Thin Air in = Thin Air Out

By: Bob Hoye | Wed, Mar 30, 2011
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The following is part of Pivotal Events that was published for our subscribers March 24, 2011.


Signs Of The Times

"The world does need order and that order needs maintenance. The idea that markets can correct their excesses turned out to be false. Perfect order and global governance are not realistic expectations. However, it is a sad fact that Western democracies provide less successful leadership than China."

~ The New York Times, March 9, 2011

"The Fed is fundamentally flawed. You can't take a group of individuals and say 'Go out there and be smarter than the markets'."

~ Business Week, July 31, 1989

Of course, the best example of central planning occurred in totalitarian police states where the individual had no freedom of choice. Free individual behaviour must be erratic and liberals admired planners in the Soviet Union. Most best-selling economics text books assumed that because central planners had supreme authority the results had to be good.

That conviction was held right up to the collapse of Communism in 1989.

Robert Reich, then a professor at Harvard wrote: "Stalin's economic organization was remarkably successful."

The first quote applauds recent performance of China and it reminds of similar reliance upon highly regarded central planners in Japan. Japan's influence was considered immense.

"Goldman Sachs estimates that nearly one in five trades executed world-wide are now Japan-related."

~ Wall Street Journal, August 16, 1989

Japan's long contraction began at the end of 1989 when the Nikkei peaked at 38,915. The low was 7,055 in March 2009.

Obviously, we have been reviewing notes made during the fateful year of 1989.

Japan was at a high then - as was Chinese Communism. Now China is on a prosperity binge that some think due to central planners in Beijing. More than likely the boom has been due to animated spirits out of Hong Kong and Taiwan, which have had a long history of boom and bust.

Perhaps it will soon be Japan's turn for a long march towards strong relative performance.

Ethereal Financial Worlds

The title describes the dreadful habit of central bankers creating credit out of thin air. This has been enabled by interventionists who paid little attention to financial history when contriving economic theories out of thin air.

Thin air in = thin air out.

Since early December, our Momentum Peak Forecaster has been calling for a magnificent surge of speculation to conclude around March. Separately, crude oil and precious metals could trend the longest as other sectors ran out of momentum.

Agricultural prices (GKX) reached the first high at 567 in mid February and after a correction made it to 570. The hit was a quick 15 percent to 482.

A similar move by base metal prices produced a 9 percent decline.

This took some of the frenzy out of the action and the testing rally is underway. This is being helped by resumed strength in precious metals.

This is still within the timing window of our Forecaster, which suggests that a cyclical peak is being established. As with the two important signals in 1973 and 1980.

Interest Rates

The long bond enjoyed an 8-point rally in two steps as formerly hot asset sectors corrected. Last week we thought that recovering prices would turn the bond down.

Yesterday's ChartWorks noted that the rebound in the devastated Muni market was technically close to ending. On momentum, last week we noted that the NPI had accomplished a big swing in the RSI from oversold to a limiting overbought.

Municipal bonds could become a serious problem with chronic inabilities to service debt. As we have been noting, monopolistic union demands upon the tolerance and abilities of the taxpayer are the problem. This will continue to bankruptcy. Default always ends monopolies.

The irony has been that the sector has been considered very safe with the additional attraction of tax relief for the investor.

Over in corporate-bond-land, the problem is the old "reaching for yield" compulsion.

As the attached chart shows the recent pattern is similar to June 2008 that led to that disaster. In both cases the RSI reached 70, followed by an initial decline of 4 points in one month. In 2008 the test of the high was followed by a 2-month gentle decline to dramatic failure.

This time around, the test of the high amounts to 2 points over one month and the character of the next decline will be interesting.

Our Forecaster is suggesting that commodities are in the process of setting a cyclical high. In which case, declining commodities would indicate weakening earnings and debt service abilities.


The ability to believe that government creates and can manage the prosperity of a new financial era is characteristic of a mania. With the shock of the inevitable collapse of speculation, orthodoxy immediately believes that more and better regulation would have prevented the crash and consequent hardship.

In our first quotation on the front page, the NYT in calling for more "order" admires the "order" that is keeping China's prosperity going.

At the exact top of the Nikkei Bubble in 1989, the Japan Times on December 26 editorialized:

"Many economists and the Japanese government as well, say the classic theory of business cycles no longer applies to Japan, which has minimized instability factors and learned to drive slowly but steadily when necessary."

MITI had accomplished "order". Like the prosperity, the order was short-lived.

The quest for perfect order is not new and perhaps every generation has wished for it and some accomplished the order of a police state. Two thousand years ago, Rome had accomplished it - for a while.

Classicist F.W. Walbank's "The Awful Revolution", published in 1946, described the collapse of the Roman Empire. For him the awful revolution was the collapse of the order of Rome and the problem was "private enterprise, when left to itself, was proving unequal to the task of feeding the civilian population."

He did not mention that the New Deal in Old Rome had built a massive welfare state with half of Rome's population on the dole.

Rome's failure marked the end of that long experiment in authoritarian government, whereby each crisis was used to expand the influence of the state. Until it failed.

However, commonsense cannot be quelled forever. Even in high places, as Bloomberg reported this week:

"Fed's Fisher Sees 'Extraordinary Speculative Activity' in U.S. on Stimulus"

Then another headline, this one from Reuters:

"U.S. New Home Sales Hit Record Low, Outlook Gloomy"

Richard Fisher at the Dallas Fed confirms that "stimulus" has gone into items that could be driven to wild speculation.

The second quote illustrates our thesis that the "stimulus" would not go into losing situations, but would, through Wall Street, go into "winners".

Massive stimulus was administered by those who would provide order - perhaps a "new world order"?


Link to March 25, 2011 'Bob and Phil Show' on



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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