Archives

                 BEST OF DOUG NOLAND

I’ll admit to occasionally being annoyed by the clan over at Pimco. Clearly, there’s more than a little envy at work here. They are extremely smart, master market operators and skilled theoreticians. Those guys are really good at articulating the financial issue de jour, as well as backing it up with some reasonable-sounding solutions. But do they somehow not appreciate that they are part of the problem?

Pimco is – here we go again - the most vocal Wall Street proponent for strong reflationary policy measures and government interventions to battle so-called "deflation" risk. Back in 2002, they were the head cheerleader for reflationary measures that historians will surely view as a Monetary Policy Blunder for the Ages. Then, the deflation threat was said to reside with downside risk to the general price level; today it’s with sinking home prices. Overwhelming force is again prescribed to fight the latest symptoms, while sidestepping diagnosis of the underlying ailment…..

Some seven or so weeks ago the existing Financial and Economic Order was in perilous jeopardy. Wall Street-backed finance was collapsing, and this implosion was about to invalidate our system’s underlying debt structure as well as the structure of the underlying Bubble Economy. But the Federal Reserve and Washington policymakers stepped in with radical measures. These included the Federal Reserve’s guarantee of ample liquidity for the Wall Street firms and virtually limitless "marketplace liquidity" throughout, as well as explicit and implicit federal backing for much of our mortgage Credit system. It may not have appeared momentous to most, but it basically placed Federal Reserve and federal government backing on trillions of securities and market liquidity risk more generally. In Minsky terminology, these measures at least temporarily "validated" the existing structure of "Financial Arbitrage Capitalism."

Will policymaking succeed over the intermediate- and long-term? Not a chance. Policymakers do today retain capacity to convince the marketplace of their power to inflate the value of debt securities and asset prices more generally. But reflationary polices and other assurances will not rescue the system, specifically because there is today nothing to stem the ongoing distortions to the underlying real economy. Validating the current structure of Financial Arbitrage Capitalism simply perpetuates the same dysfunctional incentives that got us into this mess. It may in the short-term spur the necessary Credit growth to buoy household incomes, corporate cash-flows and profits, government revenues, and securities and asset prices – but it will add relatively little in the way of real economic wealth creating capacity. And, in the end, it’s only real economy fundamentals that will determine the soundness and sustainability of a system’s Credit and Financial Structures.

Additional non-productive debt growth will definitely not alleviate the Acute Fragility associated with "Ponzi Finance" Credit system dynamics. Additional non-productive debt growth will also not stabilize dollar devaluation, nor will it help in stabilizing myriad problems at home and abroad associated with our monstrous Current Account Deficits. Instead, any extension of this period of Financial Arbitrage Capitalism will ensure the prolonging of borrowing and consuming excess, the gross misallocation of resources, massive trade deficits, a ballooning international pool of unwieldy speculative finance, and even wilder Global Monetary Disorder.

Indeed, Washington’s validation of the current dysfunctional Credit system structure could very well lay the groundwork for extreme global price distortions, volatility, and social/political unrest. On the current course of things, it’s difficult for me to not think in terms of NASDAQ 1999 or subprime 2006. Throw additional liquidity on overheated Credit, inflationary, and speculative "biases" and be prepared for the spectacular. When Financial Arbitrage Capitalism’s excesses were spurring acute U.S. securities market inflation, the system enjoyed a period of perceived rising wealth to go with a boom in Wall Street securities issuance (helping somewhat to offset inflated demand). When this Structure’s excesses were directed at the Mortgage Finance Bubble, the upshots were inflating home prices along with attendant construction and consumption booms. Now, however, with acute inflationary effects prevailing throughout global markets for food, energy, and commodities, one should be prepared for the likes of problematic supply bottlenecks and shocks, hoarding, trade frictions and interruptions, and generally heightened geopolitical instability.

I argued back in 2002 that the overriding systemic issue was not "deflation" but rather myriad risks associated with an unfolding U.S. Credit Bubble. Now, some years later, these risks have expanded alarmingly, as runaway Credit Bubbles have ballooned both at home and abroad.

Doug Noland is a market strategist at Prudent Bear Funds. Their website is www.prudentbear.com.