Global Imbalances Watch

By: Doug Noland | Fri, Jan 27, 2006
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The year of volatility... For the week, the Dow jumped 2.3%, and the S&P500 gained 1.8%. The Transports surged 3.6% to a new high, while the Utilities dropped 1%. The Morgan Stanley Cyclical index surged 4.3%, and the Morgan Stanley Consumer index added 0.6%. The broader market remains exceptionally strong. The small cap Russell 2000 surged 3.9%, increasing y-t-d gains to 8.8%. The S&P400 Mid-Cap index rose 2.2%, with 2006 gains rising to 5.0%. The NASDAQ100 rose 2.1%, and the Morgan Stanley High Tech index gained 1.9%. The Semiconductors surged 7.5%, increasing y-t-d gains to a blistering 14.9%. The Street.com Internet Index jumped 2.6% this week, and the NASDAQ Telecommunications index increased 1.6%. The Biotechs added 1.2%. Financial stocks were strong. The Banks gained 2.7%, and the Broker/Dealers surged 4.9% (up 9.1% y-t-d and 46% over one year). With bullion up $5, the HUI gold index jumped 6.8%.

The Treasury market suffered its worst decline since October. For the week, two-year Treasury yields surged 14 bps to 4.495%. Five-year government yields jumped 15 bps to 4.44%, and bellwether 10-year Treasury yields rose 16.5 bps to 4.515%. Long-bond yields surged 17 bps to 4.69%. The spread between 2 and 10-year yields widened 2 bps to 2. Benchmark Fannie Mae MBS yields jumped 17 bps to 5.76%, this week slightly underperforming Treasuries. The spread (to 10-year Treasuries) on Fannie's 4 5/8% 2014 note declined one to 32.5, while the spread on Freddie's 5% 2014 note declined 1.5 to 33. The 10-year dollar swap spread increased 1.75 to 51.25. Investment-grade spreads were little changed, while junk bond spreads narrowed. The implied yield on 3-month December '06 Eurodollars jumped 15 bps to 4.865%.

Corporate bond issuance was lead by a robust $6.1 billion of junk issuance (from Bloomberg). For the week, investment grade issuers included Citigroup $2.5 billion, Wachovia $2.5 billion, CIT Group $1.75 billion, Bear Stearns $1.5 billion, Teva Pharmaceutical $1.5 billion, Talisman Energy $500 million and Southern Cal Edison $500 million.

Junk bond fund outflows rose to $270 million (from AMG). Junk issuers included NRG Energy $3.6 billion, C&M Finance $650 million, CCH $450 million, Boyd Gaming $250 million, Exopac $220 million, and CRC Health $200 million.

Convertible issuers included Teva Pharmaceutical $1.25 billion, United Auto Group $325 million and AAR Corp $125 million.

Foreign dollar debt issuers included PEMEX $1.5 billion, Uruguay $700 million, Commonwealth Bank of Australia $500 million, Boi Capital Funding $400 million, Geophysique $165 million, and Mirant Trinidad $100 million.

Japanese 10-year JGB yields jumped 7 bps this week to 1.54%, as the Nikkei 225 index rallied almost 5% this week (up 2.2% y-t-d). Emerging markets remain generally strong. Brazil's benchmark dollar bond yields declined another 6 bps to 6.50%. Brazil's Bovespa equity index rose 2.6%, increasing 2006 gains to 13.1%. The Mexican Bolsa jumped 3.3%, with y-t-d gains rising to 6.5%. Mexican 10-year govt. yields rose 12 bps to 5.40%. Russian 10-year dollar Eurobond yields added 2 bps to 6.42%. The Russian RTS index surged 5.2%, increasing 2006 gains to 22% (one-yr gain of 124%). Year-to-date, the major equity index in Argentina is up 12.7%, Venezuela 22.3%, Colombia 20.2%, Peru 13.7%, Iceland 15.4%, Luxembourg 12.8%, Romania 19.6%, Turkey 13.9%, Egypt 20.8% and Saudi Arabia 12.2%.

Freddie Mac posted 30-year fixed mortgage rates bumped up 2 bps to 6.12% (up 46 bps in a year), the first increase in 7 weeks. Fifteen-year fixed mortgage rates increased 3 bps to 5.70% (up 56 bps in a year). One-year adjustable rates rose 2 bps to 5.20%, an increase of 102 basis points from one year ago. The Mortgage Bankers Association Purchase Applications Index jumped 6.7% last week. Purchase Applications were up 6.4% from one year ago, with dollar volume up 13%. Refi applications increased 7.8% to an 11-week high. The average new Purchase mortgage rose to $229,100, while the average ARM jumped to $337,000.

Broad money supply (M3) increased $2.0 billion (week of Jan. 16) to $10.254 Trillion. Over the past 35 weeks, M3 has inflated $629 billion, or 9.7% annualized. Over 52 weeks, M3 has expanded 8.0%, with M3-less Money Funds up 8.2%. For the week, Currency increased $2.2 billion. Demand & Checkable Deposits slipped $0.8 billion. Savings Deposits fell $6.4 billion. Small Denominated Deposits added $3.5 billion. Retail Money Fund deposits dipped $2.5 billion, and Institutional Money Fund deposits dropped $10.7 billion. Large Denominated Deposits jumped $19.5 billion (4-wk gain of $50bn). Over the past 52 weeks, Large Deposits were up $265 billion, or 23.4% annualized. For the week, Repurchase Agreements rose $1.7 billion, while Eurodollar deposits declined $4.6 billion.

Bank Credit surged $28.3 billion last week to a record $7.531 Trillion. Over the past 52 weeks, Bank Credit has inflated $688 billion, or 10.1%. For the week, Securities Credit jumped $24.9 billion. Loans & Leases were up 12.2% over the past 52 weeks, with Commercial & Industrial (C&I) Loans up 15.1%. For the week, C&I loans expanded $4.9 billion, while Real Estate loans fell $10.6 billion. Real Estate loans have expanded at an 8.9% pace over the past 20 weeks and 14.0% during the past 52 weeks. For the week, Consumer loans increased $6.0 billion, and Securities loans gained $6.3 billion. Other loans dipped $3.1 billion.

Total Commercial Paper rose $7.8 billion last week to $1.696 Trillion. Total CP is up $47.2 billion y-t-d (4wks) and expanded $278 billion over the past 52 weeks, or 19.6%. Last week, Financial Sector CP borrowings added $6.7 billion to $1.553 Trillion, with a 52-week gain of $276 billion, or 21.6%. Non-financial CP added $1.0 billion to $144 billion, with a 52-week rise of 1.6%.

About $20 billion of asset-backed securities (ABS) were issued this week (from JPMorgan). Total year-to-date issuance of $49 billion is running slightly behind the year ago level. The $35 billion y-t-d Home Equity Loan ABS issuance is ahead of last year.

Fed Foreign Holdings of Treasury, Agency Debt rose $4.2 billion to a record $1.553 Trillion for the week ended January 25. "Custody" holdings were up 12.5% annualized over the past 20 weeks and $190 billion (14.1%) over the past 52 weeks. Federal Reserve Credit declined $4.5 billion to $812 billion. Fed Credit has expanded 4.1% annualized over the past 20 weeks and 4.0% over the past 52 weeks.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $452 billion, or 12.3%, over the past 12 months to a record $4.1 Trillion. China's reserves jumped 34% to $819 billion.

Currency Watch:

The dollar index gained 0.5% for the week. On the upside, the Brazilian real jumped 3.0%, the South Korean won 1.6%, the Peruvian new sol 1.2%, and the Mexican peso 1.0%. On the downside, the South African rand fell 2.1%, the Japanese yen 1.7% and the Iceland krona 1.1%.

Commodities Watch:

January 25 - Bloomberg (Helen Yuan): "China, the world's biggest producer and user of steel, increased output of steel product 17 percent to a record last month as an investment boom boosted production of the alloy, worsening a domestic glut. The output of steel products, including reinforcement bars used in construction and cold-rolled coil used in vehicles and appliances, rose to 33.7 million metric tons..."

January 25 - Bloomberg (Simon Casey): "BHP Billiton, Rio Tinto Group and other mining companies will agree record iron ore prices this year because of rising demand for the steelmaking raw material, ING Groep NV said. Annual supply contracts, which usually start April 1, will be agreed at prices 20 percent higher than last year..."

The CRB index closed at another all-time high today. This week saw copper, platinum and zinc all trade at new record highs. March crude oil slipped 72 cents to $67.76. March Unleaded Gasoline fell 3% this week, and March Natural Gas sank 11%. For the week, the CRB index added 0.5%, increasing y-t-d gains to 4.6%. The Goldman Sachs Commodities index declined 1.2% this week, with a y-t-d gain of 4.0%.

China Watch:

January 25 - Bloomberg (Nerys Avery): "China's economy grew 9.9 percent in 2005, overtaking the U.K. as the world's fourth largest, powered by record exports and investment in manufacturing. Gross domestic product rose to 18.2 trillion yuan ($2.26 trillion) after expanding 10.1 percent in 2004... The U.K. economy was worth 1.13 trillion pounds ($2.02 trillion) in 2005..."

January 25 - Bloomberg (Nerys Avery): "Investment in China's roads, factories and other fixed assets in urban areas increased 27.2 percent last year, the National Bureau of Statistics said. Investment rose to a record 7.5 trillion yuan ($930 billion)..."

January 24 - Bloomberg (Patricia Cheng): "State Grid Corp. of China plans to spend 800 billion yuan ($99.2 billion) in the next five years to upgrade its network, China Daily reported..."

January 25 - Bloomberg (William Mellor and Allen T. Cheng): "From his 16th-floor office on Beijing's Avenue of Eternal Peace, distressed-debt specialist Jack Rodman has a grandstand view of the $160 billion worth of construction that will add the equivalent of three Manhattans to the skyline by 2008, when China's capital will host the Olympic Games. To the east, a new central business district is rising near a futuristic television tower designed by Dutch architect Rem Koolhaas. To the west, a Chinese Wall Street is taking shape around the glass-prism Bank of China Ltd. headquarters created in 2001 by Chinese-American architect I.M. Pei. Across the city, work is under way on luxury apartments, subway and rail lines, ring roads, Olympic venues and an airport terminal that will be bigger than all five at London's Heathrow. Already completed is the 4.9 million-square-foot Golden Resources Shopping Mall, which is twice the size of... Minnesota's Mall of America...'The scale of development here is unprecedented anywhere in the world,' says Rodman, 59, a partner at Ernst & Young..."

Asia Boom Watch:

January 25 - Financial Times (Khozem Merchant and Jo Johnson): "India's consumers face higher borrowing costs after the central bank yesterday unexpectedly increased short-term interest rates and warned of inflationary pressures arising from the massive surge in demand for cheap credit. In the latest sign that the economy is moving towards a higher growth trajectory, the Reserve Bank of India (RBI) also raised its forecast for economic growth in the year to April 2006 to 7.5-8 per cent, from 7-7.5 per cent. The Indian government, whose cabinet was last night poised to open up new areas of the economy to foreign investment, is aiming for a double-digit growth rate that would put the country on the same fast-track as China for the first time... India's benchmark share price index has risen by more than 40 per cent in the last year... Describing consumer spending as "robust" and credit uptake by businesses as "on the upswing", [RBI Governor] Mr. Reddy also issued a warning to banks... Non-farm credit soared 31 per cent in the nine months to December, year-on-year, against an RBI forecast expansion last April of 19 per cent. Lenders led by ICICI have seen earnings grow at a scorching pace, driven by retail loans. ICICI's retail lending in the nine months to December grew 60 per cent year-on-year."

January 26 - Bloomberg (Lily Nonomiya): "Japan's imports and exports jumped to records in December as rising domestic spending and overseas orders stoked growth in the world's second-largest economy. Imports gained 27.3 percent, the fastest since November 2004, and exports rose 17.5 percent, the most in 18 months...The trade surplus shrank 19.3 percent to 914 billion yen ($7.9 billion)."

January 25 - Bloomberg (Masahiro Hidaka and Mayumi Otsuma): "The demand for bank loans rose to the highest level in almost six years as the economy's expansion fueled business investment, according to a Bank of Japan quarterly survey."

January 24 - Bloomberg (Mayumi Otsuma): "Japan's 11 regional economies are expanding simultaneously for the first time since 1997, the Ministry of Finance said today, the latest sign the nation is emerging from a 15-year economic funk."

January 25 - XFN: "[South Korea's] gross domestic product rose 5.2% year-on-year in the fourth quarter, accelerating from 4.5% in the third, driven by robust exports, expanding facility investment and improvement in the manufacturing sector, the Bank of Korea said..."

January 26 - Bloomberg (Seyoon Kim): "South Korea's Finance Minister Han Duck Soo repeated a forecast that the economy will grow about 5 percent this year and said more jobs will be created than in 2005. Rising exports and domestic demand will continue to spur economic growth..."

January 24 - Bloomberg (Yu-huay Sun): "Taiwan's export orders grew more than 20 percent for a fifth straight month in December as global demand for the island's liquid crystal display panels and semiconductors increased. Orders, indicative of actual shipments in one to three months, gained 24.2 percent from a year earlier to $24.6 billion..."

January 26 - Bloomberg (Stephanie Phang): "Malaysia's economic growth in 2006 may exceed last year's targeted 5 percent to 5.5 percent, Reuters reported, citing Central Bank Governor Zeti Akhtar Aziz..."

Unbalanced Global Economy Watch:

January 23 - Bloomberg (John Fraher and Simone Meier): "European Central Bank Chief Economist Otmar Issing said property price inflation in parts of the dozen-nation euro region is 'unsustainable.' 'For a number of countries such as France, Ireland, Spain and even Italy, house prices are on a path which is not sustainable,' said Issing at a conference on global financial imbalances in London. 'We have a non-neglectable increase in house prices.'"

January 25 - Bloomberg (Matthew Brockett): "Business confidence in Germany, Europe's largest economy, rose to the highest in more than five years this month as economic growth accelerated."

January 25 - Bloomberg (Chris Malpass): "Import prices in Germany, Europe's largest economy, accelerated at the fastest pace in five years in 2005 as energy costs increased and the euro declined. Import prices rose 4.3 percent last year, compared with 1 percent a year earlier..."

January 24 - Bloomberg (Tasneem Brogger): "Danish consumers in January became more optimistic than ever before about the economic situation in Denmark and their own finances."

January 26 - Bloomberg (Evalinde Eelens): "Dutch consumer spending in November rose the most since June 2002 as shoppers bought more food and durable goods."

January 26 - Bloomberg (Jonas Bergman): "Swedish retail sales in December posted their biggest-ever annual gain led by purchases of shoes. Sales rose 0.3 percent from November and 10.7 percent from a year earlier..."

January 26 - Bloomberg (Jonas Bergman): "Swedish consumers this month grew the most optimistic in more than five years as economic growth and demand for labor picked up in the largest Nordic economy."

January 23 - Bloomberg (Fergal O'Brien): "Ireland's economic growth will accelerate to the fastest in three years in 2006 as more jobs and the maturing of a state-backed savings plan boost consumer spending, according to Bank of Ireland Plc. Gross domestic product will expand 6 percent this year from an estimated 4.7 percent in 2005..."

January 24 - Bloomberg (Elizabeth Konstantinova): "Bulgarian housing prices rose 36.6 percent last year as the country approaches European Union entry planned for 2007, Pari newspaper reported, citing National Statistics Institute data."

Latin America Watch:

January 24 - Bloomberg (Andrew J. Barden and Katia Cortes): "Brazilian President Luiz Inacio Lula da Silva agreed today to raise the country's minimum wage 17 percent, more than twice the increase the government initially proposed, a government leader in the lower house said."

January 23 - Bloomberg (Eliana Raszewski): "Argentine spending rose 22 percent last year as salaries and pensions increased and the government spent more on public works projects, Ambito Financiero reported."

January 24 - Bloomberg (Alex Emery): "Peru's exports jumped to a record in 2005 on surging sales of copper, gold and natural gas. Exports rose 34 percent to $17 billion from a year earlier..."

Bubble Economy Watch:

January 25 - CNNMoney.com (Les Christie): "Americans are among the world's most cash-strapped people, according to the latest semi-annual survey from ACNielsen... Nearly a quarter (22 percent) of Americans have no money left once they've paid for their essential living expenses and spent their discretionary dollars. That puts the United States at the top of a list of 42 countries for saving futility.... Others in the top 10 for most cash-strapped countries included Canada, No. 3, at 19 percent, the United Kingdom (No. 4, 17 percent) and France (No. 5, 16 percent)."

December Durable Goods Orders were up a stronger-than-expected 1.3% from November. Orders were up 13.7% from December 2004, with Non-defense Capital Goods orders up 34.4% y-o-y. Transportation orders were up 31% from the year ago period.

December Existing Home Sales (EHS) were reported at a weaker-than-expected 6.60 million annualized pace. For perspective, EHS averaged 3.993 annualized during the nineties. Total 2005 EHS were a record 7.072 million units, up 4.2% from 2004 (the previous record). December EHS were down 3% from December 2004. Average (mean) Prices were up 7% from one year ago, 16% over two years, and 27% over three years. December New Home Sales were stronger-than-expected, up about 3% from November and up 1.8% from December 2004. Average Prices were down 4% y-o-y to $272,900. The Inventory of Unsold New Homes jumped 12,000 during the month to a record 516,000, up 22% y-o-y. For the year, New Home Sales were 6.6% above 2004's record, at 1.282 million units ('90s avg. 698,000). Total Home Sales (New and Existing) were up 4.6% from 2004's record to 8.354 million ('90s avg. 4.692 million).

January 25 - PRNewswire: "The median price for existing single-family homes in Florida continued to rise in December, reaching $247,000 -- an increase of 27 percent compared to the statewide median price of $194,000 in December 2004, according to the Florida Association of Realtors. In December 2000, the statewide median sales price was $116,200, which is an increase of 112.5 percent over the five-year period..."

January 25 - Bloomberg (Joe Mysak): "Now that Indiana has sold its toll road, get ready for everyone else to do the same. On Monday, Governor Mitch Daniels said a Spanish-Australian consortium had bid $3.85 billion to run the Indiana Toll Road, a 157-mile highway across northern Indiana... A Merrill Lynch & Co. report published last July on the subject of U.S. toll road privatization asked whether sales like the Skyway were one-offs, 'or do they represent the beginning of a sweeping trend that will spread to other tolled bridges, tunnels, expressways and long-distance toll roads?' Let's bet on the sweeping trend. The money is just too big to resist..."

January 24 - Bloomberg (Brian K. Sullivan and Patrick Cole): "Princeton University, the fourth-oldest U.S. university, plans to charge $42,200 a year for an undergraduate education amid increases in such costs as faculty salaries and efforts to attract minority and low-income students. The tuition and fees will be 4.9 percent higher..."

California Watch:

January 24 - Bloomberg (Daniel Taub): "One in 13 California homes sold for more than $1 million last year as more condominiums and new homes surged past the million-dollar mark, DataQuick...said. A record 48,666 homes in the most populous U.S. state were bought for more than $1 million, an increase of 47 percent from 33,107 in 2004..."

Existing Home Sales in California sank 16% from record-setting December 2004. Median prices, however, were up $74,160 (15.6%) to $548,430. Prices were up $146,710, or 37%, over two years. The inventory of homes on the market has increased from the year ago 2 months to December's 3.6 months, still low by historical standards. Condo sales were down 21.7% from one year ago, with prices up a "modest" 10.2% to $430,910.

Fed Watch:

January 27 - Bloomberg (Brendan Murray and Rich Miller): "President George W. Bush nominated economic aide Kevin Warsh and University of Chicago economist Randall Kroszner to the Federal Reserve Board... Warsh, 35, an investment banker at Morgan Stanley in New York from 1996 to 2002, has been executive secretary of Bush's National Economic Council and special assistant for economic policy. Kroszner, 43, has taught at Chicago since 1990 and was on Bush's Council of Economic Advisers from 2001 to 2003... Less is known about Warsh, who would become the youngest Fed governor by almost two decades. Warsh graduated from Stanford University in 1992 with a bachelor's degree in public policy and from Harvard Law School in 1995. He married Jane Lauder, the granddaughter of cosmetics pioneer Estee Lauder, in 2002 at an estate in Palm Beach... He was hired by Morgan Stanley as an associate in August 1996...and then promoted to vice president in investment banking and later to executive director... During an October 2004 speech in Chandler, Arizona, Warsh said Bush's tax cuts were benefiting the economy, according to Mike Canning, executive director of the Association of Corporate Credit Unions in Washington. Warsh spoke to the group's chief executives. 'He saw signs that things were picking up, and the good growth in various quarters led him to believe some of the president's policies were coming to fruition,' Canning said." (On to the Fed's Board of Governors!)

"Project Energy" and Crude Liquidity Watch:

January 26 - Bloomberg (Caroline Salas and Walden Siew): "NRG Energy Inc., owner of power plants in 14 U.S. states, sold $3.6 billion of debt today in the biggest sale of junk bonds since 1989, to help finance its purchase of electricity producer Texas Genco Holdings LLC."

January 27 - Financial Times (Andrei Postelnicu ): "Chevron, the oil major, on Friday continued the trend of towering earnings in its industry by reporting a 16.3 per cent increase in underlying profits in the fourth quarter thanks to higher crude oil and natural gas prices. The company said net fourth-quarter profits rose just over 20 per cent, to $4.1bn..."

January 25 - Bloomberg (James Cordahi): "Kuwait, the largest shareholder in DaimlerChrysler AG, plans to use its oil revenue to invest more in developing economies such as China and Turkey to benefit from faster growth, rather than traditional markets including the U.S. and Europe. The Kuwait Investment Authority, a government agency that invests surplus revenue, is in talks with the Chinese government to buy a 10 percent stake in Industrial & Commercial Bank of China, the country's largest lender..."

January 23 - Bloomberg (Carlos Caminada): "Brazil's Agriculture Minister Roberto Rodrigues said the country must invest $10 billion over the next six years to boost ethanol output in order to meet rising foreign demand for the fuel."

Mortgage Finance Bubble Watch:

Freddie Mac's Book of Business jumped $26.3 billion (to $1.684 Trillion) during December, the strongest monthly gain since October 2003. Over the past five month, Freddie's Book of Business has surged $1.2 billion, or 15% annualized. The company's Mortgage Portfolio jumped $17.3 billion, or 30% annualized. Over the past five months, Freddie's Mortgage Portfolio has expanded at an 18% annualized rate to $710 billion. For the year, Freddie's Book of Business expanded 11.9% and its Mortgage Portfolio increased 8.7%.

January 20 - Reuters: "New York City Mayor Michael Bloomberg on Friday said the real estate market was slowing 'dramatically' and only a 'miracle' could stop soaring mortgage rates from eating into housing prices... 'The real estate market is slowing down dramatically and we're going to have a problem down the road... If people who want to sell their houses have to wait a longer time before someone comes along and buys it, it would be a miracle if prices didn't start to go down,' he said."

Federal Finances Watch:

January 26 - Bloomberg (Ryan J. Donmoyer): "Low tax rates and a strong economy lifted federal revenue from capital gains in 2004 and 2005, a trend that may not continue in coming years... The Congressional Budget Office, in its annual budget outlook, said capital gains realizations rose to $479 billion in 2004, an increase of almost 50 percent from the previous year. Such transactions rose 13 percent to $539 billion in 2005..."

Global Imbalances Watch:

January 24 - Market News International: "There are signs the current global imbalances will turn out to be prolonged and it is fallacious to believe that Asian central banks will forever fund rising US deficits, Bank of England Deputy Governor Rachel Lomax said... In a speech at a Royal Institute of International Affairs conference, Lomax joined the chorus of central bankers raising serious concerns about the threat to stability posed by the imbalances. The US current account deficit has risen to over 6% of GDP, and Lomax warned that it could not be taken for granted that Asian central bank would continue to finance it. Lomax said the US was not 'immune to the basic arithmetic of debt sustainability - sooner or later persistent deficits will lead to levels of external indebtedness that represent a significant economic burden even on the US; but it is more than usually hard to predict how long this might take,' she said."

From Ms. Lomax's speech: "Financial globalization has relaxed the constraints on countries in financing their savings investment balances, thus allowing larger imbalances to be sustained for longer. This is in principle welcome in so far as it permits more efficient adjustment over time, and smoothes the impact of economic shocks on real activity and consumption. But it also poses major new challenges for creditors and debtors, both public and private sector."

My comment: I don't believe that "financial globalization" per se is the real issue or the problem (scapegoat, perhaps). Rather, I will pin blame directly on the character of the current global financial apparatus that fosters unconstrained Credit growth and speculative excess - which I refer to as "Global Wildcat Finance." Any and every Credit system - domestic or international - that operates with unlimited capacity to create and easily disseminate liquidity will, during periods of optimism, supply too much of it. Importantly, this dynamic will work surreptitiously to distort and eventually abrogate market processes - as we continue to observe. The capacity for the unfettered global financial system to create unlimited finance is at the root of today's dangerous prevailing dynamic: a veritable breakdown in the market mechanism for creating and pricing global finance. No longer does the interaction of the supply and demand for finance determine market yields, while the surfeit of global liquidity has widely distorted asset prices, risk premiums and the allocation of Credit and finance. An unsound system has nurtured a precarious yet trumpeted backdrop, where surging demand for borrowings (by the U.S.) is easily accommodated ("relaxed constraints") at predictably low interest rates.

I take quite strong exception with any view holding that the current dysfunctional arrangement "permits more efficient adjustment over time," or that it "smoothes the impact of economic shocks." The reality of the situation is that this current market failure is prolonging U.S. excesses and only delaying what will surely be a monumental adjustment process. It is a maxim of Macro Credit Bubble Theory that the risks associated with prolonging financial and economic Bubbles grow exponentially over time and generally culminate with a "blow-off" period of manic excess. Timid policymakers have watched the global cycling and recycling of dollar liquidity in awe - deer in the headlights. Having loitered long enough to recognize that there will be no self-adjustment or correction, policymakers now face the dilemma that to impose the necessary policy restraint to commence the adjustment process comes at a cost much higher than they are willing to bear. So they are stuck hopelessly eyeballing the situation, while paying more strident, but basically useless, lip service. Meantime, highly speculative markets relish in what has evolved into an historic policy vacuum.

From Ms. Lomax: "The dollar's central role in the foreign exchange policies of Asian emerging markets adds to the uncertainty about the deficit levels at which the US will face tighter credit constraints. Since the foreign official sector - mostly Asian central banks - have been financing a substantial part of the US current account deficit and now hold a substantial amount of the outstanding stock of US Treasuries, private investors' willingness to hold dollar assets depends to some extent on their expectations of what these Asian central banks will be doing. Since many Asian [emerging market economies] already have far more reserves than they need for self-insurance against financial crisis, their appetite for continued accumulation of US dollar assets will at some stage abate; indeed, there has been some anecdotal evidence of this over the past year."

Bingo. Here Ms. Lomax hits on a very key (and timely!) point with respect to the extraordinary Global Wildcat Finance backdrop commanded by the interplay between expansionist central banks and the enterprising global leveraged speculating community. I believe very strongly that the hedge funds, "proprietary trading desks," and others' "willingness to hold dollar assets depends to" a great "extent on their expectations of what these Asian central banks will be doing." It's been the ultimate combination of market intervention, moral hazard, and trend-following speculation. And this gets right to the heart of the danger associated with the confluence of activist central banking, marketplace distortions, and speculator liquidity as a key source of system liquidity. This powerful dynamic is as alluring as it is self-reinforcing, yet it is progressively destabilizing and inevitably unmanageable. No one dares removing the punchbowl.

There is today growing concern that the indomitable "foreign bid" for Treasuries and agencies may be on the wane. To be sure, if confidence in the foreign backstop abates much at all, prospective U.S. interest rates become a whole lot more uncertain. And, as I have explained in the past, it is my view that the entire global currency derivatives/hedging marketplace has been and will continue to be dependent on the willingness of chiefly Asian central banks to act aggressively as dollar buyers of last resort. This unprecedented liquidity backstop has not only (magically) kept the dollar bear market orderly, it has as well abrogated the traditional cycle of faltering currencies begetting sinking bond prices. And while I don't at this point see foreign central banks retreating much from U.S. securities markets, I would not be all too surprised if they dabble a bit with attempts to wean the marketplace from recent heavy dependency.

It is a (yet unrecognized) legacy of the Greenspan Era for the Fed to exploit the global leveraged speculating community and foreign central banks liquidity expedients. The ease with which this policy mechanism incites predictable Credit expansion and liquidity creation responses has simply been too powerful not to abuse. Although many have argued that this extraordinary financing arrangement can finance U.S. Current Account Deficits for years to come, it is better analyzed as a huge regrettable accident in the making. Sure, the deficit is being financed as easily today as ever. Yet the negative consequences of the resulting Global Liquidity Glut have become conspicuous.

From Ms. Lomax: "While the risk of a disruptive adjustment may still be low, the sheer scale of current imbalances increases the potential costs of policy mistakes and misperceptions. Any disconnect between what the markets expect and what policy makers intend to do becomes increasingly hazardous. That puts a premium on excellent policy communication, to reduce uncertainty and minimize the risk of sharp market corrections. And policy makers need to ensure that their policies are robust to the possibility that market expectations may not be consistent with economic fundamentals."

Are "free" financial markets really so fragile? Why? I see it as a declaration of defeat anytime central bankers are compelled to openly pander to the marketplace. Putting "a premium on excellent policy communication, to reduce uncertainty and minimize the risk of sharp market corrections" may sound reasonable and commendable, but it today plays right into the hands of the leveraged speculators. Chairman Greenspan and other central bankers apparently fret over meager risk premiums, yet global policymakers seem determined to discharge all marketplace uncertainty and volatility. Of course, such efforts only augment the process of marketplace degeneration and Bubble Inflation.

New York Federal Reserve President Timothy F. Geithner also spoke at this week's Chatham House Global Financial Imbalances Conference:

From Mr. Geithner: "Monetary policy itself cannot sensibly be directed at reducing imbalances, but the past and future evolution of global capital flows will of course matter for monetary policy by virtue of their impact on the outlook for output and inflation. For example, the forces that seem to be supporting an unusual level of capital flows into the United States may be materially dampening the level of forward nominal and real interest rates, and other things being equal, this would tend to produce higher levels of demand growth than would prevail in the absence of those factors. Thus, the factors that have contributed to this pattern of external imbalances complicate the task of judging the appropriate stance of monetary policy in the United States today."

What have we done? What on earth have we created? While it is unjust in this instance to shoot the messenger, I do find it appalling that the Greenspan Era has left us with the view that "monetary policy itself cannot sensibly be directed at reducing imbalances." Then where or to whom do we turn? It's just shocking... How could we have drifted such a distance from the traditional role of central banks as prudent regulators of sound money and Credit? We know that we cannot trust politicians to restrain booms or to even recognize underlying financial distortions and excess. It should be a Credit Bubble maxim that politicians never meet a Bubble they don't adore. Central bankers must be able to analyze the soundness of Credit systems and recognize and thwart excess; it's our only hope, especially in the Wild World of Contemporary Finance. Today, the stability of the system depends significantly on a consensus group of independent, astute and principled central bankers (i.e. New Zealand's Dr. Alan Bollard). They picked an especially inopportune time to shirk traditional responsibilities.

This most prolonged Credit Cycle has certainly flourished amid The Ultimate in Asymmetrical Policy Frameworks. Greenspan's Aggressive Activist/Interventionist Policies began only weeks after his chairmanship commenced (with the '87 stock market crash); became much more pronounced with 23 straight rate cuts and 3% Fed funds in the early nineties ("mopping up" after late-80s excesses); took on a much broader scope after the collapse of LTCM; became embedded into creative analytical rationalizations and policy dictum with the runaway technology Bubble; and, with the abetment of professor Bernanke, went off the deep end with several years of 2% or below short-term rates in the Fed's reflationary battle against the phantom specter of deflation.

Since 1987, we have witnessed recurring Bubbles, each Bubble and inevitable "mopping up" policy response only more commanding than the last. For years the nagging issue has been how this all ends: What's the "end game"? Well, we're very much still in the dark. Of course, the unwieldy global liquidity glut does today "complicate the task" of monetary policy. Of course, gradually rising U.S. yields and interest-rate differentials induce speculative inflows and, failing to disrupt Credit and speculative Bubbles, sustain loose financial conditions. Of course the U.S. Bubble has gone global and the most acute inflationary manifestations have developed in the oil and commodity markets - the things that the holders of the inflating dollar balances are keenest to acquire. Of course, the massive pool of global speculative finance grows larger and more dominant with each passing year of enormous U.S. Current Account Deficits, and that the entire world is one's speculator community oyster.

But at what point do Asian central bankers finally recognize that they are trapped in a dangerous game of false prosperity? When does the euphoria associated with stockpiling unprecedented financial wealth transform to trepidation that they are accumulating receivables that will never be honored for the enrichment of their citizens - that they are being "Ponzied"? Or perhaps we're moving in the direction of an initially less dramatic case of unnerved central bankers recognizing that the recycling of U.S. Current Account Deficits is fomenting progressive inflationary pressures throughout the energy and commodities markets, not to mention Bubbling financial markets the world over. They must these days be coming to the realizations that the global financial system is in serious disarray and that the Bernanke Fed is simply not going to be up to the task. For now, I will take an increasingly vocal "chorus of central bankers raising serious concerns about the threat to stability posed by the imbalances" as a meaningful development.


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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