On November 1, Nouriel Roubini published a must read article in the Financial times titled “The Mother of all Carry Trades”.
He describes excellently what is going on in the markets and how another globally synchronized asset bubble is created by the reckless policies of the US Fed. Roubini Mother of all Carry Trades PDF, Link.
In short, Mr. Roubini explains how the financial markets have figured out a way to orchestrate an asset boom that is even more divorced from the real economy than the prior bubbles. The Fed has held interest rates near zero since Dec 2008 and has stated on Nov 4, 2009 that it will only consider raising rates if it sees a pick-up in “inflation” (which to Fed is the core CPI) or “resource utilization” (presumably employment). It also pursues quantitative easing via asset purchases that expanded its balance sheet from $800 billion in 2008 to now $2’000 billion.
In essence the Fed has created a situation where one can borrow at hugely negative interest rates (zero nominal rates coupled with a dollar depreciation) in the comfort of contracting risk premia (contracting “risks” are a happy byproduct of liquidity pushes in the world of modern finance, irrespective of and detached from real risks). The Fed is thus successfully stemming a deflation of assets with a supercharged version of its policies that created the credit mountain and asset bubble pre 2007.
Many will think to themselves that this is folly, wrong, even reckless, on so many fronts but what is the alternative? All alternatives are painful. It is very naïve, even irresponsible to assume that current policies wont be painful merely because our leaders’ horizon doesn’t extend beyond their next election cycle.
The Fed, Wallstreet and political authorities continue to hope that eventually their liquidity pushing will result in renewed economic growth. But what evidence is there that their policies are working or have ever worked?
Since 1999, in the greatest expansion of credit in human history, total credit in the US economy alone more than doubled in size from $25 trillion to now more than $55 trillion. This is close to 4 times US GDP and in relative terms 2.5 times more than prior the Great Depression.
This huge expansion in liquidity was not recognized as hyper-inflationary, as the choice of measure for inflation was and continues to be the core CPI, which for the time being continues to be only marginally affected by the liquidity generated. It was primarily asset markets such as stocks and properties that expanded at breakneck speed, despite visible deterioration of economic strength.
In the credit mania up to 2007 the American consumer still participated, somewhat. But he is done, no more expansion for him. Although his real income had hardly expanded throughout the past decades, rising property and stock prices allowed him to expand his demand by increasing debt and push consumption relative to GDP to a record 73% (USA). That compares with global averages in the low 60ies. However, as we can guess, the great leveraged boom was almost completely void of real economic substance.
In the period from 1999 to 2007, to create one dollar of real economic growth, more than seven dollars of credit was needed. Compare that to approximately 1.5 dollars of credit needed for every dollar of real growth generated back in the 1960ies.
John Mauldin shows that without mortgage equity withdrawals, the average annual growth in the US economy from 1999 to 2007 would have averaged a measly 0.5%.
Today, two years into the crisis, the Fed and politician are still trying to convince themselves that if they only push more and more credit, no matter in what form or shape, the economy will revive eventually. After 10 years of reckless monetary expansion, they simply up the ante, creating conditions for the mother of all asset bubbles without regard to history and foolishly convince themselves to know how to land this supernova of credit softly in the arms of the next economic expansion.
Is there any doubt that the US consumer has to reduce spending and leverage in the coming years and adjust his demand to levels in line with real income pattern? This will be doubled down by huge demographic effects that are starting to kick in just about now.
Is there any doubt about the real economic impact of these inevitabilities?
The American economy has been weakening to near exhaustion with ever larger liquidity infusions necessary to keep it alive. Last quarter’s positive real GDP growth of 3.5% is not the sign of recovery that is happily cheered on by a Fed and a market hell-bent to ignore the quite obvious internal weakness of this figure which is driven by an inventory cycle and silly fiscal schemes such as the “cash for clunkers” program which merely borrowed a little more consumption from the future.
Crucially, however, personal expenditures and income figures remain weak, as is employment. Investment continues to decrease as is lending, accelerating its contraction from 3.9% yoy in September to 6.8% in October. Who would expect rising investments when capacity utilization is at record low levels? Equally weak were the internals of an overall positive, but largely meaningless ISM report.
Banks, commercial banks that is, are tuned into the economic realities and they have been forced to adjust their assessment of risks and outlooks for cash flow generation. History teaches us that they will only start to lend again when they can see the cash flows well on track to recovery. As the consumer has to scale back there is no reason to expect these cash flows to come even close to the levels of the height of the boom.
But if lending is not possible or profitable in the real economy banks, that is their “hedge fund” like divisions simple leverage themselves up in a hugely profitable carry trade and pay themselves handsome bonuses, completely ignorant (or defiant) of the risks they accumulate yet again. After all, they can safely assume that in the next crisis we, the government will be there to pick up the pieces yet again.
It is very clear where Ben Bernanke, the head and brains behind this operation is leading the US and the world economy. For him, debt doesn’t matter, even if it is deployed completely divorced from any economic reality whatsoever. As long as asset prices measured in dollars are keeping up all is well for him and those who derive their income from turning those assets for a fee.
Mark Faber, one of those countless marginalized professionals who have been right every step of the way puts it as follows, “Personally, I think the future will be a total disaster….massive government debt defaults, and the impoverishment of large segments of Western society. But what I don’t know is whether this final collapse, which is inevitable, will occur tomorrow, or in five or ten years, and whether it will occur with the Dow at 100,000 and gold at US$50,000 per ounce or even confiscated, or with the Dow at 3000 and gold at US$ 1000.”
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