A Bubble Perpetuator

By: Doug Noland | Sun, Oct 30, 2005
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It seemed even more dizzying than last week. For the week, the Dow jumped 1.8%, with the S&P500 up 1.6%. The Transports surged 3.3%, and the Utilities increased 2.3%. The Morgan Stanley Cyclical index rose 3.3%, and the Morgan Stanley Consumer index posted a gain of 1.2%. The broader market was nothing to write home about. The small cap Russell 2000 added 0.4%, and the S&P400 Mid-cap index rose 1.2%. Technology stocks were on the defensive. The NASDAQ Telecommunications index dipped 0.5%, and the Morgan Stanley High Tech index fell 1.2%. The Semiconductors were hit for 3.8%. The NASDAQ Telecommunications index fell 1.6%, while the Street.com Internet Index gained 0.7%. The Biotechs rose 1.3%. Financial stocks were strong. The Broker/Dealers increased 2.8%, and the Banks jumped 3.0%. With bullion up $6.60, the HUI gold index added 1%.

The reality that the Fed has more work to do (and that Ben Bernanke will have the responsibility for doing it) weighed on the Treasury market. For the week, two-year Treasury yields jumped 18 basis points to 4.38%, the highest level since April 2001. Five-year government yields surged 20 basis points to 4.45%. Bellwether 10-year yields jumped 19 basis points for the week to 4.57%. Long-bond yields added 17 basis points to 4.78%. The spread between 2 and 10-year government yields widened one to 19 bps. Benchmark Fannie Mae MBS yields jumped 20 basis points, slightly underperforming Treasuries. The spread (to 10-year Treasuries) on Fannie's 4 5/8% 2014 note and the spread on Freddie's 5% 2014 note both widened one to 34. The 10-year dollar swap spread increased 1.5 to 50, the high since May 2004. Corporate bonds generally performed in line with Treasuries, with junk bond spreads narrowing moderately. The implied yield on 3-month December Eurodollars rose 7.5 basis points to 4.485%. December '06 Eurodollar yields surged 19.5 basis points to 4.83%.

Investment grade corporate issuance increased to $13.6 billion. Issuers included Wachovia $1.9 billion, Ford Motor Credit $1.0 billion, Bear Stearns $1.0 billion, CIT Group $1.0 billion, Prologis $900 million, Quest Diagnostic $900 million, Merrill Lynch $1.2 billion, Daimlerchrysler $750 million, Textron $515 million, Colorado Gas $400 million, Nova Chemical Corp $400 million, Caterpillar $300 million, MidAmerican Energy $300 million, HRPT Properties $250 million, and Tanger Factory Outlets $250 million.

Junk bond fund outflows slowed to $90.5 million (from AMG). Issuers included E*Trade $600 million.

Convert issues included Essex Portfolio $190 million.

Foreign dollar debt issuers included Vale Overseas $800 million, Diageo Finance $750 million, Kazkommerts $600 million, Republic of Korea $400 million, and the City of Kiev $250 million.

October 27 - Bloomberg (Jason Folkmanis and Netty Ismail): "Vietnam sold $750 billion of bonds in its first overseas debt sale as the Communist Party-ruled nation turns to global markets to fund its economic expansion. Demand for the debt exceeded the amount sold by six times, allowing the government of Asia's second-fastest growing economy to obtain a lower yield than it expected."

Japanese 10-year JGB yields added 0.5 basis points this week to 1.515%. Emerging debt and equity markets were mixed but generally resilient. Brazil's benchmark dollar bond yields dipped one basis point to 7.72%. Brazil's Bovespa equity index added 0.5% (up 11.9% y-t-d). The Mexican Bolsa jumped 4.5 (up 20.6% y-t-d). Mexican govt. yields rose 6 basis points to 5.71%. Russian 10-year dollar Eurobond yields fell one basis point to 6.45%. The Russian RTS equity index gained 2.8% this week (up 48.3% y-t-d).

Freddie Mac posted 30-year fixed mortgage rates added 5 basis points to 6.15%, up 44 basis points in seven weeks to the highest level since the first week of July. Thirty-year fixed rates were up 51 basis points from one year ago. Fifteen-year fixed mortgage rates rose 4 basis points to 5.69%, up 68 basis points in a year. One-year adjustable rates increased 2 basis points to 4.91. One-year ARM rates were up 95 basis points from the year ago level. The Mortgage Bankers Association Purchase Applications Index dropped 7.4% last week. Purchase Applications were up 5.8% from one year ago, with dollar volume up 13.6%. Refi applications fell 8.5% during the week. The average new Purchase mortgage slipped to $242,100, while the average ARM increased to $360,500. The percentage of ARMs increased to 29.5% of total applications.

Broad money supply (M3) surged $40.6 billion (week of October 17). Over the past 22 weeks, M3 has surged $442.6 billion, or 10.9% annualized. Year-to-date, M3 has expanded at a 7.7% rate, with M3-less Money Funds expanding at an 8.6% pace. For the week, Currency was unchanged. Demand & Checkable Deposits dropped $9.1 billion. Savings Deposits surged $29.4 billion. Small Denominated Deposits added $1.7 billion. Retail Money Fund deposits increased $2.7 billion, and Institutional Money Fund deposits jumped $11.8 billion. Large Denominated Deposits were unchanged. Year-to-date, Large Deposits are up $258.2 billion, or 29.6% annualized. For the week, Repurchase Agreements increased $2.4 billion, and Eurodollar deposits rose $1.8 billion.

Bank Credit jumped $25.6 billion last week. Year-to-date, Bank Credit has inflated $658.5 billion, or 12.1% annualized (up 10.5% from a year earlier). Securities Credit increased $16.0 billion during the week, with a year-to-date gain of $169.7 billion (11.0% ann.). Loans & Leases have expanded at a 12.8% pace so far during 2005, with Commercial & Industrial (C&I) Loans up an annualized 17.1%. For the week, C&I loans increased $0.8 billion, while Real Estate loans slipped $0.8 billion. Real Estate loans have expanded at a 14.4% rate during the first 42 weeks of 2005 to $2.838 Trillion. Real Estate loans were up $349 billion, or 14.0%, over the past 52 weeks. For the week, Consumer loans added $0.3 billion, and Securities loans gained $7.1 billion. Other loans added $2.1 billion.

Total Commercial Paper jumped $7.7 billion last week to $1.637 Trillion. Total CP has expanded $222.7 billion y-t-d, a rate of 19% (up 19.5% over the past 52 weeks). Financial CP added $0.4 billion last week to $1.485 Trillion, with a y-t-d gain of $200.5 billion, or 18.9% annualized (up 20.7% from a year earlier). Non-financial CP increased $7.3 billion to $151.7 billion (up 20.7% ann. y-t-d and 8.5% over 52 wks).

ABS issuance surged to $24 billion (from JPMorgan). Year-to-date issuance of $633 billion is 19% ahead of comparable 2004 and has already surpassed total issuance for the year. Home Equity Loan ABS issuance of $413 billion is 20% above comparable 2004.

Fed Foreign Holdings of Treasury, Agency Debt jumped $8.0 billion to $1.476 Trillion for the week ended October 26. "Custody" holdings are up $140.6 billion y-t-d, or 12.7% annualized (up $177.3bn, or 13.7%, over 52 weeks). Federal Reserve Credit declined $3.0 billion to $797.9 billion. Fed Credit has expanded 1.1% annualized y-t-d (up $27.3bn, or 3.5%, over 52 weeks).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $599 billion, or 17.7%, over the past 12 months to $3.985 Trillion. Malaysia's reserves were up 40.9% in twelve months to $74.05 billion.

Currency Watch:

The dollar index fell 0.5%. On the upside, the Hungarian forint gained 1.8%, the Czech koruna 1.3%, the South Korean won 1.2%, and the Philippines peso 0.9%. The euro added 0.7%. On the downside, the Polish zloty fell 1.6%, the Iceland krona 1.4%, the Argentine peso 1.2%, and the South African rand 1.2%.

Commodities Watch:

Orange juice this week traded to a 7-year high. December crude oil rose 59 cents to $61.22. December Unleaded Gasoline was about unchanged, while December Natural Gas declined less than 1%. For the week, the CRB index was little changed, with y-t-d gains of 13.5%. The Goldman Sachs Commodities index rose 0.3%, increasing 2005 gains to 40.1%.

China Watch:

October 26 - Bloomberg (Allen T. Cheng): "Chinese industrial companies' profits grew at a slower pace in September, as earnings were squeezed by higher fuel prices. Combined net income rose 20.1 percent from a year earlier to 988.3 billion yuan ($122 billion) in the first nine months..."

October 26 - AP: "China, already the world's biggest cell phone market, keeps growing. At the end of September, it had 377 million mobile phone subscribers, or an average of 9 mobile phones per every 100 people, the government reported.... That's up 7.7 percent from June..."

October 27 - Bloomberg (Philip Lagerkranser): "Hong Kong's exports grew in September at their fastest pace in a year as the city's ports handled more electronic parts en route to the mainland and Chinese-made goods bound for the U.S., Europe and Japan. Overseas sales rose 17 percent from a year earlier to a record HK$210.2 billion ($27 billion) after climbing 12.7 percent in August..."

Asia Boom Watch:

October 26 - Bloomberg (Lily Nonomiya): "Japan's exports rose 8.8 percent to a record in September on higher demand from the U.S. and China, supporting growth in the world's second largest economy. Shipments climbed to 5.9 trillion yen ($51 billion), the Ministry of Finance said..."

October 24 - Bloomberg (Harumi Ichikura): "Toyota Motor Corp., Japan's biggest automaker, said global production of its cars and light trucks rose 10.2 percent in September from a year earlier..."

October 25 - Financial Times (Khozem Merchant): "India's monetary authority on Tuesday raised a key interest rate amid general evidence of mounting inflationary pressures and an asset bubble in one of the world's fastest-growing economies.

In its mid-term monetary policy review, the Reserve Bank of India also raised its projection for gross domestic product growth in the current fiscal year from 7 per cent to 7-7.5 per cent, backed by higher industrial production and rising export earnings in technology and other services. The central bank raised the reverse repo rate - the instrument used by the RBI to squeeze excess liquidity - by 25 basis points to 5.25 per cent..."

October 24 - Bloomberg (Theresa Tang): "Taiwan's export orders rose more than expected in September, surging to a record as sales of consumer electronics picked up ahead of Christmas... Orders, indicative of actual shipments in one to three months, jumped 22 percent from a year earlier to $23.8 billion..."

October 26 - Bloomberg (James Peng): "Taiwan's central bank Governor Perng Fai-nan said the island's real interest rates are 'too low,' and must be adjusted to more normal levels."

October 26 - XFN: "South Korea's GDP grew 4.4% year-on-year in the third quarter, up from 3.3% in the second quarter, on the revival of private consumption after a prolonged recession, as export growth picked up momentum, the Bank of Korea said..."

October 27 - Bloomberg (William Sim): "South Korea's economic growth is picking up and will probably exceed 4.5 percent this quarter, Vice Finance Minister Bahk Byong Won said."

October 24 - Bloomberg (Dominic G. Diongson and Beth Jinks): "Thailand posted its second consecutive monthly trade surplus in September on record exports of farm produce, electronics, appliances and pickup trucks... Exports rose 23 percent from a year earlier to a record $10.49 billion from a restated $8.52 billion. Imports grew 20 percent to $9.67 billon..."

October 27 - Bloomberg (Beth Jinks): "Thailand's Finance Minister Thanong Bidaya will raise his growth forecast for Southeast Asia's second-largest economy in both 2005 and next year due to accelerating exports... The finance ministry's forecast for this year will be officially raised to a range of 4.5 percent to 5 percent..."

October 26 - Bloomberg (Jun Ebias): "The Philippine central bank raised its inflation forecast for 2006 to as much as 8.5 percent due to higher oil prices and next month's increase in value-added tax, Governor Amando Tetangco said."

October 24 - Bloomberg (Jason Folkmanis): "Vietnamese inflation accelerated for a second month in October, driven by rising prices for transportation, construction materials, and food. Consumer prices rose 8.3 percent in October compared with October 2004..."

Unbalanced Global Economy Watch:

October 28 - Bloomberg (Simone Meier): "Money supply growth in the 12 nations sharing the euro accelerated last month to the fastest since July 2003, adding to pressure on the European Central Bank to raise interest rates from a six-decade low. M3, the ECB's preferred measure of money supply, rose 8.5 percent from a year earlier..."

October 28 - Market News International: "The probability that high money growth will ultimately destabilize price levels has grown 'considerably' in the last year, European Central Bank Chief Economist Otmar Issing said Friday. Issing...also said that asset price developments in the eurozone needed to be watched more closely. 'The likelihood that strong monetary developments ultimately find their way through to higher prices must be seen as considerably higher [since mid-2004]. Moreover, strong money and credit growth ... and the liquidity in the euro area implies that asset price developments, particularly in housing markets, needs to be monitored more closely...'"

October 24 - Bloomberg (James Cordahi): "Saudi Arabia is likely to generate $163 billion of oil revenue this year, the most in more than two decades, on higher oil prices and more crude exports, said Samba Financial Group, the country's second-largest bank. The price of Saudi crude oil will average $51 a barrel in 2005, 45 percent more than 2004's $35.17 a barrel..."

October 24 - Bloomberg (James Cordahi): "Kuwait, which holds 10 percent of the world's oil supplies, is likely to generate record oil revenue of about $45 billion this fiscal year on higher oil prices and more output..."

October 26 - Bloomberg (Ludwig Marek): "U.S. demand for international stocks this year may be the highest in more than two decades, based on mutual-fund flows... Funds focusing on stock investments outside the U.S. may take in $87.5 billion by the end of the year, according to an estimate from TrimTabs... The inflow would be an increase from $67 billion last year and the highest since the firm's calculations began in 1985."

October 25 - Bloomberg (Alexandre Deslongchamps): "Canada's consumer prices jumped 3.4 percent in September from the same month last year, the largest increase in 30 months, reinforcing expectations the central bank will raise interest rates further."

October 26 - Globe&Mail (Deborah Yedlin): "The million-dollar knockdown has become the barometer of the real estate boom in Alberta. Tim Hearn, chief executive officer of Imperial Oil, recently slapped down $1.4-million for a house on a corner lot in Calgary's old-money neighbourhood of Mount Royal. It had been recently renovated and, by all accounts, was lovely. Mr. Hearn ordered demolition. A $2-million home in the same neighbourhood was recently scooped up by an Edmonton developer who also plans to raze the two-storey dwelling and build something more substantial -- on speculation -- with an eye to selling it for $4-million or more. These days, residential, commercial and vacation properties in Alberta have soared in value along with the price of oil and gas, which has fuelled a sense of euphoria that 'it's different this time.'"

October 25 - Bloomberg (Brian Swint): "Business confidence in Germany, Europe's largest economy, increased to a five-year high in October as oil prices fell and economic growth showed signs of picking up."

October 28 - Bloomberg (Ben Sills): "Spain's unemployment rate in the third quarter dropped to the lowest since 1979 as economic growth created enough jobs to more than offset the number of people joining the labor market. The jobless rate fell to 8.4 percent from 9.3 percent in the second quarter..."

October 24 - Bloomberg (Tasneem Brogger): "Danish house prices rose the most in a decade in the third quarter as near record-low interest rates prompted Danes to take out more mortgage loans. The average house price increased 18 percent from a year earlier..."

October 27 - Bloomberg (Tasneem Brogger): "Denmark's unemployment rate in September dropped to the lowest since December 2002 as construction and services companies hired workers. The jobless rate fell to 5.5 percent from 5.7 percent in August..."

October 27 - Bloomberg (Trygve Meyer): "Norway's jobless rate in October fell for a second month as companies stepped up hiring amid accelerating economic growth. The unemployment rate fell to 3.3 percent from 3.4 percent in September..."

October 25 - Bloomberg (Alistair Holloway): "Finland's unemployment rate unexpectedly fell to a 14-year low in September as employment rose in industries including construction, trade and real estate. The jobless rate fell to 7.1 percent..."

October 26 - Bloomberg (Halia Pavliva): "Russia's trade surplus rose 50 percent in the first nine months as crude oil shipments boosted export revenue faster than imports. The trade surplus rose to $92.8 billion, the Economy Ministry said... Exports increased 38 percent to $178.4 billion, while imports grew 28 percent to $85.6 billion."

October 25 - Bloomberg (Min Zeng): "Russia, which defaulted on $40 billion of domestic bonds in 1998, had its foreign-debt ratings raised by Moody's..., as surging oil revenue allows it to pay off debt early....The upgrade reflected 'a very rapid and significant buildup in the government's foreign-currency and oil stabilization fund reserves...'"

Latin America Watch:

October 24 - Bloomberg (Thomas Black): "Mexican banks will likely expand lending 25 percent in 2006 because Mexicans, who have the capacity to shoulder more debt, will increase borrowing as interest rates fall, said Hector Rangel, chairman of the Mexican unit of Banco Bilbao Vizcaya Argentaria SA."

October 24 - Bloomberg (Patrick Harrington): "Mexico's exports rose 15 percent in September, led by a surge in the price of oil and an increase in automobile production for sale in the U.S. market. Exports totaled $18.3 billion in September..."

October 28 - Dow Jones: "Argentine construction activity posted another large gain in September, extending the robust growth seen in the previous month to confirm continued momentum in the country's economy. According to data released Thursday by the national statistics agency, INDEC, the construction index rose 17.7% in September from a year earlier..."

October 25 - Bloomberg (Alex Emery): "Peru's exports jumped 29.1 percent in September, spurred by U.S. demand for agricultural products and Chinese demand for the country's copper, gold and fishmeal. Exports rose to $1.42 billion..."

Bubble Economy Watch:

Third quarter nominal GDP accelerated to a stronger-than-expected 7.0% rate (real GDP 3.8%). Nominal GDP was up 6.5% from Q3 2004. The GDP Price Index rose to a higher-than-expected 3.1%, up from the second quarter's 2.6% and the year earlier 1.4%. Personal Consumption expanded at a 3.9%, the strongest growth since Q4 2004.

October 24 - Bloomberg (Joe Richter): "Inflation pressures picked up during the third quarter, and companies expect to raise prices to recover higher materials costs, according to the National Association for Business Economics quarterly survey of members. An index of prices charged by member companies rose to the second-highest in the survey's 24-year history, the group said."

October 24 - Bloomberg (Andrea Rothman): "Airlines could lose as much as $10 billion in 2005 -- a third more than previously forecast -- if oil prices remain high and the threat of aviary flu deters people from traveling, the International Air Transport Association said."

October 26 - Bloomberg (Jesse Westbrook): "Ace Ltd. Chief Executive Officer Evan Greenberg said Hurricane Katrina will be a 'market changing event' triggering price increases on certain liability insurance as well as property policies... 'Ultimately the effect of these events will be felt worldwide,' Greenberg said..."

California Bubble Watch:

October 28 - Associated Press: "Mortgage defaults in California increased for the first time in more than three years during the third quarter of 2005, according to newly released data. The bulk of the default notices were sent to Southern California addresses, according to DataQuick... 'Foreclosure activity has bottomed out and is starting to go back up,' said John Karevoll, of DataQuick... Lenders sent default notices to 12,568 California homeowners during the July-September quarter, a 3.5% increase from the same period in 2004..."

"Project Energy" Watch:

October 28 - The New York Times (Simon Romero and Jad Mouawad): "First, Kim R. W. Bennetts scoured Colorado for an available drilling rig before taking his search to West Texas, New Mexico and Utah. Finally, Mr. Bennetts, an executive at a Texas natural gas company, traveled more than 7,000 miles to the heartland of China to look for the right rig to drill four wells in the Piceance Basin, a booming exploration area in western Colorado. That is how far he needed to travel to obtain the basic tools of the trade. The shortage of drilling rigs has become so acute this year that some executives blame it for slowing down new exploration projects... The oil and gas industry is awash in money. Collectively, the top five major oil companies are on track to post $30 billion in earnings for the third quarter. But even with all that cash, energy executives cannot simply snap their fingers and bring on more supplies to meet strong demand. The bottlenecks in drilling crews and rigs are not the only problems. Even before hurricane damage sent energy supplies into a tailspin this year, the oil industry had been hard pressed to find petroleum engineers and geologists, contractors and suppliers, tankers, pipelines, storage tanks, refineries and import terminals. After years of underinvestment, oil company executives now find that just about everything between the wellhead and the gas pump is in short supply."

Mortgage Finance Bubble Watch:

September Existing Homes Sales were reported at a stronger-than-expected annualized rate of 7.28 million, second only to June's 7.35 million. Average (mean) Prices were up 10.1% from a year earlier to $260,200. Calculated Transaction Value (CTV) was up 18% from one year ago (Prices 10.1% and Volume 7.2%), 32% over two years (Prices 20% and Volume 10%), 68% over three years (Prices 29% and Volume 30%), and 115% over six years (Prices 53% and Volume 41%). Year-to-date Sales are running 6.4% above last year's record pace. New Home Sales were not as impressive. Sales were flat with the year ago 1.22 million level, with Average (mean) Prices up 6.1% to $285,700. The inventory of unsold new homes was up 15,000 during September to 493,000, a notable 20% y-o-y rise.

October 25 - Bloomberg (Kathleen M. Howley): "U.S. home buyers chose 'interest-only' loans, which initially require payment of only financing costs, for almost a quarter of all mortgages in the first half of 2005. The share of interest-only loans grew to 23 percent of all home mortgages from 17 percent a year earlier, according to...the Mortgage Bankers Association. More than nine of 10 interest-only loans carried adjustable rates..."

October 26 - Dow Jones (Danielle Reed): "Consumers preference for non-traditional mortgages such as interest-only and option adjustable-rate loans increased in the first half of 2005, according to a Mortgage Bankers Association survey...dollar volume of first-mortgage originations increased 10% in the first six months of the year. The survey also highlighted a shift in consumer demand from 'traditional' adjustable-rate mortgage products to newer products such as Alt-A loans, generally issued to borrowers who have good credit but lack full documentation, as well as interest-only loans and so-called option ARMs."

October 25 - PRNewswire: "The housing market has yet to cool off in Illinois as home sales rose 6.3 percent in September, according to...the Illinois Association of Realtors. Total home sales...were 16,663 in September 2005, up 6.3 percent from 15,671 sales in September 2004. The Illinois median home price in September was $207,000, up 9.8 percent from $188,500 a year earlier."

A Bubble Perpetuator:

To frame my analysis of Dr. Bernanke as Fed Chairman, I thought it worthwhile to highlight comments made yesterday by the highly respected Reserve Bank of New Zealand (RBNZ): "The Reserve Bank has increased the Official Cash Rate (OCR) by 25 basis points to 7.00 percent. Reserve Bank Governor Alan Bollard said: 'As noted in our September Monetary Policy Statement, medium term inflation risks remain strong. Persistently buoyant housing activity and related consumption, higher oil prices and the risk of flow-through into inflation expectations, and a more expansionary fiscal policy are all of concern. While there has been a noticeable slowing in economic activity, and a particular weakening in the export sector, we have seen ongoing momentum in domestic demand and persistently tight capacity constraints. Hence, we remain concerned that inflation pressures are not abating sufficiently to achieve our medium term target, prompting us to raise the OCR today. The most serious risk to medium term inflation is the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending. Significant dis-saving by the household sector is showing through in a worsening current account deficit, now 8 percent of GDP. Borrowers and lenders alike need to recognise that the current rate of debt accumulation is unsustainable. The correction of these imbalances and associated inflation pressures will require a slowdown in housing, credit growth and domestic spending. We also expect a significantly lower exchange rate. The longer these adjustments in behaviour and asset prices are deferred, the more disruptive they are likely to be. Today's increase in the OCR, combined with higher world interest rates and pipeline effects from the repricing of fixed rate mortgages, are expected to slow the housing market and household spending over the coming months. However, the prospect of further tightening may only be ruled out once a noticeable moderation in housing and consumer spending is observed. Certainly, we see no prospect of an easing in the foreseeable future if inflation is to be kept within the 1 percent to 3 percent target range on average over the medium term."

RBNZ Governor Alan Bollard is successfully filling the large shoes left by his predecessor - the legendary Dr. Donald Brash, in the process upholding the high esteem long afforded the Reserve Bank. Please note how their pronouncement leaves little doubt where the Reserve Bank stands or what key fundamental factors drive policy decisions. No obfuscation necessary: "The correction of these imbalances and associated inflation pressures will require a slowdown in housing, credit growth and domestic spending." Policymaking becomes unduly complex only when central banking drifts from traditional central banking analysis and doctrine, as it has (and is about to take another giant step) in the U.S.

We will certainly not be reading RBNZ-like language from the Bernanke Federal Reserve. Dr. Bernanke comes at central banking from a completely different perspective and analytical framework (note: the issues of transparency and inflation targeting become moot when applied within the context of a flawed framework). And while there is some media banter with respect to the "dove" or "hawk" label, there is no question that Dr. Bernanke is An Impassioned Inflationist. As for fighting inflation: he'll talk the talk - of course, and there will come a day when talk will not suffice. In the past, I have labeled chairman Greenspan both an Inflationist and monetary policy radical. Incredibly, Professor Bernanke takes these to a whole new, dangerous extreme.

I was very much hoping Donald Kohn would be Alan Greenspan's replacement, but would have been satisfied with several potential candidates including Roger Ferguson and Larry Lindsey. And I can say with complete seriousness that of all the leading economists in the country, Mr. Bernanke would be my least favored pick. Is it mere coincidence that the candidate at the very bottom of my list is at the top of the Administration's and Wall Street's? Of course not.

I have no reason to doubt that Dr. Bernanke is a "kind and decent man," as such described by our President. He conveys an aura of integrity, and he is clearly extremely intelligent and a very hard worker. He is said to be a nice guy, and I like nice guys. I very much respect all of these attributes. And I do sense that his instincts are to be a straight-shooter. The nature of his new position, however, will demand a change, and it appears this process is well underway. He has no chance of becoming the master obfuscator, like his predecessor, or attaining Greenspan's amazing capacity to dodge every tough question and "never take a punch." Dr. Bernanke will provide an easy target. I am tempted to fault Dr. Bernanke for "being an academic," although it is more clearly stated that I view his background as a distinct handicap for presiding over this New Age of Wall Street Market and Speculation-based Finance in what I expect to be an increasingly hostile environment.

Candidly, I am concerned that he is such an accomplished econometrician and theorist. He has decades invested in his models and analytical framework; he's too intellectually, analytically and emotionally committed to a perspective of how the financial sector and economy work, one I don't expect will serve him well. Not only will his talents and perspective bias his view of the uncertain world in which we live, it is my fear that an econometrician's analytical framework leaves one today at a decided disadvantage in discerning and appreciating the nuances of contemporary Wall Street Finance.

From Steven Pearlstein of the Washington Post: "Bernanke is smart and will figure out the markets before long." Well, I'm not sure it's that easy. It's not about "smarts" or even so much with his lack of market experience. I don't believe career "marketicians" would be well-suited for economic research. Do econometricians have an analytical perspective conducive to "figuring out the markets"? I believe the Bernanke chairmanship is likely to illuminate the major divide that exists today between academic research and real world markets - a chasm not commonly recognized. (note: warning to academia - your research is being set up as The Fall Guy.)

I don't believe there's any hope for effectively modeling complex financial systems or markets. Greed, fear and speculative dynamics are not generally the favored elements of the econometrician. Furthermore, it is my view that models don't offer much value (negative value?) when it comes to the underlying complexities, subtleties, and whims of Credit expansion, financial flows, speculative dynamics and asset inflation/Bubbles. The model-maker must work to radically simplify a perplexing, convoluted and changing world. For example, instead of the nebulous and difficult to quantify "Credit," there will be a modelers bias toward the more easily quantified parameter - such as (narrow) money supply. Cause and effect will be, conveniently, in the eye of the beholder.

Dr. Bernanke and I actually have something in common. As he wrote in his book - Essays on The Great Depression, a compilation of his papers on the subject - "I guess I am a Great Depression buff, the way some people are Civil War buffs." But while my studies and analytical framework lead me to focus on the excesses and distortions of the Roaring Twenties - in particular the commanding effect that speculative liquidity came to possess on the asset markets and, consequently, on the nature of spending, investing and financial claims creation/intermediation - Professor Bernanke's preoccupation is with supposed policy errors committed by the Fed commencing (late in the game) in late-1928. Apparently, he has little problem with the boom. My view is that the unsound U.S. boom ensured a commensurate bust. Sure, there were post-boom mistakes that worsened the outcome. Yet policy confusion and error should be recognized as an integral and unavoidable aspect of the late-boom and post-Bubble environment, and why the best cure for a Bubble is to ensure it doesn't develop to begin with (as Dr. Richebacher informs us). "Mopping up" should absolutely never evolve into a concerted strategy, but recognized only as a last resort "long-shot."

And I have my own theory as to Professor Bernanke's stunning meteoric rise to prominence. As a disciple of Milton Friedman and as one of the leading academics in the field of post-Bubble reflationary monetary policies, he was a natural selection for the Fed when nominated in late-2001. It was the Greenspan Fed's view that the U.S. economy had entered a post-Bubble environment, and there were some real advantages associated with procuring the esteemed academic research and analytical firepower to dignify their plan for less-than-admirable inflationary policies.

I will conjecture that if the markets had responded negatively to the new Fed governor's open discussion of "helicopter money," "government printing presses," "pegging the 10-year Treasury yield," "unconventional measures," and the "global savings glut," well, he would have been sent packing back to Princeton and the seasoned central banker Donald Kohn (nominated as Fed Governor with Bernanke) would be slated as our next Chairman. But an anxious Wall Street was quickly smitten with the temerity of "Helicopter Ben" and what he represented for the extreme direction of Federal Reserve policies. If there was ever an "all's clear" message signaled directly and unmistakably from one of our leading policymakers to the markets, it was given in late 2002 by Dr. Bernanke. Go out and speculate in junk bonds; better cover your short positions in Ford bonds and Credit default swaps; buy stocks and CDOs; aggressively accumulate emerging market debt and equities; load up on commodities, get out of "money" instruments and grab any risk asset available (while you have a chance!). What ensued was one of the greatest redistributions of wealth in history.

Not quite as barefaced, Dr. Bernanke's long-time emphasis on fighting deflationary risk by inflating the "money supply," lent strong support to a vulnerable Wall Street "structured finance" apparatus. Recall that in 2002 the corporate debt crisis was at risk of jumping the firewall to the household sector (Household Finance, Ford Credit, etc.), with the potential to engulf the burgeoning ABS marketplace. Wall Street investment bankers working closely with their "financial engineers" had become prominent producers of contemporary U.S. "money" stock. So Dr. Bernanke's long obsession with remedial "money" supply inflation ensured that he was both a proponent for and potentially powerful asset of Wall Street Finance. When Governor Bernanke made assurances that the Fed would do absolutely anything and everything to avoid "deflation," Wall Street rightfully understood that Fed inflationary policies were in the process of expunging what had been a looming risk of systemic debt collapse. The sophisticated leveraged speculators were immediately emboldened; bankers were emboldened; investors were emboldened; and Wall Street "structured finance" was really emboldened (outstanding ABS has since doubled). At that point, seemingly no degree of Credit or speculative excess was too much, not with Professor Bernanke and the determined Greenspan Fed ready and more than willing to experiment with "mopping up" strategies.

There is one overriding fundamental issue I have with this whole amazing development: the view that we had fallen into a post-Bubble environment was flawed from the get-go. The technology Bubble had burst, but it was only an offshoot of the much greater Credit Bubble that was very much still Bubbling. Rather than combating deflationary forces and stabilizing some (fictitious) general price level, aggressive inflationary policies were instead poised to most intensely inflate markets already demonstrating the strongest inflationary biases (i.e. real estate, Treasuries, agencies, MBS and asset markets generally). Rather than buttressing an impaired post-Bubble Credit system, reflation stoked the Stalwart Mortgage Finance Bubble to unimaginable excess (and power). Instead of inflationary policies working to "stabilize" financial and economic conditions as the dauntless monetary theorist would ascertain, the resulting unprecedented Credit and speculative excesses guaranteed Precarious Monetary Disorder and Myriad Unwieldy Bubbles Both at Home and Abroad.

I will admit to being sympathetic to the theoretical premises supporting post-Bubble monetary stimulus. As we have witnessed, however, such policies will invariably be used prematurely - in the process acting to bolster boom-time dysfunctional Monetary Processes, resulting in only progressively precarious asset/speculative Bubbles, financial fragility and economic maladjustment. And, as we are also living these days, the greater and more precarious the Bubble(s), the more likely seductive notions of benevolent inflation will resonate throughout the entire system. To be an Eager Implementer of Reflationary Programs - an especially natural bias for someone of Dr. Bernanke's intellectual perspective - virtually guarantees worldly mutation to Closet Bubble Perpetuator. They go (Un-Invisible) Hand in hand. The only hope against such an unfavorable outcome would be a keen understanding and appreciation for the dynamics of Credit and speculative excess, as well some regard for a "Mises" view of economic mal-adjustment. I have seen no indication suggesting that such mitigating factors will be at play for Dr. Bernanke.

What our system desperately needs right now is some Reserve Bank of New Zealand determination to rein in excess - pure and simple. I would be shocked to see such an approach from the new Fed Chairman. He holds special disdain for "Bubble Poppers," and faults the post-Benjamin Strong Fed for the Great Depression. ("...it is now rather widely accepted that Federal Reserve policy turned contractionary in 1928, in an attempt to curb stock market speculation.") At Milton Friedman's ninetieth birthday party, he stated, "Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we [the Fed] did it. We're very sorry. But thanks to you, we won't do it again." These days, he continues to downplay the risk of inflation. And from Nell Henderson's Wednesday article in the Washington Post: "Ben S. Bernanke does not think the national housing boom is a bubble that is about to burst, he indicated to Congress last week.... U.S. house prices have risen by nearly 25 percent over the past two years, noted Bernanke... But these increases, he said, 'largely reflect strong economic fundamentals,' such as strong growth in jobs, incomes and the number of new households."

Take and hour or so and carefully read his April 2005 speech, "The Global Savings Glut and the U.S. Current Account Deficit." I can honestly say - with a conscious effort to avoid hyperbole - that it is one of the most flawed and suspect pieces of analysis I have ever read from a respected economist. And the subject matter is one of the most pressing issues that must be confronted by our policymakers. It actually does seem like he is oblivious to the fact that our intractable Current Account Deficit is foremost a reflection of unrelenting Credit excess, inflated asset prices, over-consumption and economic distortions. He is similarly oblivious to the reality that this "global savings glut," being accumulating by our trading partners, is largely IOU's we created in the process of mortgage and asset-based borrowings. Yet, this line of reasoning is consistent with his analytical framework. From the preface of his book: "I believe that there is now overwhelming evidence that the main factor depressing aggregate demand [during the Great Depression] was a worldwide contraction in world money supplies. This monetary collapse was itself the result of poorly managed and technically flawed international monetary system (the gold standard, as reconstituted after World War I)." Dr. Bernanke has a troubling (Friedman-like)) penchant for looking outside the U.S. Credit apparatus, financial system and markets when it comes to identifying the true source of instability.

And from his 1995 article, The Macroeconomics of the Great Depression: A Comparative Approach: "To understand The Great Depression is the Holy Grail of macroeconomics... We do not yet have our hands on the Grail by any means, but during the past fifteen years or so substantial progress toward the goal of understanding the Depression has been made... To my mind...the most significant recent development has been a change in the focus of Depression research, from a traditional emphasis on events in the United States to a more comparative approach that examines the experiences of many countries simultaneously."

And from his March 2004 speech, Money, Gold, and the Great Depression: "Some important lessons emerge from the story. One lesson is that ideas are critical. The gold standard orthodoxy, the adherence of some Federal Reserve policymakers to the liquidationist thesis, and the incorrect view that low nominal interest rates necessarily signaled monetary ease, all led policymakers astray, with disastrous consequences. We should not underestimate the need for careful research and analysis in guiding policy. Another lesson is that central banks and other governmental agencies have an important responsibility to maintain financial stability. The banking crises of the 1930s, both in the United States and abroad, were a significant source of output declines, both through their effects on money supplies and on credit supplies. Finally, perhaps the most important lesson of all is that price stability should be a key objective of monetary policy. By allowing persistent declines in the money supply and in the price level, the Federal Reserve of the late 1920s and 1930s greatly destabilized the U.S. economy and, through the workings of the gold standard, the economies of many other nations as well."

I do agree with the notion that "ideas are critical." Unfortunately, our new Fed chief has some very flawed and dangerous ideas of how to deal with critical events that could very well develop early in his term. He should be talking restraint and the risks associated with attempting a "soft-landing." But he and his fellow Inflationists will have none of that. And while the stock market has already demonstrated its stamp of approval, the bond market and dollar could not quite shield their grimaces. There remains this dogged hope that a housing cool-down will damp inflationary pressures - allowing Dr. Bernanke to cut rates early next year. At this point, I wouldn't bet that a moderation in mortgage Credit growth will significantly alter the inflationary backdrop. Inflationary pressures are becoming only increasingly pronounced and oblivious to little baby-step rate increases. The system beckons for an actual tightening of financial conditions, a development certainly not accomplished by a little restraint employed at the fringe of mortgage lending excesses.

And, if I had to place a bet, I would wager that the more folks (certainly including our foreign creditors) delve into Dr. Bernanke, the more the bond and currency markets will question his credibility. And a novice Fed Chairman with credibility issues is not - I would hope - going to quickly reverse course and stimulate. Where's the "continuity" in that? And whether he does or does not, we've not heard the last growl from the Dollar Bear. I do not envy Dr. Bernanke. He attained the pinnacle of success he has always dreamed. His chairmanship is quite likely going to be a nightmare. The wrong man - and his deeply flawed analytical framework - at the wrong time. How could it be? A Bubble Perpetuator.


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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