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Jim Cook

 

RUNAWAY SOCIAL SYMPATHY

Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

 
Best of Doug Noland
June 21, 2011
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The world is in the midst of history’s greatest Credit Bubble.  A dysfunctional global financial system essentially operates without mechanisms to regulate the quantity and quality of debt issuance.  In response to severe banking system impairment and fiscal problems in the early-nineties, the Greenspan Fed helped nurture a Credit system shift to nontraditional marketable debt.  The bank loan was largely replaced by mortgage-backed securities (MBS), asset-backed securities (ABS), GSE debt instruments, derivatives and a multitude of sophisticated “Wall Street” Credit instruments.  The Credit expansion grew exponentially, while becoming increasingly detached from production and economic wealth-creation (the boom, in fact, exacerbated deindustrialization).

The Fed implemented momentous changes in monetary management to bolster the new “marketable debt” Credit system structure, including “pegging” short-term interest rates; serial interventions to assure “liquid and continuous markets;” and adopting an “asymmetrical” policy framework that disregarded asset inflation/Bubbles, while guaranteeing the marketplace an aggressive policy response to any risk of market illiquidity or financial/economic instability.  Massive expansion of marketable debt coupled with a highly-accommodative policy backdrop incited incredible growth in speculation and leveraging.  Over time, trends in U.S. Credit, policy and speculative excess took root around the world.

Global markets suffered a devastating crisis of confidence in 2008.  The failure of Lehman Brothers, in particular, set off a panic throughout global markets for private-sector debt, especially Credit intermediated through sophisticated Wall Street structures.  Unprecedented government intervention reversed the downward spiral in Credit and economic output.  Especially in the U.S., Trillions of private debt instruments were put under the umbrella of government backing.  Meanwhile, Trillions more were acquired by the Fed, ECB and global central bankers in the greatest market intervention and debt monetization in history.  Policy making – fiscal and monetary, at home and abroad – unleashed the “Global Government Finance Bubble”.

Currency market distortions have been instrumental in sowing financial fragility and economic instability.  Chiefly because of the dollar’s special “reserve currency” status, U.S. Credit system excesses have been accommodated for way too long.  Global central banks have been willing to accumulate Trillions of our I.O.U.s, providing a critical liquidity backstop for the marketplace.  Highly liquid and orderly currency markets have been instrumental in ensuring a liquid Credit market, which has provided our fiscal and monetary policymakers extraordinary flexibility to inflate our Credit, our asset markets and our economy.  Meanwhile, massive U.S. Current Account Deficits and other financial flows have inundated the world, creating liquidity excess and unfettered domestic Credit expansion throughout the world. 

It has been my thesis that last year’s aggressive market interventions – QE2, the European fiscal and monetary “bailouts,” and massive global central bank monetization – incited a highly speculative Bubble environment vulnerable to negative liquidity surprises.  And now we’re down to the final few weeks of QE2.  The European bailout strategy is unwinding, with little possibility of near-term stabilization.  Meanwhile, the US economy has downshifted in spite of massive fiscal and monetary stimulus.  Risk and uncertainty abound; de-risking and de-leveraging are making a comeback.

Bloomberg went with the headline, “Fed’s Maiden Lane Sales Trigger Bank Stampede to Dump Risk.”  At The Wall Street Journal, it was “As ‘Junk’ Bonds Fall, Some Blame the Fed.”  Both articles noted the deterioration in pricing for a broadening list of Credit market instruments, including junk bonds, subprime mortgage securities, and various Credit derivatives.  And while the Fed’s liquidation of an old AIG portfolio is surely a drag on some prices, I believe the rapidly changing liquidity backdrop is more indicative of global de-risking dynamics.  This is providing important confirmation of the bear thesis.

There are fascinating dynamics at work throughout our Credit market.  Arguably, the U.S. is the King of Non-Productive Debt.  In the wake of a historic expansion of non-productive household debt comes a Bubble in government (Treasury and related) Credit.  The assets underpinning too much of the U.S. debt mountain are of suspect quality, although this hasn’t mattered recently.  And in true Bubble fashion, the marketplace has increasingly gravitated to Treasury debt as the “Greek” crisis escalates and contagion effects gather momentum.  The corporate debt market has enjoyed extreme bullish sentiment – along with waves of investment and speculative inflows.  While the corporate balance sheet appears sound, I would counter that corporate earnings and cash flows have been artificially inflated by unsustainable federal deficits.  In particular, the bubbling junk bond market would appear vulnerable to the deteriorating liquidity backdrop.

Elsewhere, there is the murky world of subprime derivatives and such.  This bastion of speculative excess certainly enjoyed the fruits of policy-induced reflation.  But not only has housing performed dismally, there are now the market issues of de-risking and liquidity uncertainties.  Today from the WSJ:  “Since April, prices of many subprime mortgage securities have declined between 15% and 20%... The decline in subprime mortgage bonds accelerated in the last two weeks…”  From Bloomberg this morning:  “Declines in credit-default swaps indexes used to protect against losses on subprime housing debt and commercial mortgages accelerated this month, reaching almost 20% in the past five weeks..”  Also from Bloomberg:  “Default swaps on the six largest U.S. banks have gained an average of 19.4 bps to 137.2 bps since May 31…”

In conclusion, support seemed abundant this week for the thesis which holds that the U.S. Credit system and economy are much more vulnerable to contagion effects than is commonly appreciated.  Treasury and dollar rallies appear constructive for system liquidity.  In reality, it is likely that both markets are heavily impacted by speculative trading (speculators, in various forms, have used Treasury and dollar short positions to finance higher-returning holdings).  Strength in the Treasury market and the dollar are indicative of – and place additional pressure on – the unwind of leveraged trades.  And it is when the speculator community finds itself back on its heels and backing away from risk that liquidity becomes a critical market issue.