Ideological and Hostile

By: Doug Noland | Fri, Nov 19, 2010
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For the week, the S&P500 was unchanged (up 7.6% y-t-d), while the Dow added 0.1% (up 7.4%). The S&P 400 Mid-Caps added 0.8% (up 17.0%), and the small cap Russell 2000 increased 0.7% (up 15.8%). The Banks declined 2.3% (up 7.7%), while the Broker/Dealers were unchanged (down 1.9%). The Morgan Stanley Cyclicals added 0.4% (up 15.1%), and the Transports gained 1.4% (up 18.9%). The Morgan Stanley Consumer index was little changed (up 7.5%), while the Utilities slipped 0.7% (down 0.1%). The Nasdaq100 dipped 0.1% (up 14.8%), while the Morgan Stanley High Tech index gained 1.1% (up 9.9%). The Semiconductors rose 1.2% (up 7.6%). The InteractiveWeek Internet index dipped 0.5% (up 28.8%). The Biotechs gained 1.4%, increasing 2010 gains to 24.5%. With bullion declining $, the HUI gold index declined 1.1% (up %).

One-month Treasury bill rates ended the week at 12 bps and three-month bills closed at 14 bps. Two-year government yields were little changed at 0.51%. Five-year T-note yields ended the week 16 bps higher at 1.50%. Ten-year yields jumped 9 bps to 2.88%. Long bond yields declined 4 bps to 4.25%. Benchmark Fannie MBS yields were 12 bps higher at 3.76%. The spread between 10-year Treasury yields and benchmark MBS yields widened 3 bps to 88 bps. Agency 10-yr debt spreads were 4 bps wider to 18 bps. The implied yield on December 2011 eurodollar futures declined 7.5 bps to 0.73%. The 10-year dollar swap spread increased 1.75 bps to 15.75. The 30-year swap spread declined 7 bps to negative 30. Corporate bond spreads narrowed. An index of investment grade bond risk declined 45 bps to 89 bps. An index of junk bond risk declined 5 to 481 bps.

Investment grade issuers included Pacific Gas & Electric $1.6bn, Procter & Gamble $500 million, Lowes Companies $1.0bn, Prudential $1.0bn, Laboratory Corp $925 million, Ace Ina $700 million, Steelriver Transmission $560 million, Delta Air Lines $475 million, Continental Airlines $425 million, Genworth Financial $400 million, Southern Cal Gas $300 million, Dun & Bradstreet $300 million, GATX $250 million, TTX $150 million, and California Water Services $100 million.

Junk bond funds saw outflows of $723 million (from Lipper), ending the streak of inflows at 11 weeks. Junk issuers included Ally Financial $1.0bn, Dunkin Brands $625 million, Avis Budget Car Rental $600 million, Ball Corp $500 million, Covanta $400 million, AMO $385 million, Stone Energy $375 million, El Paso Pipeline $375 million, Affinity Group $333 million, NV Energy $315 million, Spirit Aerosystems $300 million, Thermadyne Holdings $260 million, CMS Energy $250 million, and Service Corp International $250 million.

Converts issues included Rightnow Technologies $150 million, Kaman Corp $115 million, and PDC Energy $100 million.

The list of international dollar debt sales included Wind Acquisition $1.3bn and Gazprom $1.0bn.

Global yields are on the rise. U.K. 10-year gilt yields jumped 18 bps this week to 3.38%, and German bund yields surged 19 bps to 2.70%. Ireland yields declined 2 bps to 8.11%. Greek 10-year bond yields rose 18 bps to 11.56%. Ten-year Portuguese yields were little changed at 6.73%. The German DAX equities index jumped 1.6% (up 14.9% y-t-d) to a 2010 high. Japanese 10-year "JGB" yields jumped 7 bps to 1.06%. The Nikkei 225 rallied 3.1% (down 5.0%). Emerging markets were mixed. For the week, Brazil's Bovespa equities index edged up 0.7% (up 3.4%), and Mexico's Bolsa advanced 1.5% (up 14.0%). South Korea's Kospi index increased 1.5% (up 15.3%). India's equities index fell 2.9% (up 12.1%). China's Shanghai Exchange dropped 3.2% (down 11.9%). Brazil's benchmark dollar bond yields rose 7 bps to 4.00%, and Mexico's benchmark bond yields rose 20 bps to 4.02%.

Freddie Mac 30-year fixed mortgage rates reversed course, jumping 22 bps last week to 4.39% (down 44bps y-o-y). Fifteen-year fixed rates surged 19 bps to 3.76% (down 56bps y-o-y). One-year ARMs were unchanged at 3.26% (down 109bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 9 bps to 5.25% (down 61bps y-o-y).

Federal Reserve Credit rose $4.0bn to $2.293 TN. Fed Credit was up $73.2bn y-t-d (3.7% annualized) and $102bn, or 4.6%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 11/17) rose $4.9bn (23-wk gain of $265) to a record $3.341 TN. "Custody holdings" have increased $386bn y-t-d (14.8% annualized), with a one-year rise of $413bn, or 14.1%.

M2 (narrow) "money" supply jumped $16bn to $8.802 TN. Narrow "money" has increased $277bn y-t-d, or 3.6% annualized. Over the past year, M2 grew 3.3%. For the week, Currency added $1.5bn, and Demand & Checkable Deposits jumped $90.4bn. Savings Deposits dropped $70bn, and Small Denominated Deposits declined $4.8bn. Retail Money Fund assets dipped $0.8bn.

Total Money Market Fund assets (from Invest Co Inst) slipped $4.0bn to $2.798 TN. Year-do-date, money fund assets have dropped $496bn, with a one-year decline of $541bn, or 16.2%.

Total Commercial Paper outstanding sank $50.6bn to $1.08 TN. CP has declined $87bn year-to-date, and was down $184bn from a year ago.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.520 TN y-o-y, or 20.2%, to a record $9.034 TN.

Global Credit Market Watch:

November 17 - Bloomberg (Veronica Navarro Espinosa and Helder Marinho): "Banco Bradesco SA and Banco Industrial e Comercial SA withdrew bond offerings as a global market rout and an investigation into alleged bank fraud pushed Brazilian corporate borrowing costs to a seven-week high."

Global Government Finance Bubble Watch:

November 17 - Wall Street Journal (Michael Aneiro and Stu Woo): "America's strapped states and cities took another hit Wednesday, with California seeing tepid demand for its latest bond sale and other governments pulling about $700 million worth of borrowing deals this week as investors continued stepping away from the municipal bond market. The normally staid market has grown volatile the past week, posting its sharpest selloff in nearly two years, as investors demand higher interest rates to buy paper issued by states, cities and counties to finance their operations."

November 18 - Bloomberg (Jon Menon and Gavin Finch): "Chancellor of the Exchequer George Osborne says Britain 'stands ready' to assist Ireland. What he didn't say is that U.K. taxpayers have already funded the largest part of an 18.4 billion-pound ($29.4 billion) bailout for Irish lenders. The aid was used to prop up the Irish units of Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc since the onset of the credit crisis..."

Currency Watch:

The dollar index increased 0.5% (up 0.8% y-t-d) to 78.50. On the upside for the week, the New Zealand dollar increased 0.7%, the Mexican peso 0.7%, the Brazilian real 0.4%, the Australian dollar 0.2%, the Singapore dollar 0.1%, and the Swedish krona 0.1%. On the downside, the Japanese yen declined 1.22%, the Swiss franc 1.15%, the British pound 0.8%, the Norwegian krone 0.7%, the South African rand 0.5%, the Canadian dollar 0.4%, the Taiwanese dollar 0.4%, and the euro 0.1%.

Commodities Watch:

November 18 - Bloomberg (Madelene Pearson): "Gold imports this year by India, the largest consumer, have already exceeded 2009 levels as consumers boost jewelry purchases, according to the World Gold Council. Imports totaled 624 metric tons by the end of the third quarter, compared with 559 tons in all of 2009..."

November 18 - Bloomberg (Rudy Ruitenberg): "World food imports will exceed $1 trillion this year, close to the record reached in the food- crisis year of 2008... The global cost of importing foodstuffs will jump 15% to $1.026 trillion in 2010..."

November 16 - Bloomberg (Luzi Ann Javier and Susan Li): "China, the biggest cotton importer, may buy 20 million bales this year to meet rising demand from the domestic textile industry, sustaining price gains, Olam International Ltd. said. The amount would be a record. The Asian nation purchased 10.9 million bales in the year ended July 31..."

The CRB index declined 1.6% (up 5.5% y-t-d). The Goldman Sachs Commodities Index (GSCI) dropped 2.8% (up 7.9% y-t-d). Spot Gold fell 1.2% to $1,353 (up 23% y-t-d). Silver rallied 4.8% to $27.19 (up 5% y-t-d). January Crude dropped $3.36 to $81.98 (up 3% y-t-d). December Gasoline slipped 0.6% (up 7% y-t-d), while December Natural Gas rallied 9.6% (down 25% y-t-d). December Copper declined 1.4% (up 15% y-t-d). December Wheat dropped 3.7% (up 19% y-t-d), and December Corn fell 2.5% (up 26% y-t-d).

China Bubble Watch:

November 16 - Financial Times (Geoff Dyer): "China is considering a package of price controls and other measures to contain inflation which rose sharply last month and has become the principal risk to the economy. The National Development and Reform Commission, China's main economic planning body, is putting together a 'one-two punch' of policies to limit food inflation, state media reported... in a sign that debate is breaking out over how to tackle rising prices. Several major cities in China have announced plans to try to cap food prices, while two officials in Beijing also confirmed this week that the government was looking again at price controls."

November 17 - Bloomberg: "China may impose temporary price controls to counter the fastest inflation in two years, the cabinet said. Price caps on 'important daily necessities' and production materials will be used if necessary, the State Council said... China's accelerating inflation has sent stocks and commodities sliding on speculation that efforts to curb prices will cool the world's fastest-growing major economy."

November 16 - Bloomberg: "Chinese Central Bank Governor Zhou Xiaochuan said China is under 'pressure' from capital inflows as a state newspaper said price controls could be imposed to cool the fastest inflation in two years. Zhou reiterated government goals of 'moderate' credit growth and stronger liquidity management..."

November 16 - Bloomberg: "China's four biggest banks will not issue any new loans to property developers for the rest of the year, the state-run China Real Estate Business reported..."

November 16 - Bloomberg (Scott Reyburn): "The sale of an 18-century white-jade carving has rounded off a series of auctions of Chinese art in the U.K. that raised a record 105 million pounds ($168 million). The carving of a deer with its young fetched 3.8 million pounds... The price was the second-highest of the series after the 51.6 million pounds for a Qianlong Imperial vase, an auction record for Chinese art, also set at a regional saleroom, Bainbridges in west London. Asian collectors are prepared to pay ever-higher prices for objects associated with Chinese emperors, wherever in the world they are offered, dealers said. 'China has always been the poor relation of Western art,' said London-based dealer Alastair Gibson, a director of Asian Art... 'Now, it's up there with Picasso and Warhol."

Asia Bubble Watch:

November 18 - Bloomberg (Eunkyung Seo): "South Korea's economy is expected to grow 6.2% this year, the Organization for Economic Cooperation and Development said..."

November 17 - Bloomberg (Eunkyung Seo and William Sim): "The Bank of Korea's second interest-rate increase this year leaves its benchmark below the pace of inflation... Governor Kim Choong Soo raised borrowing costs by 0.25 percentage point to 2.5% yesterday."

November 18 - Bloomberg (Shamim Adam and Andrea Tan): "Singapore said its economy will expand a record 15% this year, the fastest pace in Asia, even as slowing global growth threatens to damp export demand. The island's currency rose."

Latin America Watch:

November 18 - Bloomberg (Randy Woods): "Chile's gross domestic product in the three months through September grew at its fastest pace since 2005... Chile's GDP expanded 7% in the third quarter from the previous year..."

Unbalanced Global Economy Watch:

November 16 - Bloomberg (Svenja O'Donnell): "Bank of England Governor Mervyn King said inflation will remain 'elevated' throughout 2011 after it unexpectedly accelerated in October, forcing him to write the fourth letter of explanation to the Treasury this year... Consumer prices increased 3.2% in October from a year earlier..."

November 18 - Bloomberg (Maria Petrakis and Christos Ziotis): "Greece's government plans to cut the budget gap by 5 billion euros ($6.8bn) in 2011 by reducing spending, including wages at state companies, and increasing sales taxes to meet targets under a European Union-led rescue. The deficit will decline to 7.4% of gross domestic product..."

U.S. Bubble Economy Watch:

November 17 - Bloomberg (Jody Shenn and John Gittelsohn): "Home ownership may be falling out of reach for more Americans as lenders toughen their standards for Federal Housing Administration-insured loans beyond what the agency itself requires. Mortgage lenders... have raised the minimum credit score on FHA-insured loans that they will buy to 640 from 620. About 6.3 million people fall within that range, according to FICO, which created the formula for the ratings."

November 16 - Bloomberg (Jeff Wilson, Alan Bjerga, Yi Tian): "The best second-half for commodities in a generation is pushing U.S. farm incomes and agricultural land prices toward record highs. While the 17% rise in the Thomson Reuters/Jefferies CRB Index of 19 raw materials since the end of June reflects higher prices for all commodities, agriculture led the biggest rally since 1972."

November 17 - Bloomberg (David J. Lynch): "Southern Copper Corp., a Phoenix- based mining company that boasts some of the industry's largest copper reserves, plans to invest $800 million this year in projects such as a new smelter and a more efficient natural-gas furnace. Such spending sounds like just what the Federal Reserve had in mind in 2008 when it cut interest rates to near zero and started buying $1.7 trillion in securities to spur job growth. Yet Southern Copper, which raised $1.5 billion in an April debt offering, will use that money at its mines in Mexico and Peru, not the U.S...."

November 16 - Bloomberg: "Gap Inc., J.C. Penney Co. and other U.S. retailers may have to pay Chinese suppliers as much as 30% more for clothes as surging cotton prices boost costs. 'It's a little terrifying to deal with cotton suppliers now,' said Vicky Wu, a sales manager at Suzhou Unitedtex Enterprise Ltd., a closely held, Jiangsu province-based clothes maker that counts Gap and J.C. Penney among its clients. Cotton futures in China have surged more than 70% this year..."

November 16 - Bloomberg (Christopher Palmeri and Tim Jones): "The nation's Republican governors and governors-to-be met for the first time since the Nov. 2 election that gave their party control of 29 statehouses, promising to address budget deficits by chopping the size of government. 'Why do you exist?' Pennsylvania Governor-elect Tom Corbett said that he would ask every state agency... New Mexico Governor-elect Susana Martinez said she would reduce the public payroll by 5% through attrition to deal with a deficit she said recently nearly doubled to $452 million..."

Real Estate Bubble Watch:

November 18 - Bloomberg (Kathleen M. Howley): "Foreclosures on prime fixed-rate mortgages in the U.S. jumped to a record in the third quarter... The inventory of homes in foreclosure financed by prime fixed-rate loans rose to 2.45% from 2.36% in the previous three months..."

Central Bank Watch:

November 18 - Bloomberg (Craig Torres and Scott Lanman): "Federal Reserve Chairman Ben S. Bernanke defended his expansion of record monetary stimulus in a meeting with Senators as top Republican lawmakers stepped up their criticism of the central bank chief's policies. Bernanke, in a closed-door meeting yesterday, said the Fed's plan to buy $600 billion in assets would spur job growth while keeping inflation under control. John Boehner, the presumptive House speaker, and three other Republicans sent Bernanke a letter expressing 'deep concerns' about a policy they said risked weakening the dollar and fueling asset bubbles."

November 17 - Bloomberg (David J. Lynch and Mike Dorning): "The Federal Reserve is facing the fiercest political assault on its powers in three decades as it struggles to help revive the U.S. economy. The Fed's plan to expand its purchases of Treasury securities has triggered criticism from Republican lawmakers, some economists who wrote an open letter to the Fed protesting the move, and finance officials in Germany, China and Brazil. While central bank officials are pressing ahead with the $600 billion bond-buying program announced this month, analysts said the criticism may fan dissent within the Fed over the quantitative-easing policy. That may limit Chairman Ben S. Bernanke's ability to take further measures if the economy remains weak."

November 16 - Bloomberg (Steve Matthews and Joshua Zumbrun): "The Federal Reserve may soon need to tighten policy even amid a high U.S. unemployment rate to avert a rise in prices similar to the 1970s, Richmond Fed President Jeffrey Lacker said. 'At some point in the not-too-distant future, we are likely to face an economy growing in a self-sustaining way while the unemployment rate is still relatively high by historical standards,' Lacker said... 'The decisions we make at that time will be the true test of whether we've learned our lessons.'"

November 17 - Bloomberg (Svenja O'Donnell): "The Bank of England's Monetary Policy Committee split three ways for a second month as some officials became more concerned that Britain's bout of inflation will dislodge price expectations."

Muni Watch:

November 16 - Financial Times (Nicole Bullock): "Municipal bonds had their biggest one-day sell-off yesterday since the height of the financial crisis, prompting some borrowers to delay financing plans. The yields on triple A 10-year bonds rose 18 bps to 2.93%, the largest one-day rise since October of 2008... The $2,800bn 'muni' bond market where states and municipalities raise money has been under pressure over the past week amid a rise in the yields of benchmark US Treasury bonds, heavy bond sales and uncertainty about federal support for the market."

November 16 - Bloomberg (Dunstan McNichol): "Washington state... may collect $1.2 billion less in taxes than forecast over the next 31 months because of a sluggish economy, a state council said."

California Watch:

November 16 - Bloomberg (Michael B. Marois and Brendan A. McGrail): "California is selling $10 billion of one-year notes to boost cash on hand, as the state that produces 13% of the U.S. gross domestic product tries to assure investors it can repay the loan amid a $25 billion budget gap... The issue comes after the state's Legislative Analyst's Office said California's deficit may exceed $25 billion in the next 19 months..."

November 16 - Bloomberg (Michael B. Marois): "California began marketing $2.75 billion of taxable debt today, including $2.5 billion of Build America Bonds. $1.65 billion segment of 30-year Build America securities is being offered to investors at a yield equivalent to 3.3 percentage points above a comparable-maturity Treasuries... The average extra yield Build America Bonds pay over 30-year Treasuries was 184 basis points yesterday..."

New York Watch:

November 16 - Bloomberg (Henry Goldman): "New York City, facing a $3.3 billion deficit in next year's budget, will cut its workforce by more than 10,000 over the next year-and-a-half, Mayor Michael Bloomberg's budget office reported."


Ideological and Hostile

With Eurozone tensions on the rise, Wednesday's headline from the Financial Times read "Anger at Germany boils over." "Bernanke Fires Back, Takes Aim at China," was how the Wall Street Journal titled its analysis of the Fed Chairman's speech this morning in Frankfurt. Paul Krugman also takes direct aim at Germany and China - and throws in the Republicans - with his "Axis of Depression" piece in today's New York Times. In a troubled backdrop beckoning for level-headed analysis and cooperation, the mood has turned decidedly ideological and hostile.

Dr. Bernanke has compiled speeches and academic papers that will be scrutinized for generations to come. He added one more to his list this morning. Global policymakers - already deeply skeptical - will not be impressed. Officials from the "developing" economies are sure to be displeased. The Chinese must be incensed - and it is difficult for me to discern how this will work to our advantage. We're the big debtor and importer. In no way does our policymaking qualify as the "moral high ground." Indeed, most would argue we've been permanently disqualified. QE2 was one step too far - it crossed the line.

The Bernanke Fed has boxed itself in a corner. QE2 has been poorly received at home and abroad. Yet with this policy having succeeded in inflating global markets, there will be no turning back for our monetary experiment. Bernanke came out swinging today - or at least finger pointing. Appreciating that QE3, 4, and 5... are now anything but sure things, he calls for help from additional fiscal stimulus. In the following breath, he pays lip service to the need to resolve long-term fiscal challenges. We're at the point where it all lacks credibility. Dr. Bernanke has always been an inflationist - and these stripes are increasingly apparent for all to witness. Having been unsuccessful in "marketing" his latest installment of Treasury debt monetization, it is apparently now time to identify culprits.

From Dr. Bernanke's speech, "Rebalancing the Global Economy": "As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new... In particular, for large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account. Thus, it would be desirable for the global community, over time, to devise an international monetary system that more consistently aligns the interests of individual countries with the interests of the global economy as a whole."

After Treasury Secretary Geithner's "global rebalancing" proposals smacked up against a cement wall at the G20, Chairman Bernanke must know his global rebalancing speech will be flatly rejected in terms of providing a legitimate policymaking proposal. It was instead a rehash of flawed doctrine - and a stinging slap in the face. Our economy has been running Current Account Deficits since the eighties. The Fed has been accommodating financial excesses since the eighties. We've had insufficient household and national savings since the eighties. Monetary policy has nurtured imbalances for decades. So, we're going to castigate the Chinese?

I find it embarrassing - to blame our trade partners and Creditors for our predicament. Worse yet, it is frightening that there is obviously no plan of attack for dealing with our nation's structural issues. The Geithner/Bernanke "global rebalancing" gimmick is to have China and the "developing" economies inflate domestic demand and stimulate imports. In the meantime, we stay the course with massive deficits, monetization and near-zero interest rates. This approach has no chance of rectifying our deep structural impairment nor resolving global imbalances. It does, however, increase the odds of a crisis of confidence in our debt markets and currency.

"In Defense of Ben Bernanke" (Wall Street Journal, November 15, 2010), Alan Blinder states that QE2 is "not a radical departure from conventional monetary policy." Only an individual that has been an integral part of the revolution of monetary management at the Federal Reserve would make such a statement.

Beginning back with early-nineties banking system impairment, the Greenspan Federal Reserve nurtured Wall Street financial engineering and the rapid expansion of non-bank marketable debt. The GSEs, securitization markets and derivatives were viewed as instrumental for fostering the needed Credit expansion in the face of severe banking and fiscal headwinds. The Fed unleashed a lion.

No longer was monetary policy focused on creating and extracting banking system reserves in an effort to influence bank lending. The old rules for governing a largely contained financial system no longer applied. A New Era was born. The Fed now could manipulate short-term borrowing costs and immediately stimulate flows into the securities markets, speculator risk-taking and leveraging, asset inflation, mortgage refinancing and equity extraction, home price gains, additional household net worth, spending... It became The Age of the Maestro, The Masters of the Universe, the enterprising investment banker and opportunistic mortgage originator. Traditional measures of economic health - the Current Account, savings rates, sound investment, productive capacity, stable money and Credit, balanced financial flows - were discarded. What mattered now were the markets, market perceptions and how the Fed could be counted on to orchestrate and sustain a boom.

I've argued for years now that the Fed had adopted a radical approach to monetary management - and it was disturbingly apparent that our central bank had become enamored with history's most powerful monetary policy mechanism. And with dynamic marketable debt increasingly supplanting the boring old bank loans as the main driver of system Credit expansion (especially as the nineties progressed), the Federal Reserve had to take an increasingly aggressive and activist approach to ensuring ample marketplace liquidity and unwavering market confidence. The '94 bursting of the bond/MBS Bubble, SE Asia, LTCM, the tech bust... The Fed nurtured a historic Credit Bubble and the larger the Bubble inflated the greater role monetary policy had to play to ward against a devastating crisis of confidence. Policy was conspicuously radicalized in the aftermath of the 2008 collapse of the mortgage/Wall Street finance Bubble.

But the chickens are bound to come home to roost. Especially after the past two years' unprecedented global expansion of government debt, marketable debt securities now absolutely dominate the world. The specter of market illiquidity reemerged with this spring's Greek contagion crisis, and it was sufficiently scary. The ECB intervened to support struggling debt issuers and a vulnerable banking system. The Fed, fearing a more systemic crisis, played its QE2 trump card. The markets perceived this move as an unending commitment from the Fed to provide the markets a liquidity backstop. Risk markets have inflated across the globe.

It is my view that a world financial apparatus dominated by marketable debt instruments is inherently unstable. Implement a monetary policy regime to manage marketplace liquidity and asset prices at your own peril. Be prepared for market dependency and ever-increasing liquidity injection requirements. Such a regime will reward the savviest speculators and ensure acute systemic vulnerability. To be sure, recent notions of perpetual QE inflated global markets indiscriminately. The "liquidity trade" threw caution to the wind. Liquidity overabundance also pushed inflationary forces in China and throughout Asia into the danger zone.

These days, Fed policy to manipulate U.S. securities markets has extraordinary spillover effects. In my vernacular, inflationary biases have shifted from U.S. mortgage finance and American housing to China, Asia, the "developing" economies and commodities. The Fed will now have an increasingly challenging task of ensuring sufficient liquidity to sustain inflated U.S. securities markets. Meanwhile, the "periphery" will have an increasingly frustrating job of trying to manage unwieldy financial flows into their markets and attendant overheated economies.

The basic premise of the "Bretton Woods II" thesis has been that it is in the interest of both parties for the U.S. to run Current Account Deficits and for Asian economies to send us manufactured goods while their central banks recycle the resulting dollar flows back into U.S. securities. And for as much distaste as I've had for "BWII" analysis, there has been the semblance of truth to the thesis of mutual benefits. I've argued that the arrangement where we exchange new debt instruments for imported goods, services, energy and commodities was dysfunctional and unsustainable. Today, with our massive expansion of non-productive - hence inherently vulnerable - debt and Asia's heightened susceptibility to inflation and unwieldy financial flows, this arrangement has turned problematic. It is also fundamental to global marketplace liquidity.

Our policymakers are acting to the detriment of our Creditors. They speak in a tone that does not inspire confidence and may likely antagonize. The Chinese, in particular, can be counted on to act in what they perceive as their own best interest. They today confront serious inflation, "hot money" and overheating issues. As such, what has appeared as favorable prospects for continued global liquidity overabundance now look a lot less certain. Global yields were on the rise again this week, with heightened attention to structural debt issues. U.S. municipal bonds were hammered. My premise has been that the markets will inevitably discipline Washington. This may occur after it works its way up the food chain.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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