<blockquote>'
From my analytical perspective, we’re in the midst of history’s greatest and most perilous financial Bubble. And I am beside myself that nobody in a position of influence seems to care. We’ve witnessed momentous analytical and policy errors over the years – and these blunders are allowed to repeat themselves without thorough analysis and review. All this talk about fighting deflation and helping Main Street misses the point – and only feeds the Bubble. I’m fed up with ideology trumping sound analysis.
Why is there no consensus recognizing that the number one priority must be to protect the soundness of our government debt market – the heart of contemporary “money.” For me, talk emanating from bond fund managers about how to help the average guy rings hollow. It is fundamental to our nation’s future that we stabilize the government debt Bubble and secure the integrity of our monetary system. The chorus of calls for larger deficits and greater Fed monetization is fueling distortions that risk financial calamity.
...
As the great German economist Dr. Kurt Richebacher was fond of saying, “The only cure for a Bubble is not to allow it to inflate.” Regrettably, there is little government policymaking can do in the short run to improve the situation. There is, however, a great deal policymakers are doing to make a bad situation worse. The current backdrop – certainly impacted by the Greek debt crisis, related market tumult and a faltering U.S. recovery – has created an elevated risk of further policy mistakes.
A multi-decade Credit Bubble badly distorted our economy’s underlying structure. The harsh reality is that this structural maladjustment can only be rectified gradually over a period of many years. There’s just no quick fix. Ongoing massive fiscal and monetary stimulus only exacerbates our economy’s ills. Moreover, it risks an inevitable crisis of confidence in our debt markets and monetary system.
The economy is muddling through right now. It’s frustrating and discouraging but, under the circumstances, this is about the best we could have hoped for. I am increasingly troubled by the direction (and tone) of economic analysis and policy discussion. All the inflationism histrionics, including the notion that the Fed and Congress are committing a dereliction of duties by not stimulating more aggressively, are unhelpful. Describing fiscal policy as increasingly “austere” is ridiculous. But mostly, calls for the (un-independent) Federal Reserve to monetize a massive federal spending plan are as irresponsible as they are dangerous.'</blockquote>
Let's Change the DebateBy Doug Noland
August 20, 2010
SourceAugust 19 – Bloomberg (Laura Litvan): “The U.S. Congressional Budget Office predicted the budget deficit for fiscal year 2011 will be $1.066 trillion, revised up from an estimate of $996 billion in March… CBO Director Doug Elmendorf said the agency’s projections haven’t changed significantly since its March forecast… ‘Unfortunately, this is a case where no news is not good news,’ Elmendorf said. ‘The country faces serious budget problems and serious economic problems.’ …The CBO said… the deficit for the current fiscal year ending Sept. 30 will be $1.34 trillion. That is 9.1% of GDP, or the second largest shortfall in the past 65 years, exceeded only by last year’s 9.9%.”
August 19 – MarketNews International (John Shaw): “Congressional Budget Office director Doug Elmendorf said… his agency’s new fiscal report may ‘significantly underestimate’ the nation’s short-term deficit outlook because of the requirements of budget estimating. …Elmendorf emphasized that under budget law the CBO must make its baseline estimates by assuming that current tax and spending laws are unchanged. He added the U.S. fiscal outlook would be ‘quite different’ if other, arguably more plausible, assumptions were made. …‘This is an extraordinarily high level of debt’ when viewed in the context of American history, he said…”
“It’s important to be a diplomat for the diplomatic corps, it’s not so important for a central bank. I think it’s very important for central banks to be clearly focused and also, if necessary, to deliver undiplomatic messages to governments.” Bundesbank President Axel Weber, August 20, 2010 (interviewed by Bloomberg)
Push the inflation/deflation debate to the backburner. The critical issue these days is whether global debt markets have succumbed to Bubble Dynamics. Are investors and speculators, once again, participating in a historic bout of (Hyman Minsky) “Ponzi Finance”? Is flawed policymaking fomenting yet another dangerous speculative Bubble and period of deepening economic maladjustment? Are central bankers and markets accommodating history’s greatest expansion/inflation of non-productive government debt?
As an analyst who has for some time been warning of mounting risks associated with a Global Government Finance Bubble, it now seems obvious that the situation has taken a decided turn for the worst: Bubble Dynamics have become more entrenched and dangerous, while policymaking has reached the precipice of outright failure.
There reaches a point in the evolution of a Credit Bubble where things really begin to get out of hand; the “terminal phase of excess.” If policymakers fail to act forcefully to rein in “terminal” government borrowing excesses, they will be held hostage to escalating risks from an out of control Bubble (think mortgage finance Bubble 2005/’06). There would be no turning back. A consensus view is taking shape that would amount to the worst-case policy scenario from a Credit Bubble analysis perspective.
Some claim (reminiscent of views held back in 2002) that “fat tail” deflation risk is the critical issue. They argue forcefully for more extreme inflationary policymaking – larger deficits and additional Federal Reserve monetization. With inflation now effectively out of the picture, they believe the only policy risk is a lack of resolve for inflating/stimulating sufficiently. There is increasing contempt and ridicule directed at the Fed, Administration and Congress for not stimulating more aggressively.
Some argue that the Federal Reserve has a profound duty to balloon its balance sheet by monetizing Treasury debt. They state that the Fed has a profound duty to sacrifice its independence, as it works in concert with extreme fiscal measures to eliminate deflation risk. This is no more than New Age theorizing and experimental policymaking lacking of any historical basis of support. It is, at the same time, a skillfully sophisticated version of age-old inflationism propaganda and monetary quackery.
Nowhere from this (“inflationists”) camp do we see any recognition of the potentially catastrophic Bubble that – after years of migrating from one market to the next - has finally found its home right in the heart of our monetary system. Indeed, the inflationists have deep disdain for Bubble analysis. They write off the mortgage finance Bubble as a housing boom led astray by one-off failures in underwriting standards and supervision. Such analysis ignores the key policy, monetary, and global market dynamics that only a few years ago were allowed to destroy the creditworthiness and market confidence in our system’s (non-government guaranteed) mortgage Credit (almost bringing down the global financial system).
I have posited that the 2008 bursting of the mortgage/Wall Street finance Bubble unleashed an even bigger (“mother of all…”) Bubble throughout global fixed-income marketplaces. I trace today’s Bubble back at least to the Greenspan Fed’s 1987 post-crash systemic reliquefication. Resulting late-eighties’ excess led to severe early-90’s banking system impairment; followed by an another aggressive monetary policy response; the 1992/93 bond market Bubble; the 1994 bond bust and Mexican crisis; expanded monetary largess; the South East Asian Bubbles and collapses; additional policy accommodation; the Russian and LTCM fiascos; more extreme monetary stimulus; the resulting technology Bubble; and historic monetary stimulus and reliquefication leading to the mortgage/Wall Street Bubble. Recent history of monetary disorder fueling serial boom and bust cycles is unequivocal.
From my analytical perspective, we’re in the midst of history’s greatest and most perilous financial Bubble. And I am beside myself that nobody in a position of influence seems to care. We’ve witnessed momentous analytical and policy errors over the years – and these blunders are allowed to repeat themselves without thorough analysis and review. All this talk about fighting deflation and helping Main Street misses the point – and only feeds the Bubble. I’m fed up with ideology trumping sound analysis.
Why is there no consensus recognizing that the number one priority must be to protect the soundness of our government debt market – the heart of contemporary “money.” For me, talk emanating from bond fund managers about how to help the average guy rings hollow. It is fundamental to our nation’s future that we stabilize the government debt Bubble and secure the integrity of our monetary system. The chorus of calls for larger deficits and greater Fed monetization is fueling distortions that risk financial calamity.
The Treasury Department’s conference this week on housing finance overhaul epitomizes the dysfunctional backdrop. These days, Fannie, Freddie, Ginnie, the FHA, etc. ensure that mortgage borrowing costs are quite low and mortgage Credit reasonably available. The mortgage market has already essentially been nationalized, and the GSEs are an unmitigated financial black hole. Enough already. Yet policy proposals are presented including a massive refinancing of current mortgages to reset at today’s historic low rates. The idea seems impractical. Yet such notions – proving that there are no longer any bounds on policy reasonableness or government intrusion – along with the possibility for a tsunamis of mortgage refis throw additional weight upon the Treasury yield collapse, while spurring general market instability (and big profits for those on the right side of the trade).
The U.S. housing mania was historic - and it’s over. Mortgage Credit will not provide a meaningful source of system Credit expansion for some years to come. This post-Bubble reality is misdiagnosed as “deflation.” As we’ve already witnessed, even enormous fiscal and monetary stimulus does little to incite mortgage borrowing. Just as post-tech Bubble reflation bypassed the technology sector in favor of inflating mortgage Credit, the MBS marketplace, and housing prices, today’s reflationary forces flow vigorously to government (and related) debt markets.
I found it interesting that hedge fund legend Stanley Druckenmiller announced his retirement this week, ending an incredible 30-year run in hedge fund management. And today’s New York Times ran a story highlighting the ongoing difficulties suffered by the “quant” hedge funds. Massive government stimulus may be benefiting bond fund managers, but it’s certainly not improving the overall functioning of the financial markets. I would not be surprised if sophisticated market operators such as Mr. Druckenmiller look at the current backdrop and are content to exit the game before the bloody havoc of the next bursting Bubble.
As the great German economist Dr. Kurt Richebacher was fond of saying, “The only cure for a Bubble is not to allow it to inflate.” Regrettably, there is little government policymaking can do in the short run to improve the situation. There is, however, a great deal policymakers are doing to make a bad situation worse. The current backdrop – certainly impacted by the Greek debt crisis, related market tumult and a faltering U.S. recovery – has created an elevated risk of further policy mistakes.
A multi-decade Credit Bubble badly distorted our economy’s underlying structure. The harsh reality is that this structural maladjustment can only be rectified gradually over a period of many years. There’s just no quick fix. Ongoing massive fiscal and monetary stimulus only exacerbates our economy’s ills. Moreover, it risks an inevitable crisis of confidence in our debt markets and monetary system.
The economy is muddling through right now. It’s frustrating and discouraging but, under the circumstances, this is about the best we could have hoped for. I am increasingly troubled by the direction (and tone) of economic analysis and policy discussion. All the inflationism histrionics, including the notion that the Fed and Congress are committing a dereliction of duties by not stimulating more aggressively, are unhelpful. Describing fiscal policy as increasingly “austere” is ridiculous. But mostly, calls for the (un-independent) Federal Reserve to monetize a massive federal spending plan are as irresponsible as they are dangerous.
An increasing weight of evidence supports the global government finance Bubble thesis. But, of course, there’s nothing like the euphoria associated with rapidly inflating asset prices (in this case bonds) to embolden those dismissive of Bubble analysis. All the more reason that it is imperative that we not ignore this Bubble as we did the mortgage/Wall Street finance Bubble. The risks and costs today are infinitely greater.