The PhD Standard
For the week, the S&P500 sank 4.7% (down 10.7% y-t-d), and the Dow fell 4.0% (down 6.6%). The Morgan Stanley Cyclicals were hit for 10.1% (down 24%), and the Transports fell 8.7% (down 17.3%). The Morgan Stanley Consumer index declined 2.1% (down 10.3%), while the Utilities rallied 1.8% (up 2.3%). The Banks dropped another 5.9% (down 32.0%), while the Broker/Dealers sank 6.3% (down 30.8%). The S&P 400 Mid-Caps dropped 6.6% (down 13.2%), and the small cap Russell 2000 fell 6.6% (down 16.8%). The Nasdaq100 lost 6.6% (down 8.1%), and the Morgan Stanley High Tech index sank 8.1% (down 19.6%). The Semiconductors were hammered for 8.2% (down 20.8%). The InteractiveWeek Internet index sank 9.5% (down 17.1%). The Biotechs declined 2.4% (down 15%). With bullion surging $103, the lagging HUI gold index gained 3.0% (up 1.4%).
One and two-month Treasury bill rates ended the week at zero, nothing, nada. Two-year government yields were little changed at 0.19%. Five-year T-note yields ended the week down 7 bps to 0.99%. Ten-year yields dropped 19 bps to 2.07%. Long bond yields sank 33 bps to 3.40%. Benchmark Fannie MBS yields fell 11 bps to 3.19%. The spread between 10-year Treasury yields and benchmark MBS yields widened 8 to 112 bps. Agency 10-yr debt spreads widened 8 to 9 bps. The implied yield on December 2012 eurodollar futures rose 5 bps to 0.485%. The 10-year dollar swap spread declined 3 to 13.75 bps. The 30-year swap spread increased 3 bps to negative 35 bps. Corporate bond spreads widened further. An index of investment grade bond risk jumped 7 bps to 123 bps. An index of junk bond risk surged 49 bps to 701 bps.
Investment-grade issuers included AT&T $5.0bn, Occidental Petroleum $2.125bn, Walt Disney $1.85bn, Dentsply $1.0bn, Kinross Gold $1.0bn, Burlington Northern $750 million, VF Corp $900 million, Neighbors Industries $700 million, Magellan Midstream $550 million, Southern Co. $500 million, Coca Cola Enterprises $500 million, Progressive Corp $500 million, Northern Trust $500 million, PPL Electric Securities $400 million, Western Union $400 million, San Diego G&E $350 million, Florida Power $300 million, Oglethorpe Power $300 million, Flir Systems $250 million, and Boston University $100 million.
Junk bond funds saw outflows of $408bn (from Lipper). Junk debt issuers included AVD $400 million.
I saw no convertible debt issued.
International dollar bond issuers included Canadian Housing Trust $5.0bn, Quebec $1.4bn, and Transporte Energia $100 million.
German bund yields sank 23 bps to 2.10% (down 86bps y-t-d), and U.K. 10-year gilt yields fell 15 bps this week to 2.39% (down 112bps). Greek two-year yields ended the week up 344 bps to 36.50% (up 2,426bps). Greek 10-year note yields jumped 96 bps to 16.16% (up 374bps). Italian 10-yr yields declined 8 bps to 4.92% (up 11bps) and Spain's 10-year yields dipped 3 bps to 4.94% (down 50bps). Ten-year Portuguese yields rose 22 bps to 10.32% (up 374bps). Irish yields declined 36 bps to 9.26% (up 20bps). The German DAX equities index sank 8.6% (down 20.7% y-t-d). Japanese 10-year "JGB" yields dropped 6 bps to 0.98% (down 14bps). Japan's Nikkei declined 2.7% (down 14.8%). Emerging markets were under pressure. For the week, Brazil's Bovespa equities index declined 1.9% (down 24.3%), and Mexico's Bolsa slipped 0.7% (down 14%). South Korea's Kospi index declined 2.8% (down 14.9%). India's equities index sank 4.3% (down 21.3%). China's Shanghai Exchange fell 2.3% (down 9.7%). Brazil's benchmark dollar bond yields sank 19 bps to 3.55%, and Mexico's benchmark bond yields dropped 27 bps to 3.41%.
Freddie Mac 30-year fixed mortgage rates sank 17 bps to 4.15% (down 27bps y-o-y). Fifteen-year fixed rates dropped 14 bps to 3.36% (down 54bps y-o-y). One-year ARMs declined 3 bps to 2.86% (down 57bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 4 bps to 4.91% (down 44bps y-o-y).
Federal Reserve Credit declined $6.5bn to $2.848 TN. Fed Credit was up $440bn y-t-d and $546bn from a year ago, or 23.7%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 8/17) increased $8.6bn to a record $3.479 TN. "Custody holdings" were up $128bn y-t-d and $303bn from a year ago, or 9.5%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $1.589 TN y-o-y, or 18.6% to a record $10.136 TN. Over two years, reserves were $3.047 TN higher, for 43% growth.
M2 (narrow) "money" supply jumped another $43bn to a record $9.517 TN. "Narrow money" has expanded at a 12.6% pace y-t-d and 10.2% over the past year. For the week, Currency increased $1.4bn. Demand and Checkable Deposits declined $3.9bn, while Savings Deposits surged $40.9bn. Small Denominated Deposits declined $3.7bn. Retail Money Funds increased $8.4bn.
Total Money Fund assets rose $10.2bn last week to $2.631 TN. Money Fund assets were down $179bn y-t-d, with a decline of $198bn over the past year, or 7.0%.
Total Commercial Paper outstanding dropped $22.6bn to a 15-week low $1.147 Trillion. CP was up $175bn y-t-d, or 23.6% annualized, with a one-year rise of $36bn.
Global Credit Market Watch:
August 17 - Bloomberg (James G. Neuger and Simon Kennedy): "The latest Franco-German strategy to counter the euro debt crisis stressed ideas already in the works, shunning bolder steps investors were seeking to calm markets. German Chancellor Angela Merkel and French President Nicolas Sarkozy ruled out steps such as the issuance of euro bonds or expanding the bailout fund. They backed a plan being drawn up for national balanced-budget amendments and reheated one rejected last year for a financial-transactions tax. They called for the 17 euro leaders to hold two summits a year, the same number of times they have already met in 2011."
August 15 - Bloomberg (Jana Randow): "The European Central Bank jeopardizes its independence by buying government bonds of distressed euro-region countries, Otmar Issing, former chief economist, said... 'It cannot be the task of a central bank. If it enters political territory, it risks its independence,' Issing said... Issuing euro bonds would be a 'catastrophe' that might result in higher taxes and spending cuts, he said."
August 15 - Bloomberg (Patrick Donahue): "The general secretary of Chancellor Angela Merkel's Christian Democratic Union, Hermann Groehe, rejected the opposition Social Democrats' call for joint European bonds, saying the plan would cause interest rates to soar and could endanger the single currency..."
August 16 - Bloomberg (Sonia Sirletti and Esteban Duarte): "Italian retail investors are spoiled for choice as the country's banks prepare to refinance a third of their debt at a time when the government is offering yields at euro-era records on its securities. The country's lenders, including UniCredit SpA and Intesa Sanpaolo SpA, have more than 100 billion euros ($145 billion) of bonds to repay by the end of 2012. The government, which has paid more for its money than financial firms for the past four months, will sell quadruple that amount in the same period. 'The maturities of the Italian public debt create a sort of competition with the issues of the banking sector,' Paola Sabbione, an analyst at Deutsche Bank AG, wrote..."
August 15 - Bloomberg (Donal Griffin and Christine Harper): "Citigroup Inc. and Goldman Sachs Group Inc. increased gross exposures to French banks in the year's first half before the European nation's financial stocks plunged amid perceived dependence on short-term funding. Citigroup... boosted gross 'cross-border outstandings' with French banks 40% to $15.7 billion from Jan. 1 through June 30... Goldman Sachs increased claims by 31% to $38.5 billion in the first half..."
August 15 - Bloomberg (Christine Idzelis): "The cost to finance leveraged buyouts in the U.S. is the highest since December as Europe's debt crisis and a weakening economy damps demand for high-yield, high-risk loans. Average monthly interest rates on institutional leveraged- loans, or the debt used to finance LBOs, rose to 491 bps more than benchmarks in July... Margins increased from a February low of 378 bps."
August 17 - Financial Times (Telis Demos): "Investors' shift out of higher-risk corporate credits is hitting the convertible bond market, which is on track for its worst monthly performance since the height of the financial crisis. Prices of the hybrid securities, typically issued as bonds that can be converted to equities, have fallen 6.6% so far in August..."
August 19 - Bloomberg (Ben Martin and Hannah Benjamin): "Junk-rated European company bond yields climbed above 10% for the first time in a year as investors demand more compensation for the region's stalling economic growth."
August 18 - Bloomberg (Tasneem Brogger and Frances Schwartzkopff): "Denmark's regional banks are cutting lending and selling off assets to generate cash needed to escape an international funding wall as policy makers grope for measures to boost liquidity. 'It still looks difficult for banks of our size to get money in the international markets,' Lasse Nyby, chief executive officer at Spar Nord Bank A/S, Denmark's fourth-largest listed lender, said... 'We think it will remain that way for some time.'"
August 18 - Bloomberg (Johan Carlstrom): "Swedish banks must do more to prepare for a deterioration in Europe's debt crisis that could freeze interbank markets and cut off funding, said Lars Frisell, chief economist at the country's financial regulator. 'It won't take much for the interbank market to collapse,' Frisell, who is also a member of the Basel Committee for Banking Supervision, said... 'It's not that serious at the moment but it feels like it could very easily become that way and that everything will freeze.'"
August 18 - Bloomberg (Denis Maternovsky and Jack Jordan): "Russia failed to borrow as much as it intended to at a sale of ruble-denominated bonds, the third straight auction to fall short this month, as investors concerned by the economic slowdown and world market turmoil demand higher yields."
Global Bubble Watch:
August 15 - Bloomberg (Jeff Black): "The European Central Bank spent a record amount on government bonds last week as it began buying Italian and Spanish securities to contain the debt crisis. The Frankfurt-based ECB said... it settled purchases worth 22 billion euros ($31.7 billion) in the week..."
August 18 - Bloomberg (Garth Theunissen and Keith Jenkins): "The European Central Bank needs to back up last week's record purchases of government debt with further buying to prevent speculators from driving borrowing costs for Spain and Italy back up again. 'The ECB's bond purchase program has been a very effective deterrent to panic selling, and as long as they don't blink now, they can have this problem of speculative shorting licked in weeks rather than months,' said Luca Jellinek... head of European rate strategy at Credit Agricole... The success mirrors the initial benefit of the ECB's first program of buying Greek bonds in May 2010... 'They don't need to do massive amounts every week, but they do need to remain in the market to help stabilize the situation,' said Olaf Penninga, who helps manage 140 billion euros at Robeco Group... 'They could probably get away with a few billion a week if asset markets remain relatively stable, but they would have to do considerably more if political tensions arise, like internal disagreement within the ECB or opposition to the buying from Germany.'"
August 19 - Bloomberg (Allison Bennett): "The yen rallied to the strongest level since World War II versus the dollar as the U.S. economic slowdown and Europe's debt crisis stoked concern global growth is slumping bolstered the refuge appeal of Japan's currency."
The U.S. dollar index slipped 0.8% this week at 74.00 (down 6.4% y-t-d). For the week on the upside, the Swedish krona increased 1.9%, the British pound 1.2%, the Norwegian krone 1.1%, the Danish krone 1.1%, the euro 1.1%, the Brazilian real 0.8%, the Australian dollar 0.5%, the Japanese yen 0.2%, the Singapore dollar 0.2%, and the Mexican peso 0.1%. On the downside, the New Zealand dollar declined 1.7%, the Swiss franc 0.9%, the South Korean won 0.7%, the Canadian dollar 0.3%, the South African rand 0.1%, and the Taiwanese dollar 0.1%.
Commodities and Food Watch:
August 17 - Bloomberg (Steve Stroth): "Agricultural losses from a drought in Texas have reached a record $5.2 billion and may worsen without more rain, Texas AgriLife Extension Service, a unit of Texas A&M University, said... Losses exceed the previous record of $4.1 billion during a drought in 2006..."
August 18 - Bloomberg (Daniel Cancel and Nathan Crooks): "Venezuelan President Hugo Chavez ordered the central bank to repatriate $11 billion of gold reserves held in developed nations' institutions such as the Bank of England as prices for the metal rise to a record. Venezuela, which holds 211 tons of its 365 tons of gold reserves in U.S., European, Canadian and Swiss banks, will progressively return the bars to its central bank's vault, Chavez said..."
Commodities were notably resilient. The CRB index gained 0.9% this week (down 1.0% y-t-d). The Goldman Sachs Commodities Index slipped 0.3% (up 1.5%). Spot Gold surged 5.9% to $1,850 (up 30%). Silver jumped 9.7% to $42.93 (up 39%). September Crude fell $2.81 to $82.57 (down 10%). September Gasoline added 1.4% (up 17%), while September Natural Gas declined 3.1% (down 11%). December Copper declined 0.9% (down 10%). September Wheat jumped 4.0% (down 8%), and September Corn added 1.3% (up 13%).
China Bubble Watch:
August 16 - Bloomberg (David Yong and Andrea Wong): "Chinese corporate borrowing costs are rising at the fastest pace this year, reaching a record compared with interest rates on government debt, as bank lending curbs drive companies to the bond market and the economy cools."
August 16 - Bloomberg: "China cracked down on illegal 'hot money' cases worth a combined value of more than $16 billion, a 27% rise from a year ago, the State Administration of Foreign Exchange said..."
August 16 - Bloomberg: "Frank He said he faked a divorce from his wife of 10 years to skirt China's ban on third mortgages and obtain a bank loan for a third property, a 12 million yuan ($1.9 million) suburban villa. 'My wife and I love each other, but as long as we can get the mortgage from the bank for the deal, we'll take it,' said He, a 40-year-old manager at a chemical company. The forged document, which cost the Shanghai couple 20,000 yuan, helped them get a loan amounting to 60% of the purchase price... Chinese homebuyers and developers are finding loopholes as they come under pressure from government policies to curb gains in residential prices..."
August 15 - Bloomberg (Go Onomitsu and Stuart Biggs): "Agura Bokujo, operator of a cattle ranch north of Tokyo, became Japan's biggest corporate failure this year after consumer fears over beef contaminated with radiation damaged sales, Tokyo Shoko Research said. The closely held company in Tochigi prefecture had 433.1 billion yen ($5.6 billion) in liabilities..."
Asia Bubble Watch:
August 18 - Bloomberg (Shamim Adam and Gan Yen Kuan): "Malaysia's economy grew at the slowest pace since 2009 last quarter... Gross domestic product rose 4% in the three months through June from a year earlier, after expanding a revised 4.9%..."
August 18 - Bloomberg (Madelene Pearson): "Investors in India are dumping bonds and pumping record amounts of money into gold as they seek refuge from inflation and the financial-market turmoil that was spurred by developed nations' debt crises."
August 19 - Bloomberg (Luzi Ann Javier): "India, the biggest sugar user, may produce less than it consumes as early as October 2012, possibly spurring the first net imports in three years, said ITC Ltd. That would push up global prices, said Standard Chartered Plc. 'India is likely to become a structural importer' like China, said Somnath Chatterjee, ITC's head of procurement..."
Latin America Watch:
August 17 - Bloomberg (Matthew Bristow and Andre Soliani): "Brazil's economy shrank in June for the first time since the global financial crisis of 2008, causing traders to increase bets that the central bank will cut interest rates this year."
Unbalanced Global Economy Watch:
August 16 - Bloomberg (Jana Randow): "The German economy, Europe's largest, almost stalled in the second quarter as the region's sovereign-debt crisis weighed on confidence. Gross domestic product... rose 0.1% from the first quarter, when it jumped a revised 1.3%... The worse-than-expected GDP data from Germany, which had been powering euro-area growth, add to signs Europe is flirting with a renewed economic slump as the debt crisis curbs spending across the region. France's recovery unexpectedly ground to a halt in the second quarter, Italian and Spanish expansion remained sluggish and Greece's economy contracted."
August 16 - Bloomberg (Simone Meier): "European economic growth slowed more than economists forecast in the second quarter as Germany's recovery almost ground to a halt amid the worsening sovereign- debt crisis. Gross domestic product in the 17-nation euro area rose 0.2% from the first quarter, when it increased 0.8%..."
August 16 - Bloomberg (Diana ben-Aaron and Kati Pohjanpalo): "Finland's economic growth slowed in June... as policy makers in the northernmost euro member tackle sluggish export markets amid weakening global recovery prospects. Gross domestic product expanded an annual 2.5% in June, down from a revised 4.8% in May..."
August 16 - Bloomberg (Greg Quinn): "Canadian factory sales declined for a third month in June, the longest drop since the last recession, led by petroleum and jewelry. Sales fell 1.5% on a seasonally adjusted basis..."
August 17 - Bloomberg (Svenja O'Donnell): "U.K. unemployment claims increased the most in more than two years in July, adding pressure on Prime Minister David Cameron as the economic outlook worsens."
August 17 - Bloomberg (Richard Vines): "The cost of dinner for two in London has surged 11% over the past year -- the biggest gain in more than two decades -- and now exceeds 90 pounds ($148) for the first time, the publishers of a restaurant guide said..."
U.S. Bubble Economy Watch:
August 19 - Bloomberg (Shobhana Chandra, Alex Kowalski and David J. Lynch): "Signs that consumer prices are rising even as the U.S. economy slows may delay additional moves by Federal Reserve Chairman Ben S. Bernanke to spur growth. The Fed chairman, who is scheduled to speak at a Jackson Hole, Wyoming, conference on Aug. 26, used the annual gathering of economists last year to hint at a second round of so-called quantitative easing..."
August 17 - Bloomberg (Alex Kowalski): "Wholesale costs in the U.S. rose more than forecast in July, led by higher prices for tobacco, trucks and pharmaceuticals, showing declines in commodity expenses have yet to filter to other goods... Compared with July 2010, companies paid 7.2% more for goods last month..."
August 15 - Bloomberg (Elizabeth Campbell): "U.S. meat consumers are swapping premium steaks for cheaper ground beef as concern for high unemployment and slower economic growth forces families to trim their food budgets, according to industry researcher CattleFax. ...retail ground-beef prices... climbed 17% this year and averaged $2.774 a pound in June, the highest since at least 1984."
Central Banking Watch:
August 17 - Reuters: "European Central Bank policymaker Juergen Stark, turning to monetary policy... warned against too-low interest rates. Noting that the Frankfurt-based central bank had never cut its main interest rate to an extremely low level, he added: 'Keeping interest rates too low for too long carries risks.' 'Such a policy contributes to excessive risk-taking and wrong investments and therefore undermines an economy's growth potential..."
August 17 - Bloomberg (Jeannine Aversa and Tom Keene): "Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said the Fed will probably need to raise interest rates before mid-2013 and that policy makers should have waited to see how the economy performed before pledging to hold rates at record lows for two years. 'It was inappropriate policy at an inappropriate time,' Plosser... said... 'We're reacting too quickly here... A little patience might be a good idea.'"
August 17 - Bloomberg (Steve Matthews): "St. Louis Federal Reserve Bank President James Bullard, who was the first Fed policy maker to urge the round of bond purchases that started last year, said the central bank isn't signaling a third stimulus program with its commitment to keep rates near zero through mid-2013."
August 18 - Bloomberg (Zeke Faux): "The U.S. Justice Department is probing Moody's... and Standard & Poor's over ratings of mortgage-backed securities, according to three former employees who said they were interviewed by investigators."
Real Estate Watch:
August 15 - Bloomberg (Alan Bjerga): "A drought that devastated crops in the southern Great Plains during the second quarter slowed the growth of land values, eroded agricultural income and led to fewer purchases of farm equipment, the Federal Reserve said. While the pace of gains in cropland slowed from the first quarter, properties in a seven-state region that includes Nebraska and Oklahoma were 20% more expensive than a year earlier, the Federal Reserve Bank of Kansas City said... Ranchland was up 11% from a year earlier, and farm-credit conditions remained positive even as farmers cut back spending, the bank said."
August 18 - Bloomberg (Simon Packard): "Irish investor Aidan Brooks's Tribeca Holdings Ltd. paid 13% more than the asking price for a shop on London's Bond Street that generates slightly more income than a U.K. government bond. It beat three other offers. Buyers like Tribeca made the British capital the world's top destination for property investment for the past two years as they sought safe bets amid economic, financial and political uncertainty."
August 17 - Bloomberg (Will Daley): "New York State Comptroller Thomas DiNapoli said all governmental funds receipts for fiscal year 2011 to 2012 rose $3.3 billion, or 8.4%, over last year through July 2011... All funds receipts were $351.5 million below financial plan first quarterly update projections, which largely evaporates the positive balance seen in tax collections through the first quarter... 'New York's recovering economy is struggling to reach cruising altitude,' Dinapoli said..."
The PhD Standard
"There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose." John Maynard Keynes
This week, Federal Reserve "money printing" became a focal point of American political discourse. Across the Atlantic, a worsening banking crisis failed to diminish German resolve against backing the issuance of "eurobonds." Many of us have read and pondered Keynes's famous quote on debauching the currency so often we're rather numb to it. But in light of recent developments, it's worth reminding readers that history is unequivocal: The soundness of money - monetary stability - is fundamental to the well-being of both the economy and society. The myriad consequences of prolonged monetary instability are these days increasingly difficult to disregard.
I have argued that the global financial "system" for decades now has operated in a unique environment. I know of no comparable period in history where there were no restraints on either the quantity or quality of global Credit creation. I have further posited that "Unconstrained Credit is the Bane of Capitalism." Unfettered finance ensures severe pricing distortions, speculative excess, the misallocation of resources, Bubble dynamics, acute financial and economic fragility - and the "debauching" of currencies across the globe. Again, increasingly difficult to disregard.
I have referred to this anchorless global Credit system as "Global Wildcat Finance." As a proponent for the return to the Gold Standard, Jim Grant has coined the term "The PhD Standard" to describe the current state of monetary affairs. I hope Mr. Grant doesn't mind too much if I borrow his brilliant terminology. It's just too perfect. And as a product of public schools and universities (and a couple decades of diligent independent study of finance and economic history), it's too tempting to label the unfolding tumult the "Ivy League Crisis."
My hunch is that unfolding developments will likely catch a lot of very intelligent - and highly degreed - folks completely unprepared. Recent comments from some of this era's most successful investors suggest they are increasingly out of touch. The talk today is that stocks are so "cheap," especially in terms of price-to-earnings multiples. And on a historical basis, valuations don't appear expensive. Yet I would argue that equity multiples should be extraordinarily low today - specifically because system finance is extraordinarily unstable. And proponents for investing in equities and corporate bonds point to the soundness of corporate America's balance sheet. But again, there is much more here than meets the superficial analytical eye.
Federal debt has increased in the neighborhood of $5.0 TN during the past three years. This unprecedented expansion of government debt fueled spending and inflated corporate cash flows and earnings. This followed a decade of similar effects from an unprecedented expansion of household and financial sector borrowings. In just the past two years, global central bank international reserve holdings expanded over $3.0 TN. The greatest concerted fiscal and monetary stimulus in history ("The Global Government Finance Bubble") stoked the reflation of global financial and economic systems. Now, the global marketplace has meted out harsh punishment to those investors/speculators caught extrapolating the near-term effects of inflationary policymaking - albeit recent growth trajectories, earnings trends or financial asset valuation metrics.
The debt market experiences of Greece, Ireland, Portugal, Spain and Italy point to "systemic extrapolation risks". In such an exceptionally unstable Credit environment, most financial assets should trade at discounted valuations. Future earnings and cash flows are highly uncertain - and extraordinary uncertainties dictate that future cash flows should be discounted back at reasonably high discount rates (definitely not Treasury yields). There has been an extremely wide divergence between bull and bear valuation metrics, and the markets have begun to move decisively in the "bear's" direction.
My thesis remains that the European crisis marks the piercing of the global government debt Bubble. I fully expect unfolding developments to prove a momentous inflection point in financial and economic history. The world is today awash in endless debt, financial claims, and financial contracts - and faith in underpinning debt structures is waning.
At the center of the current storm, the European banking system is increasingly impaired by suspect assets - chiefly the liabilities of hopelessly over-indebted sovereign borrowers. Forced austerity measures and abruptly tightened finance ensure economic disappointment, as the unavoidable downside of a prolonged Credit cycle gathers momentum. As major global derivative players and financiers to the "leveraged speculating community" (especially after the demise of much of their American competition in the '08 crisis), the stability of the major European financial institutions has become a major global market issue.
The bursting of the Global Government Finance Bubble portends major changes to the derivatives market landscape. First, some of the major derivatives players are increasingly impaired from holdings of sovereign and related debt instruments. Second, an important part of my thesis is that government policymaking, in general, will be increasingly incapacitated in the face of a rapidly changing landscape. The efficacy of fiscal and monetary management is clearly waning, which I believe brings into question key assumptions underpinning much of the derivatives marketplace, including "liquid and continuous markets". And as confidence in sovereign debt and policymaking deteriorates - and global markets convulse - the capacity for hundreds of Trillions of derivatives to function as advertised will be questioned. An issue that should have been addressed in 2008 (better yet, 1998) was allowed (incentivized) to fester. The PhDs and their quant models are in for another severe test.
European policymaking has become an easy target for market pundits. "They are timid and lack resolve." "Their incompetence and failure to adopt bold action is at the roots of an unnecessary crisis." "There is a complete lack of political leadership." Essentially, the markets want the Germans to back a new eurobond that could be issued in sufficiently enormous quantities to reflate European markets, economies, banking systems and markets. The consensus market view holds that such a policy course offers huge benefits with limited costs. And for markets that have grown accustomed to getting whatever they demand from global policymakers, this is a major shock. The Germans don't want to play ball.
No society understands the dangers of debauching the currency better than the Germans. And they have principled elder statesmen that understand what's at stake at this critical juncture in financial history. I wouldn't count on them backing down. They appreciate that bailouts and debt guarantees commence a slippery slope of Credit and currency debasement. Put a German guarantee on the debt required to bailout profligate borrowers and be prepared for years of German-backed debt certain to impair German and European creditworthiness. The Bundesbank, in particular, must today appreciate that safeguarding their monetary system has become an absolute priority both for the German people and for Europe. Impairing the stable "core" in the name of assisting a failed periphery would be extremely detrimental to Germany and for European integration.
The long-held German (and Austrian!) notion of "sound money" fails to resonate in The Age of the PhD Standard. Especially in the U.S., the Great Depression is understood as a consequence of gross dereliction of the Federal Reserve's responsibility for ensuring sufficient "money" and bank capital. Somehow it is forgotten that the harbinger of devastating economic collapse was the collapse of confidence in Credit and financial assets. Instead of a German-like tenacity for protecting the Creditworthiness and stability of the system's core, our monetary doctors are instead determined to gamble the bedrock of our financial system on a policymaking course that amounts to little more than unending government debt issuance and monetization (contemporary "money printing").
Texas governor Perry was lambasted for his verbal attack on "treasonous" Federal Reserve "money printing." "Presidential" it was not. But do I expect this type of message to resonate? Bet on it! American society is showing the increasing strains of monetary mismanagement. More and more, it seems that only the PhDs and stock market punditry actually believe that Fed policymaking is on the right track. And it really is a fascinating and frightening dynamic where the general populace has this right and policymakers have it dead wrong.
This is a huge monetary experiment run amuck - and the evidence is everywhere (i.e. high unemployment, rising inflation, massive federal deficits, the Fed's balance sheet, unstable markets, rising wealth inequality, intractable trade deficits, the value of the dollar, the price of gold, waning American power and influence, public anger and distrust...). The American people no longer buy the notion that piling on more debt and "money printing" offers a reasonable solution. They are appreciating that it's instead the problem, and there will be less tolerance for this "experiment" going forward.
And the PhDs? They stick steadfastly with their doctrine, not for a minute admitting the experimental and theoretical nature of their policy prescriptions. And I see no willingness on their part to question their view that contemporary monetary management is enlightened and superior to the past. There is an element of hubris that gets in the way of objectivity.
I have for years now referred to this theoretical framework - both from an economic doctrine and policymaking perspective - as little more than a sophisticated version of "inflationism." And we are increasingly witness to the age-old Scourge of Inflationism. And as we've already witnessed recently, the inflationists will warn about the dangers of not being bold - of losing resolve. "Don't repeat the mistakes of Japan!" As it's been throughout history, it always seems to be a case of "just one more bout of money printing" and government spending - and then we'll get monetary religion. Did I really hear and read this week that the remedy for our nation's problems is to be found with one more economic stimulus package coupled with additional measures ensuring long-term deficit reduction?
Fiscal and monetary policies are rapidly losing credibility. Treasury prices may be inflated, but don't mistake this for confidence in our system's "core". It may exist completely outside of the PhD's sophisticated framework, but the markets and regular folk are feeling the ill-effects of currency debauchery.