And yet again this blogger was side-tracked by the intensity of starting up businesses. I sure hope to be able to write more in 2010. Although somewhat belated, I don’t want to miss wishing you and your loved ones great health, abundant wealth and happiness in the New Year ahead.
During this reflective season the words of a wise friend of mine came to mind, “our dreams and aspirations are the blueprints to our lives”, a good thought to start my year.
As much as I believe in the basic truth of these words, there are some things that remain (for now) impossible for us humans, like teleporting or turning lead into gold.
As we begin a new year, markets, media, pundits and officials are united in celebration of a crisis behind us. The Economist calls it the “Great Stabilisation”. Mainstreet, small businesses and the growing rank of unemployed are asked to be patient, after all employment is never the first statistic to turn around. Demand will eventually return, somehow, as it always has, irrespective of the fact that in recent years it was driven entirely by an unsustainable credit expansion.
And there it is, the word “unsustainable”. Ben Bernanke along with the ruling interests disagrees, believing it is all a matter of liquidity and confidence, as they have “proven” for decades now. If everyone just believes that there are no limits to credit, it will make it true.
Consensus economic and stock-market expectations are far too optimistic. They limit their expectations to past “crisis” that were all “solved” by injecting liquidity into the system. The difference today is that this liquidity doesn’t flow through to the real system anymore. It stops at the banks and reverses flow into the central bank. The only life-blood that reaches Main street comes in the form of silly consumption driven programs such as “Cash for Clunckers”. TARP money spent on investment is almost negligible.
While the economy has become too risky for the financial gatekeepers, Ben Bernanke rides to the rescue in making financial “investment” (once more) a sure bet, even at zero interest rates.
It created the dollar carry: “investors” (banks, in one form or another) are taking credit at zero interest in a currency (the dollar) that is driven down by the FED’s degrading balance sheet and fiscal debt expansion as it trades its pristine assets with the rubbish the market has accumulated during the heydays of the subprime mania. In essence, any hedge fund trading the rebound is paid to leverage itself up with what is effectively a net negative interest rate. As Bernanke promised in his infamous “Helicopter Speech” the game doesn’t stop at zero interest rate…. at least not as long as it holds.
Markets are up, risk indicators down, bonuses large, economy? Not as bad as it used to be, conclusion: crisis averted, hail Time Magazine’s man of the year Ben Bernanke.
Given the enormous interventions and consumption promoting activities in the US (and elsewhere), I find the scale of the “rebound” is rather disappointing.
Retail sales are still a good 10% below last year’s, durable goods orders in the US have hardly recovered, down 23% from last year, construction spending is down 13 percent and still sliding, housing starts are at minus 30% and flat-lining.
Whether signs of recovery are large, small or in-existing, Credit, the main driving force behind the demand that defined almost a decade of economic growth is contracting and will continue to do so. Consumer credit is contracting the fastest, delinquencies have exploded to 9% and credit card limits are cut almost across the board. The only party that is expanding credit is the government. The FHA (Federal Homeloan Agency) is underwriting mortgages as if there is no tomorrow with down-payments of as little as 3.5% while 25% of their loans given out just 2 years ago are delinquent. Maxine Waters, California Congresswoman, rightly points out “Let’s be clear. Without FHA there would be no mortgage market today.”
Unfortunately, as inflationary as the government’s intention much of its actions are deflationary by definition as total money (money plus credit) in the system as a whole continues to contract.
Re-regulating the financial system, no matter how benign, is deflationary. Although I do applaud the increasing popularity of bringing Glass-Steagall back, any form of it will be deflationary.
Far from signaling the end of the recession, the story of the financial markets in 2009 brings to mind the great Baron of Munchhausen, who, in one of his famous fantasies pulls himself and his horse out of a swamp by his own hair.
Liquidity propelled stock-markets are supposed to pull the economy out of its deleveraging mode with the gracious help of the FED and yet another carry trade.
Whatever the economic benefit or efficiency of this new credit, according to the Fed chief, fresh leverage is supposed to fix the economy. A formula that has been working for a long, long time but unfortunately, not unlike drug addiction, the system screams for every larger dosis with ever increasing leverage needed to create the same effect. In the 1960ies a dollar of debt taken on resulted in more than 60 cents of real economic growth. In the past 10 years one dollar of new debt meant no more than 14 cents of real growth. Shall we guess the efficiency of the current government driven debt expansion? Our debt is already 3 times the size it was before the Great Depression. What has gotten into us?
At the center of this financial madness are the large universal banks that have even increased their size and dominance since the crisis started not by lending but by swallowing smaller, less important institutions. And our financial superstores are largely left to continue as they were, managing huge balance sheets with the same silly risk models that are to a large extent responsible for this crisis.
And as to our monetary leadership, it seems ironic that a band of modern day Keynesians with their utter disregard for a coherent theory of capital and risk has been left in charge of a financial system that has become all about capital and risk.
Existing risk models had been discredited long before the crisis and have yet to be addressed by any of the new financial regulations announced. Not in any of Mr. Bernanke’s analysis of the Great Depression have I found reference to the effects of leverage, the size and quality of debt as a major factor in both economic and monetary management. Why is everybody assuming investment during the past 30 years on the wings of modern financial theories was so immensely efficient? In many professional experts’ view quite the opposite is actuality.
It is no secret that liquidity stabilizes markets. That is its inherent quality, no magic! However, we should not confuse market stabilization with a reduction of risk. Unless we are experiencing an historic break, the productive underbelly of our economy is driven by investments and cash flows and not fictitious asset valuations conjured up with ever-increasing leverage. Unless Baron Munchhausen’s tale has a happy ending stockmarkets will eventually reverse south, possibly quite viciously.
Quite often I am being asked where to put money when everything is so gloomy. Indeed it is a bit tricky, gone are the days of buy and hold and everything is going up. The way down will be a bumpy ride. As a stock-picker I have always relied on company specific investments and cared less about the general environment. And that is what I am doing, but say you have excess funds, in the long-run, I would buy a lot of gold, physical Gold. Although, short term, I believe we will see a sizeable correction in Gold during the next 6 months as financial deleveraging accelerates. In a deleveraging environment generally liquid markets move highly correlated. I see that monetary push that pulled the carry trade is exhausted. The Fed will stop the mortgage train in March. What happens to the carry trade and markets when the long expected relief rally in the dollar takes off is clear. All asset markets correct, US treasury bills will be the safe haven >> ergo buy US 10 year T bills. No stocks, no fringe securitized paper, no commodities.
During the course of this probably quite long bear market (low in 2012/2013 as a guess), one will have to be nimble and reassess the risks on an ongoing basis. It could get wild.
Next to all this gloominess, I can see many reasons to be optimistic for our future. One of them is technological change that is visibly accelerating and is transforming our lives in many positive ways. When I find time next to write, I will share some of my thoughts on the bright future I see ahead.
Until then, keep safe and enjoy the moment. HsO
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