbai index was only slightly positive for the week, but closed at an all-time high. The index is up 17.6% y-t-d and 51.1% over 12-months (2yr gain of 99.7%). The Australian S&P/ASX index rose 2.1% this week to a new record high. This increased 2005 gains to 10.3% and the one-year rise to 28.1%. The Singapore Straits Times index traded last week at the highest level since early year-2000 (up 11.5% y-t-d and 22% over 12 months). Elsewhere, the Taiwan TAIEX index is up 3.4% y-t-d and 18.3% over 12-months. The Jakarta (Indonesia) Composite index sports y-t-d gains of 15.4% and 12-month gains of 52%. The major New Zealand index is up 9.0% y-t-d, the Philippines 11.8% y-t-d, Malaysia 3.3%, and Thailand 2.0%.
But no longer is the Asian Boom the major global liquidity story. International energy markets and exporting economies are now a major beneficiary of the Global Liquidity Bubble - the booming Middle East in full bloom as a powerful Inflationary Manifestation. The major equity index in Kuwait is up 40.5% y-t-d, Qatar 67.6%, United Arab Emirates 83.7%, Oman 53.6%, Jordan 90.9%, and Saudi Arabia 69.8%. Moreover, an astonishing amount of finance is today being accumulated throughout the region.
Wednesday from the Financial Times (Javier Blas): “Arab Gulf oil producing countries will embark this year and next on a “massive accumulation of foreign assets” as they cash in on record oil prices and soaring worldwide petroleum demand… The region will buy about $360bn of foreign assets, from bonds to property in 2005 and 2006 – 50 per cent more than their total purchases of the past five years, according to a study by the Institute for International Finance, the leading association of private banks. “The Gulf Co-operation Council countries are in the midst of a period of exceptional economic performance,” says the IIF, which specializes in tracking capital flows in emerging markets. It estimates that accretions of foreign assets this year and next by the governments and private investors of Saudi Arabia, Kuwait, United Arab Emirates, Bahrain, Oman and Qatar will outgrow China’s accumulation of foreign exchange reserves over the past two years. “High oil prices and production should ensure that the economic boom is sustained,” it adds. The region is pumping oil at the highest rate in 25 years to keep pace with growing demand from the US and Asia, and oil is trading at close to $65 a barrel, triple the average of the 1990s.”
Until recently, the Global Credit Bubble was predominantly a U.S. and Asia dynamic. Things began to evolve with the Chinese's massive accumulation of dollar balances and consequent global quest for resources. Not yet garnering the attention it deserves, the emergence of the Global Energy Boom has profoundly altered the global financial landscape. To be sure, the size and scope of today’s “Bubble-dollars” have the potential to make the ‘70’s “Petro-dollars” look like small change in comparison. Furthermore, U.S. financial institutions will not this cycle be the major intermediaries for the massive liquidity being accumulated by the oil exporters, as they were during the 1970/80s.
Sunday from United Press International: “Saudi Arabia said Sunday it was working to bring back to the kingdom a total of $360 billion invested abroad in the last 18 months. Foreign Minister Prince Saud al-Faisal told reporters the government was working on returning these ‘national assets’ back to the oil-rich Arab country and to attract foreign investments in Saudi Arabia. He said the kingdom has ‘established qualified institutions for that purpose,’ but did not elaborate.”
The global geo-political environment has changed profoundly since the seventies oil boom. Along with regional investment and development, it would appear that the ballooning Middle East treasure trove has its sights on greater Europe. This is an intriguing contrast to the symbiotic U.S. and Asia booms that tended to recycle dollar balances right back into U.S. securities markets, leaving forsaken Europe stuck in the economic mud. It is worth noting that France’s CAC 40 index is sporting a 17.2% y-t-d gain, Germany’s DAX 16.0%, Spain’s IBEX 12.2%, Italy’s Milan 8.2%, UK’s FTSE 100 11%, the Swiss Market index 16.8%, Denmark’s Copenhagen index 27.8%, Norway’s OBX index 26.8%, Finland’s HEX index 19.0%, Sweden’s Stockholm index 16.9%, and Austria’s ATX 33.1%. Today, U.S. equities are the lonely laggards. Recognizing the global and regional liquidity backdrop, Macro Credit Analysis would suggest that the fledgling European recovery could easily surprise on the upside.
The two weak links in the Global Inflationary Boom Thesis have been Europe and Japan. But an increasingly strong case can be made that Japan has turned the corner, finally dragged out of its deep morass by the powerful U.S./Chinese/Asian/global booms. There are recent indications that Europe, as well, is being wrenched back to growth by the Global Credit and Liquidity Boom. European money and Credit growth has accelerated, asset prices are booming and M&A activity remains robust. If, as I expect, oil-exporter excess liquidity is directed toward Europe’s asset markets, investment and products (specifically content to avoid the U.S.), the lagging European economy could be the unfolding growth story and an alluring liquidity destination (Middle Eastern and otherwise).
It is my view that the Global Inflationary Boom scenario is especially problematic for the U.S. For one, our policymakers have argued for some time that the U.S. Trade Deficit and global imbalances, generally, could be rectified by stronger growth overseas. It is becoming increasingly apparent that a more robust and synchronized global expansion will, first and foremost, precipitate spiking energy and commodities prices and future shortages. Truth be told, the services-based U.S. economy is ill-structured to enjoy the fruits of a global boom, but will instead pay an enormous price to satisfy its insatiable energy needs.
Importantly, the character of the unfolding Global Inflationary Boom ensures only more extreme U.S. and global imbalances. Our hollowed-out manufacturing sector has limited capacity at this point to further ramp up exports, while surging energy costs and generally rising prices will be maintain an inflationary bias for our imports. Rather than working to rectify our massive Trade Deficits, the unfolding Global Inflationary Boom assures that our predicament only worsens. And, let there be no doubt, a continuation of these deficits will only further stoke unstable global growth, inflationary pressures and market distortions (why they’re called Bubbles!).
At least since the late-eighties, the Federal Reserve has enjoyed the luxury of applying monetary policy irrespective of global factors. The bursting of Japan’s Bubble and the collapse of socialist economies created global economic slack and disinflationary pressures to last a decade. This afforded the Greenspan Fed great flexibility to run a perpetually accommodative monetary policy. These days, analysts mistake the effects of massive global manufacturing investment (a Credit Inflation Manifestation!) for a continuation of the nineties “disinflationary” environment. This is a major analytical error.
Unprecedented global production capacity may have a restraining effect on the prices for autos, computers, flat-panel televisions and the like. However, the prominent pricing pressures manifest in the markets for the energy required to power the endless supply of products (and manufacturing capacity) distributed lavishly across the globe. These pressures and expanding shortages have incited a global energy investment boom, a boom that puts further demands on key resources while providing another expansive avenue for Credit expansion. All the while, the U.S. Credit Bubble, global central banker accommodation, unlimited (“contemporary”) global finance and a ever-expanding pool of global speculative finance guarantee more than sufficient monetary expansion to validate the inflationary boom. We have witnessed the U.S. Credit Bubble spread methodically to Asia, Latin America and now to the Middle East and Europe. Credit Inflation Manifestations spread from U.S. stocks and bonds to American real estate to global securities and real estate to energy and commodities. Powerful Monetary Processes have taken hold that will stubbornly disseminate inflationary fuel and expanding pricing pressures. And while the environment admittedly offers sufficient data points for adherents to cling to the “disinflationary” case, this argument founders when it comes to deciphering the key facets of current financial, economic, and speculative dynamics.
Things get quite interesting when the emerging Global Inflationary Boom is juxtaposed against the ingrained perception that the U.S. economy and financial system are too fragile for any meaningful Federal Reserve tightening. The harsh reality is that U.S. and global financial systems are in desperate need of monetary restraint. Our current 3.5% short-term rate is strongly stimulating, although this rate is pricy when compared to much of Asia and Europe. The global liquidity environment beckons for significantly higher rates throughout. The Fed is nonetheless trapped in Baby Steps, and global central bankers are trapped by the vulnerable dollar. The dollar benefits from exceptionally low yen and euro yields only as long as Europe and Japan remain stuck in their respective economic quicksands (restraining a full-fledged Global Inflationary Boom). Increasingly, the underpinnings for continued dollar support (weak Europe and Japan) appear suspect.
I certainly do buy into the U.S. fragility argument and recognize why the bond market takes comfort from the fact that the Fed will surely back off come the first indication of systemic stress. Spiking oil prices an economic risk, buy bonds! Equities look susceptible, buy bonds! Housing prices peaking, buy bonds! Initial cracks forming in mortgage finance, speculate in bonds! But it is this ingrained Credit system “inflationary bias” that keeps U.S. and global bond prices high, speculative leveraging extreme and market rates low – which assure the ongoing monetary fuel to power the Global Inflationary Boom. And this gets to the heart of the market pricing system’s current incapacity for moderation or self-regulation.
If the securities-based Credit system is incapable of moderating excess – and a strong case can be made that this is a fundamental facet of seasoned Credit Bubbles – then I am once again forced to my “default” position: the likelihood that a dollar and/or financial crisis will commence the necessary adjustment period. And as we witnessed again this week, there is nothing like a weak dollar to stoke the Global Inflationary Boom – that would seem to imply only further dollar weakness...
And, in our ongoing pursuit of the reasons why booms cannot last forever, I am again drawn analytically to fragilities associated with a Ballooning Financial Sphere. I am intrigued by rumblings in the “repo” market. The ongoing issue of “failures” only seems to worsen. And the fiasco settling the June bond futures contract in Chicago (see Gretchen Morgenson’s article in last Sunday’s NYT) has brought more attention to the reality that the ballooning derivatives markets have outgrown (and now dominate) the underlying cash market in bonds and other securities. To what extent this market distortion has tended to inflate bond prices and create liquidity is unknown. But the seriousness of this development will surely take on more urgency during the next bond bear market. And there is this week’s revelation that Fannie’s restatements are likely still one year away, with 2005 financials further down the road. This follows recent revelations regarding the sad state of Credit derivatives back-office and accounting functions. It is today an increasing leap of faith to have confidence in the fidelity of structured finance.
There are myriad reasons that the U.S. financial sector will be resolute in its determination to sustain the Credit Bubble. But the ballooning Financial Sphere and resulting Monetary Disorder will only become more destabilizing and unmanageable. And one of the paramount risks going forward will be an increasingly problematic Global Inflationary Boom and, as it implies, diminishing control over our financial and economic destiny.