'As painful as this process will become, and as deeply distressing it will be to see so many hopes, dreams and expectations crushed, the Powell Fed is taking the best approach. The Bubble would have inevitably burst. Indeed, the global Bubble has been deflating since earlier in the year. That the U.S. “Terminal Phase” of Bubble excess continued even as the global Bubble faltered created a perilous divergence that would end badly. It’s ending now - badly. The miserable downside would have only been worse had the Fed stepped in, bolstered the markets once again and extended the “Terminal Phase.”''I’ve always had serious issues with central banks promoting the perception that they would eagerly backstop market liquidity. Liquidity is a fundamental market risk – that can’t be permanently transformed, transferred or mitigated. It’s a precarious proposition to promote the belief that contemporary central banks - with unlimited capacity to create liquidity - will do “whatever it takes” to ensure highly liquid markets. Nevertheless, it’s an extreme challenge to convey to market participants, central bankers, politicians and the general public why central banks aggressively underpinning the markets over the long-term promotes pernicious instability for the markets, real economies and humanity more generally.
The implicit “Fed put” seemed so innocuous when things looked good – so long as the Bubble was inflating. For going on a decade, Bubble Analysis has appeared a pathetic waste of time. Suddenly, cracks appear, confidence wanes, liquidity disappears, credit falters - and ramifications are anything but subtle: so much teeters on the markets’ perception of the efficacy of central bank market backstops. The world today hangs in the balance – markets, economies, politics and geopolitics. One of the greatest risks associated with the global government finance Bubble has been a crisis of confidence in policymaking.
It was inevitable the “Fed put” would turn problematic. The more explicit central backstops become, the more market distortions promote self-reinforcing speculative excess and Bubbles. The greater the scope of Bubbles, the more deeply manic markets become convinced that central bankers won’t allow the good times to end. Importantly, speculation and leverage will invariably expand beyond the expected capacity of liquidity backstops. This is why “whatever it takes” and “QE infinity” were so reckless. There became essentially no degree of excess that troubled the marketplace. It degenerated into a complete malfunctioning of the market mechanism.
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As painful as this process will become, and as deeply distressing it will be to see so many hopes, dreams and expectations crushed, the Powell Fed is taking the best approach. The Bubble would have inevitably burst. Indeed, the global Bubble has been deflating since earlier in the year. That the U.S. “Terminal Phase” of Bubble excess continued even as the global Bubble faltered created a perilous divergence that would end badly. It’s ending now - badly. The miserable downside would have only been worse had the Fed stepped in, bolstered the markets once again and extended the “Terminal Phase.”
It would have been the easy decision for Powell to just pull a Greenspan, Bernanke or Yellen. Just give the markets what they want and silence the temper tantrum. The three preceding Fed chairs invariably acted in the interest of sustaining or resuscitating Bubble Dynamics. In my view, at least two of the three seemed preoccupied with their own reputations and legacies.'
- Doug Noland,
Powell Federal Reserve Lowers “Fed Put” Strike Price, December 22, 2018
'The Bubble has burst – the greater global Bubble, the Bubble in leveraged lending, and Bubbles across asset classes around the globe. In the case of leveraged loans, I don’t expect another bout of QE to resuscitate Bubble Dynamics. Excess within this market, similar to so many, went to parabolic extremes. Risk misperceptions went to extremes; lending terms to extremes; and speculation to extremes. Now the downside.''Proponents of central bank stimulus operations take a sanguine view. They note that the ECB joined the global QE party late (2014). Truth be told, the ECB and global central banks are a full decade into their exalted monetary experiment. Let’s not forget Draghi’s “whatever it takes,” along with the ECB’s 2012 “Outright Monetary Transactions" program (OMT). Then there was 2011’s “Long-term Refinancing operations (LTRO),” where the ECB lent $640 billion directly to eurozone banks (liquidity in many instances used to buy government bonds). And back in 2010, the ECB adopted their “Securities Market Program.” All told, the ECB’s balance sheet expanded from a pre-crisis $1.5 TN to almost $4.7 TN.
Proponents proclaim a decade of central bank stimulus has proven a tremendous success. They would point first to stock, bond and asset markets more generally. I view the same markets and see acute instability and fragility. I believe a decade of monetary stimulus has exacerbated financial, economic, social, political and geopolitical instabilities. This will surely be debated for decades to come.
Credit is a financial claim – an IOU. New Credit creates purchasing power. Credit is self-reinforcing. When Credit is expanding, the creation of this new purchasing power works to validate the value of Credit generally. In general, new Credit promotes economic activity, both spending and investment, in the process promoting higher incomes. Credit expansions fuel higher price levels throughout the economy, including incomes, real estate, stocks and bonds. Higher perceived wealth stimulates self-reinforcing borrowing, spending and investment.
Traditionally, bank lending for business investment was a prevailing mechanism for finance to enter into the economic system. There were various mechanisms that worked to contain Credit expansions, including the gold standard and disciplined monetary regimes. As important, there were traditions against deficit spending, running persistent trade deficits and profligacy more generally. Moreover, there were bank reserve and capital requirements that placed constraints on lending and financial excess. In short, there was a limited supply of “money,” with excessive borrowing demands pressuring interest rates higher. There was certainly cyclicality, but systems tended toward adjustment and self-correction.
It’s not only the decade-long experiment with QE (with ultralow rates) that makes contemporary finance unique in history. As the key source of additional system “money” and Credit, banks and business investment were some time ago supplanted by market-based finance and leveraged securities/asset purchases. Contemporary (“digitalized”) finance expands virtually without constraint.
Meanwhile, finance entering the system to speculate on higher asset prices creates a very different dynamic than back when bank loans were financing capital investment. Excessive borrowing and investment placed downward pressure on profits, in the process reducing the incentive to borrow, invest and lend. In contrast, a system of unfettered “money” and Credit financing asset prices is acutely unstable. Expanding finance leads to higher asset prices and only greater impetus to borrow and speculate.
Going on a decade now, I’ve been chronicling the “global government finance Bubble.” It has not been ten years of systemic smooth sailing. History’s greatest Bubble stumbled in 2011 on fears of the Fed’s “exit strategy.” The Fed quickly backed off – and then proceeded to double its balance sheet again by 2014. Europe tottered badly in 2011 and 2012, inciting “whatever it takes” and a reckless ECB balance sheet gambit. Fed, ECB and global central bank liquidity stoked a historic boom throughout the emerging markets. China’s epic Bubble, pushed into overdrive with aggressive global crisis-period stimulus, inflated uncontrollably. All of it almost came crashing down in late-‘15/early-’16. But the Chinese adopted more stimulus, the ECB and BOJ boosted QE, and the Fed postponed “normalization.”
I believe the world over the past two years experienced a momentous speculative blow-off – in stocks, bonds, corporate Credit, real estate, M&A, art, collectibles, and so on. I would further argue that speculative melt-ups are quite problematic for contemporary finance. Surging asset prices spur rapid increases in speculative Credit, unleashing new self-reinforcing liquidity/purchasing power upon markets, financial systems and economies around the globe. The problem is it doesn’t work in reverse. The greater the price spikes, the more vulnerable markets become to destabilizing reversals. De-risking/deleveraging dynamics then see a contraction of speculative Credit, leading to problematic self-reinforcing destruction of marketplace liquidity.
As inflationism has demonstrated throughout history, QE was always going to be a most slippery slope. The notion of inflating risk asset markets with central bank liquidity has to be the most dangerous policy prescription in the sordid history of central banking. And, importantly, the longer central bankers held to this policy course the deeper were market structural distortions. Rather than attempting to rectify crucial flaws in contemporary finance, central bankers chose inflationism and market backstops as stabilization expedients. This was a monumental mistake.
The expansion of central bank balance sheets ensured a parallel expansion in global speculative leverage. Over time, there was an increasing multiplier effect on each new dollar/yen/euro/etc. of central bank “money.” The original Fed QE “money” program basically accommodated speculative deleveraging. In contrast, the past few years (in particular) incited an aggressive expansion of speculative leverage throughout global securities and asset markets.
In addition, the parabolic increase in central bank liquidity over recent years was instrumental in the parabolic ballooning of ETF assets and passive investment funds more generally. While not “leverage” in the conventional sense, the enormous growth in ETF/passive funds and associated risk misperceptions have amounted to a historic market distortion. Trillions flowed into risky stocks, bonds, corporate Credit, EM assets and derivative structures believing that these fund shares were a liquid store of (nominal) value. The phenomenon of perceived money-like ETF shares was integral to the global risk market speculative blow-off.
The problem with speculative blow-offs is that they inevitably reverse. Upon the reversal, the seriousness of the problem is proportional to the amount of underlying leverage, the degree of market misperceptions and the scope of associated market and economic structural maladjustment. The world now confronts one hell of a problem.
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The Bubble has burst – the greater global Bubble, the Bubble in leveraged lending, and Bubbles across asset classes around the globe. In the case of leveraged loans, I don’t expect another bout of QE to resuscitate Bubble Dynamics. Excess within this market, similar to so many, went to parabolic extremes. Risk misperceptions went to extremes; lending terms to extremes; and speculation to extremes. Now the downside.
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It was a timely reminder of how deeply Bubble Dynamics have permeated the marketplace. I would argue that some of the greatest excesses have unfolded in perceived low-risk sectors and strategies, certainly including the “defensive” healthcare space. Perceived low risk became a risky Crowded Trade. In the unfolding bear market, there will likely be few places to hide.
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I don’t want to imply that resurgent Chinese Credit growth and/or even a more dovish Fed wouldn’t matter. I just believe at this point the bursting global Bubble is increasingly beyond resuscitation. A bold statement, I fully appreciate. But Fear is rapidly supplanting greed in “Core” U.S. securities markets. The “Core” has seen de-risking/deleveraging dynamics attain important momentum. Latent “Core” fragilities are being exposed. And the further the global Bubble deflates, the greater the scope of monetary stimulus required to re-energize broad-based securities market inflation. I fully expect more QE. But it will come in a crisis backdrop. I’ll presume the first few Trillion or so will, at best, accommodate deleveraging.'
- Doug Noland,
The Perils of Inflationism, December 15, 2018
'..Why do I have the feeling I’ll be using Q3 2018 Z.1 data for Household Net Worth (along with both Equities and Total Securities to GDP, etc.) as THE Cycle Peak for years (decades?) to come?''There are many aspects of the unfolding downturn that go unappreciated. I worry about deep economic structural maladjustment. How many thousands of uneconomic enterprises have propagated from all the easy finance and surging asset prices? I have deep concern for Silicon Valley. If the unfolding trade and cold war with China wasn’t enough, they’re about to get the rug pulled out from under them by the financial markets. How much perceived wealth will be lost in a bursting Bubble of inflated technology shares and private business equity, compounded by a deflating Bubble in wildly inflated real estate prices surrounding the tech hubs? I fear a complete lack of understanding and preparation.
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A dollar break would really catch the speculator community (and investors) positioned poorly. It’s reached the point that NOTHING can be taken for granted in these chaotic financial markets. Which portends something really important: ongoing pressure to de-risk and deleverage. Why do I have the feeling I’ll be using Q3 2018 Z.1 data for Household Net Worth (along with both Equities and Total Securities to GDP, etc.) as THE Cycle Peak for years (decades?) to come?'
- Doug Noland,
Q3 2018 Z.1 and THE Cycle Peak, December 8, 2018
Context (Banking Reform - English/Dutch) '..a truly stable financial and monetary system for the twenty-first century..'What’s Wrong With the 2 Percent Inflation Target - By Paul VolckerPaul Volcker, at 91, Sees ‘a Hell of a Mess in Every Direction’'..Once interest rates hit zero, so did the collective IQ of Wall Street.''..the inanity of monetary policy today..''..The Quest for Sound Money and Good Government..' - '..the Fed's total incompetence in understanding inflation..''..global central bankers .. history's most reckless monetary mismanagement .. Harsh geopolitical fallout is unavoidable..''..the Netherlands and Denmark best placed with A-Grade world class retirement income systems with good benefits..'