<blockquote>'Bubbles tend to be varied and complex. In their most basic form, I define a Bubble as a self-reinforcing but inevitably unsustainable inflation. This inflation can be in a wide range of price levels – securities and asset prices, incomes, spending, corporate profits, investment and speculation. Such inflations are always fueled by some type of underlying monetary expansion – typically monetary disorder. Bubbles are always and everywhere a Credit phenomenon, although the underlying source of monetary fuel often goes largely unrecognized.
I’ll posit another key Bubble Dynamic: De-risking/de-leveraging at the Periphery is problematic, with a propensity for risk aversion and associated liquidity constraints to spur contagion effects. At the Core, de-risking/de-leveraging becomes highly destabilizing. Indeed, I would strongly argue that de-leveraging at the “Core of the Core” is tantamount to financial crisis.
It is the “Core of the Core” that now concerns me the most. That is where Federal Reserve (and global central bank) policies have left their greatest mark. It is at the “Core of the Core” where momentous misperceptions and market mispricing have become deeply entrenched. It’s the “Core of the Core” that has attracted enormous amounts of “money” over recent years. It’s also here where I believe leverage has quietly been used most aggressively. Over recent years it became one massive Crowded Trade. Now the sophisticated players must contemplate beating the unsuspecting public to the exits.
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Returning to “Core of the Core” analysis, investment-grade corporate debt has rather abruptly joined the market turmoil. After a rocky first week of 2016, investment-grade debt spreads widened again this week to a three-year high, as investment-grade funds suffered their eighth straight week of outflows.
“Triple A” MBS occupied the mortgage finance Bubble’s “Core of the Core”. GSE securities were perceived as “money”-like (“Moneyness of Credit”), with implied backings from the Treasury and Fed seemingly guaranteeing safety and liquidity. Throughout the global government finance Bubble period, I have often invoked the concept “Moneyness of Risk Assets.” With the Federal Reserve and global central banks determined to do just about anything to uphold booming securities markets, the marketplace perceived that safety and liquidity were virtually ensured. Trillions flowed into global stock and bond mutual funds, the majority into perceived low-risk U.S. equities indexes and investment-grade corporate debt products.
It is worth recalling that my tally of Total U.S. Securities (Treasuries, Agencies, Corp Bonds, Munis and Equities) ended Q2 2015 at a record $76.924 TN, or 429% of GDP. This was up $30.90 TN (77%) from 2008’s $46.034 TN (313% of GDP) – and greatly exceeded 2007’s $53.279 TN (368% of GDP).
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The bottom line is that Bubbles destroy and redistribute wealth, though the true effects are masked for a while by inflated securities and asset markets – along with resulting unsustainable spending patterns and economic activity. Regrettably, years of policy mismanagement, gross financial excess, deep structural maladjustment and the most imbalanced economy in our nation’s history will now come home to roost. At this point, I cannot confidently forecast how quickly the bust will unfold. I do, however, believe this process has begun as Bubbles falter at the “Core of the Core.” '
- Doug Noland,
Cracks at the Core of the Core, January 16, 2016</blockquote>
'If the Fed can’t accurately forecast the economy, can anyone?<blockquote>'Actually, I’m going to spend the first few pages demonstrating that the mathematical models used to forecast GDP and all sorts of interesting economic events are basically nonsense.
For me, forecasting the year ahead is somewhat like being an explorer who comes to the top of a high new mountain pass along with a group of his friends and looks far out in the distance and sees another mountain pass, shrouded in clouds but offering the promise that it’s possible to continue the journey. It is clear to him that they should all forge ahead to find a way to that next mountain pass, but between his location and his destination lie all manner of unknown geographical features, not to mention the prospect of unfriendly natives who may want to contest their passage.
So today, as we crest the mountain pass of a new year, I will look off in the distance and tell you what I see. Let me be clear, though, that I’m not coming back from the future and telling you what it’s like; I am merely hoping to get our general direction right. Some years the path ahead seems remarkably straightforward and clear of obstructions. I can tell you right now that this year the challenges seem particularly fog-shrouded. But what’s an explorer to do but to press ahead?
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If the Fed can’t accurately forecast the economy, can anyone? Surely someone in the federal government has better answers.
The Congressional Budget Office issues forecasts much as the Federal Reserve does. And like the Fed, the CBO grades itself. You can see for yourself in “
CBO’s Economic Forecasting Record: 2015 Update.”
Read that document, and you will find the CBO readily admitting that its forecasts bear little resemblance to reality. Their main defense, or maybe I should say excuse, is that the executive branch and private forecasters are even worse.
I’m not kidding. The CBO report includes the following chart. I removed other categories they measure so we can look specifically at their GDP estimates. I should also point out that they cooked the books a little by averaging two-year forecasts to make themselves look better. But even so…
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Central banks tell us that they know when to raise or lower rates, when to resort to quantitative easing, when to end the current policies of financial repression, and when to shrink the bloated monetary base. However, given their record at forecasting,
how will they know? The Federal Reserve not only failed to predict the recessions of 1990, 2001, and 2007; it also didn't even recognize them after they had
already begun. Financial crises frequently happen because central banks cut interest rates too late or hike rates too soon.
The central banks tell us their policies are data-dependent, but then they use that data to create models that are patently wrong time and time again. Trusting central bankers now, whether in the US, Europe, or elsewhere, is a dicey wager, given their track record. Unfortunately, the problem is not that economists are simply bad at what they do; it's that they're
really, really bad. They're so bad that their performance can’t even be a matter of chance.
The reason is that they base their models on flawed economic theories that can only represent at most a pale shadow of the true economy. They assume they can use what are called dynamic equilibrium models to describe and forecast the economy. In order to create such models they have to make assumptions – and when they do, they assume away the real world.
It is not so much that the models I am criticizing are useless – they can offer economic insights in limited ways – but they cannot be (successfully) used to predict the economy or stock markets with anything close to certainty. They are simply not complex enough – and they cannot be made complex enough – to accurately describe the nonlinear natural system that is the economy.
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If I were a young and mathematically gifted economist, I think I would explore the use of complexity theory to model the economy, based not on Keynesian nonsense or the hubristic assumption that an economy can ever be in a state of equilibrium (it can’t), but using Claude Shannon’s information theory instead as a better way to demonstrate how economics works in the real world (an idea brilliantly suggested by George Gilder in
Knowledge and Power).'
- John Mauldin,
Economicus Terra Incognita, January 10, 2016</blockquote>
Context<blockquote>
'..recessions are not primarily driven by weakness in consumer spending..''..Like monetarists, Keynes held no capital theory .. the role time plays..' - Jesús Huerta de Soto</blockquote>