Page 1 of 3 CREDIT BUBBLE BULLETIN The newest abnormal
Commentary and weekly watch by Doug Noland
The 1980s brought us Japan's "miracle economy". The '88 Michael Dukakis
presidential campaign delivered the "Massachusetts miracle" - not many years
later renamed "Massachusetts miserable". The Asian Tiger "miracle economies"
(and markets!) were all the rage in the mid-'90s - until their systems blew
apart. Here at home, there was all the "new paradigm" and the "new era" hoopla.
And until the recent crisis and double-digit gross domestic product (GDP)
downdraft, many bravely trumpeted Ireland's Celtic Tiger miracle.
It's as if there's a contest to coin a catchy phrase that will gain popular
acceptance. There was "muddle through" to describe the
expected course of the post-tech bubble economy. The "great moderation" lauded
newfound policymaker success in moderating economic (and inflation)
variability. And who can forget the vaunted "stable and desirable" global
monetary "system" - "Bretton Woods II" - analysis that rationalized credit
bubble excesses. Then there was the pride and joy of coining "the shadow
banking system." Now it's "the new normal".
I must be a grump, as I'm rarely fond of popular economic catchphrases. The
"miracles" were - without exception - belatedly recognized as bubbles. Bullish
visions of new eras and paradigms were similarly bubble delusions. I never
bought into the post-technology bust notion of a "muddle through" economy. It
was just inconsistent with bubble analysis - and the dynamic of a more powerful
bubble throughout mortgage finance emerging from the tech wreck. bubbles tend
to not muddle.
I scoffed at "the great moderation." The framework from which it originated was
flawed. An optimistic view held that astute central banking had become quite
adept at tinkering with interest rates. Students of economic history found this
disconcertingly reminiscent of the fateful view from the "Roaring Twenties"
that central banking had conquered the business cycle. Central banking has
repeatedly been given way too much Credit, while the expansive influence of
speculative finance is always easily ignored.
There was no disputing the impressive potency central bank rate cuts had
attained (over the past 20 years) for reigniting and sustaining economic
growth. Yet rigorous analysis of the credit system would have illuminated the
newfound role of the Wall Street firms, Fannie Mae, Freddie Mac, the Federal
Home Loan Banks, the massive securitization marketplace, derivatives, and the
hedge funds.
Central bankers hadn't become smarter or even more sophisticated. But never had
they enjoyed such a powerful monetary policy tool - an expanse of aggressive
players keen to stimulate credit expansion, the markets and the economy at a
moment's (or 25 basis points) notice. Over a period of many years the credit
system - and the Federal Reserve's transmission mechanism to the real economy -
had been completely transformed. It should have appeared shadowy only to those
that had clung to a narrow focus on banking systemcredit.
"Bretton Woods II" propaganda really rubbed me the wrong way. "How can
intelligent analysts not see that the US has exported its credit bubble to the
rest of the world," I would mumble to myself at the time. There was certainly
nothing stable or desirable about the arrangement of the US massively inflating
credit - using these IOUs to feed asset bubbles and over-consumption,
especially with foreign central banks content to monetize these dollar flows,
in the process dangerously inflating their asset markets and economies. Again,
the key to sound analysis was rigorous analysis of underlying credit structures
and financial flows.
Which brings me to the latest and greatest: "The new normal". It's not that I
have huge issues with the analysis - it's certainly not "miracle", "new era",
or "Bretton Woods II" silliness. I just sense it's incomplete and misses some
important aspects of the unfolding backdrop. From Bill Gross, co-chief
investment officer of Pacific Investment Management Co: "We're transitioning
due to popped bubbles and de-risking of portfolios and balance sheets ... A
simple way to look at it is that private market capitalism simply went too far
over the last 10-20 years, and now we're in the process of pulling back and
accommodating deleverging, regulating and de-globalization."
From my perspective, "the new normal" appears more like the old than something
new: I'm thinking more "the newest abnormal". To be sure, there have been some
popped bubbles. But we remain trapped in the same old bubble-inciting paradigm
of activist central banking and government intervention. I have expounded the
view that a "government finance bubble" emerged with the bursting of the Wall
Street/mortgage finance bubble. I would argue that bubble dynamics have taken
firm hold in China, throughout Asia, and in the "developing" economies more
generally. New normal reminds me too much of "muddle through."
"Deleveraging" is at this point overrated. Our federal government issued about
US$1.9 trillion of additional debt over the past year. In my book, that's
"leveraging". The Fed's balance sheet has become much more leveraged. The
mortgage businesses of Fannie Mae, Freddie Mac, Ginnie and the Federal Housing
Administration have become much more "leveraged". The newest abnormal is about
massive synchronized global government credit expansion and extreme monetary
looseness. The newest abnormal sees massive "private" credit expansions in
China, India, Brazil and the "developing" markets.
The newest abnormal has seen a major resurgence in the global leveraged
speculating community. The newest abnormal is acting with great speed to impair
the dollar as the world's reserve currency - taking unfettered financial
"globalization" to a whole new level. The newest abnormal has animal spirits
that could give the old ones a run for their money.
Mr Gross's New Normal - constrained by "deleveraging and reregulation" - seems
to imply a more subdued and therefore stable credit landscape. Such a backdrop
would be consistent with lower average economic growth and lower investment
returns. The newest abnormal - with varieties of newfangled bubbles, excesses
and uncertainties - would point to ongoing financial and economic volatility.
The "averages" may indeed be lower going forward - but it may be the
divergences that prove most noteworthy (hard asset returns versus securities;
non-dollar versus dollar; China GDP versus US, for example).
The new normal implies more monetary order, while the newest abnormal suggests
unrelenting monetary disorder. The proponents of the new normal would tend to
view extreme government intervention as a stabilizing force appropriate for a
(deflationary) post-bubble landscape. From The newest abnormal perspective,
massive government deficits and market interventions inaugurate a dangerous new
stage of global inflationism. Newest abnormal analysis posits that a more
stable new normal backdrop would, at this point, likely arise only after a
major government debt crisis.
It was a newest abnormal kind of week that brought October to a conclusion. For
months now, unprecedented global government intervention has spurred a stampede
back into risk assets. Buoyant risk markets then sparked a run of bullish
optimism. Not surprisingly, everyone ended up on the same crowded side of the
reflation trade.
Last week, global equities, emerging market bonds, commodities, and most
currencies were rocked by heavy selling pressure. Those borrowing in yen to
leverage higher-yielding currencies in, for example, New Zealand or Sweden, had
their heads handed to them. The reflation bet definitely had some air kicked
out of it. And many believing, with two months to go, that they had great years
in the bag are now recalling that sick 2008 feeling. It's a reasonable bet that
heightened uncertainty and market volatility have returned and will be sticking
around a while.
WEEKLY WATCH
For the week, the S&P500 sank 4.0% (up 14.7% y-t-d), and the Dow declined
2.6% (up 10.7%). The Banks were hammered for 9.1% (down 4.7%), and the
Broker/Dealers were hit for 5.5% (up 44.4%). The Morgan Stanley Cyclicals fell
9.2% (up 49.1%), while the Transports dropped 5.0% (up 2.2%). The Morgan
Stanley Consumer index declined 3.2% (up 15.2%), and the Utilities fell 3.6%
(down 4.1%). The S&P 400 Mid-Caps declined 6.0% (up 22.5%), and the small
cap Russell 2000 fell 6.3% (up 12.7%). The Nasdaq100 declined 4.9% (up 37.6%),
and the Morgan Stanley High Tech index fell 4.9% (up 51.5%). The Semiconductors
dropped 6.3% (up 39.8%). The InteractiveWeek Internet index sank 5.1% (up
58.7%). The Biotechs fell 6.4% (up 26.9%). Although Bullion declined only $11,
the HUI gold index was hammered for 9.1% (up 29.3%).
One-month Treasury bill rates ended the week at 2 bps, and three-month bills
closed at 5 bps. Two-year government yields dropped 17 bps to 0.78%. Five-year
T-note yields fell 17 bps to 2.25%. Ten-year yields were 11 bps lower to 3.39%.
Long bond yields declined 7 bps to 4.23%. Benchmark Fannie MBS yields dropped
10 bps to 4.29%. The spread between 10-year Treasuries and benchmark MBS yields
widened one to 90 bps. Agency 10-yr debt spreads narrowed 4.8 bps to a tiny
little 0.2 bps. The implied yield on December 2010 eurodollar futures sank 21.5
bps to 1.535%. The 10-year dollar swap spread was little changed at 18 bps; and
the 30-year swap spread declined 1.25 to negative 8.25 bps. Corporate bond
spreads were wider - for a change. An index of investment grade bond spreads
widened 8 bps to 148, and an index of junk spreads widened 2 bps to 569 bps.
Investment grade issuers included GMAC $2.9bn, Mead Johnson Nutrition $1.5bn,
FMR $700 million, Prologis $600 million, Amphenol $600 million, Oglethorpe
Power $400 million, Eastman Chemical $250 million, New York University $100
million, and San Clemente Leasing $115 million.
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