The following is part of Pivotal Events that was published for our subscribers Thursday, February 26, 2009.
"Soaring interest rates will end abuse of credit markets, otherwise known as policymaking. "
- Page 3
Signs Of The Times:
"Taken together, the signs from the world economy are troubling. The credit binge will not unwind quickly or gently. Asset prices will fall, but central bankers and regulators have the tools to stop a downturn from becoming a slump, so long as they use them wisely."
- The Economist, January 24, 2008
That was from the lead editorial, and the last sentence records a strong belief in the philosopher king concept, or even better, a committee of said philosophers. The boast from an Harvard economist, just a month earlier, claimed that the US was being run by a "dream team" of economists, implying that nothing could go wrong.
With another cool winter on the record, it seems appropriate to review some other ironies from last year:
On February 8, 2008, Dr. David Suzuki accused those who dismissed evidence of man-caused warming of committing "intergenerational crime". And continued with "What we challenge you to do is see if there is a legal way of throwing our so-called leaders into jail because what they are doing is a criminal act."
"Terrorists kill people. Weapons of mass destruction have the potential to kill an enormous number of people, but global warming has the potential to kill everybody."
- Mayor Bloomberg, The New York Sun, February 12, 2008
"Snow cover over North America, Mongolia and China is greater than at any time since 1966."
- National Post, February 25, 2008
* * * * *
"The Snow Must Go On: Gore Braves Winter Storm To Testify On Global Warming"
- Drudge Report, January 28, 2009
"Climate change will bring a screeching halt to human civilization and threaten the fabric of life everywhere on earth."
- Al Gore, Washington Post, January 29, 2009
"50-Below Sets Maine Record"
- Maine News, January 16, 2009
The story noted that the previous record was 48 below in 1925.
"Japan's recent economic decline is faster than that of the U.S., which has been experiencing the worst financial crisis in a century."
- Head of research, Bank of Japan, Bloomberg, February 9, 2009
"Hillary Pleas With Communists to Keep Buying Treasury Bonds"
- Drudge Report, February 22, 2009
On Mrs. Clinton's visit to Beijing.
* * * * *
Our brief memo of February 3 registered our dismay that equity returns in the first quarter would not be as good as we were looking forward to back in November. We noted that the gains to the first week in January were rather good, but "too much, too soon". The decline is concerning and as Ross notes, within the typical post-mania pattern, which provides guidance on the big picture.
That memo considered that the cyclicals, such as energy and base metals could trade up to a seasonal high in April while we were uncertain about other sectors. Regrettably, this view continues due to the distortions introduced by "hope and change" tout of the Obama phenomenon. As the street is beginning to understand, post-bubble contractions do not respond to the nonsense of interventionist theories, no matter who is spouting them.
Other than the "too much" rally, there is something else going on. The main one is the relentless reports of financial disasters, combined with the same for an array of standard, but bad, economic reports - typically of stuff a few months old. The latter should be considered as noise within a post-bubble contraction of undeniable force and our policy is to trade the swings in markets and our focus is on the next exit.
In the meantime, the classic fall crash has not been followed by a classic first quarter rebound and this requires some review. In the 1929 and 1873 examples, the crash was from a record high in early September and initial panic to November prompted a technical rebound out to spring.
Then, the bear market resumed with a series of plunges into the first quarter of 1931 when the underlying contraction in liquidity began to take out banks in Europe. Creditanstalt was the biggest bank in Austria-Hungary, and in the initial troubles was encouraged to take over a failing lesser bank. Under accumulating problems, Creditanstalt failed in May, 1931. Some researchers have concluded that that "caused" the depression to worsen.
This goes along with the orthodoxy that the Fed "caused" the depression by raising the discount rate from 5% to 6% in August 1929.
Our view is that such salient events do not cause a depression, but along with the political turn to protectionism, are the basic features of a "Great Depression".
While it was inevitable, it wasn't until our January 29 edition that we wrote that the next "Great Depression" had begun. That brief mention was a good introduction and prompted by real long interest rates jumping from minus 1.2% to plus 3.6%. This was the last key to fall into place.
It is important to note that every great bubble in financial and tangible assets has been followed by a prolonged contraction where each recession is severe and not offset by the next business expansion.
We have been asked about the popular notion about the "V"-Bottom outlook for the economy. On the bigger picture, the typical post bubble contraction has been in the form of "V"-Bottom; with the decline amounting to some 20 years, followed by a dynamic rebound of equivalent duration. For example, the contraction following the 1873 bubble was called the "Great Depression" and it lasted until 1895. The other side of the "V" ran from 1895 to 1929.
Real Interest Rates: The next increase in nominal rates will represent another step up in real long interest rates, which typically, has amounted to twelve percentage points. In the last few months the increase has been four points. Soaring real long interest rates will likely be one of Mother Nature's best methods in ending chronic abuse of the credit markets, otherwise known as policymaking.
The twelve percentage point increase, or 1.2 x basis points, will be devastating to most markets and business sectors. Now that the trend is on, it is appropriate to provide a guess on the numbers needed to accomplish this. Perhaps the rate of CPI inflation could get to minus 3 percent and with the bond yielding 8 percent the real rate would be 11 percent. Starting a few months ago at minus 1 percent, this guess at the numbers could accomplish the usual 12 points.
Link to February 27, 2009 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1121