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Jim Cook



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
July 21, 2010
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The Greek crisis has reshaped the financial world.  I’m just not convinced that it has altered what evolved a few years back into an unrelenting – and self-reinforcing - flood of finance from the “Core” (U.S. Credit system) out to the “Periphery.”  Over the past couple of months, we’ve witnessed important changes in market risk perceptions, which incited speculator de-leveraging and pressured global markets.  There was a bout of enormous demand for dollars.  But have global dynamics revamped the powerful “Core” to “Periphery” Monetary Process?

The rally in the dollar and Treasurys – in the face of European currency and debt market tumult – nurtured a consensus view that the U.S. once again enjoys a “King Dollar” safe haven status.  This implies that a deepening global crisis would entail (nineties-style) robust flows to the dollar and our securities markets, possibly reversing the “Core” to “Periphery” dynamic.  Such a development would support the global deflation thesis.

A differing view holds that the dollar and Treasury rallies were more technically driven in the (speculative, leveraged and complex) marketplace, rather than indicating a fundamental change in market perceptions regarding dollar soundness and U.S. creditworthiness.    Especially in the case of the dollar, a short squeeze was likely a powerful market dynamic.  It is worth noting that during the 2008 crisis the dollar index rallied from a low of about 71 to almost 90 – on its way back to about 75 by the end 2009.  The dollar closed today at about 84, down from the June high of 88.7.

I have offered the theory that the dollar and Treasurys benefited from the market perception that the U.S. enjoyed a post-Greece competitive advantage in reflationary policymaking.  While the markets were imposing harsh discipline on Greece – and increasingly on Portugal, Spain and all of Europe – our Treasury lavishly borrowed for several months at a few basis points and for 10 years at less than 3%.  I do believe the dollar and U.S. marketable debt have benefited from market faith that Washington’s unending capacity to borrow, spend and monetize will continue to support our market and economic recoveries. 

So, what’s it going to be?  Does the dollar win or lose from the unfolding environment?  Safe haven - or does the world’s newfound keen focus on structural debt issues put our currency, markets and economy at heightened risk?

Back in 2007, I found it ironic that the eruption of the subprime crisis was a catalyst for big rallies in agency debt and MBS.  As the great mortgage finance Bubble burst, the market flocked to fundamentally vulnerable mortgage-related debt instruments.  These securities, with their implicit or explicit federal guarantees, enjoyed safe haven status.  On the surface, much of the debt marketplace benefited, which seemed to suggest the underlying Credit foundation was sound.   Today, the Treasury, agency debt and MBS marketplaces lend support to the view that the U.S. is immune to global debt fears.  However, I would caution that, similar to 2007, dynamics below the market’s surface are creating systemic fissures.

U.S. junk and municipal debt markets were notable for lagging during this week’s rally in global risk assets.  In particular, the cost of protecting against defaults by some of our largest states remained stubbornly high.  The cost of California (310bps) and Illinois (332bps) CDS are significantly above the levels for Portugal (265bps) and Spain (213bps).  If I am correct that market focus is shifting from European to U.S. structural debt issues, I would expect our expansive municipal debt markets to become a key analytical focal point.  And the loss of Credit Availability for our marginal state and corporate borrowers would be a blow both to the U.S. recovery and the perception of the dollar as safe haven.

But what would a weakening dollar do for global reflationary forces?  Will the market reverse course and begin repricing commodities higher?  Would expectations for the emerging markets improve?  It is worth mentioning how well emerging debt markets have performed throughout this debt crisis.  Brazil dollar bond yields ended today at 4.54% and Mexico at 4.44%, just off of record low yields.  At this point, the emerging markets, in general, appear to have retained their robust inflationary biases.

And what about China and Asia?  If (and perhaps it’s a big “if”) global markets stabilize, I don’t think it will take much for sentiment to shift to a more constructive stance on near-term Chinese economic prospects.  Weak global markets – and the Chinese authorities’ move to somewhat rein in mortgage lending excesses – has engendered talk of real estate collapses and bursting Bubbles.  I’m content to stick with my view that the current “terminal phase” of Chinese Bubble excess can be expected to – as they tend to do – surprise both on duration and the scope of excesses.  Moreover, the global crisis may prove an impetus for Beijing erring on the side of further stimulus and Bubble accommodation. 

There is, indeed, another bearish Scenario possibility outside of deflationary collapse.  At least in the short-term, festering U.S. debt problems and a vulnerable dollar could create a backdrop conducive to a surprising counteroffensive from (thought dead and buried) global reflationary forces.  Stranger things have happened.