I think Noland absolutely nails it this week. I was reading it thinking he left out a discussion of the dollar when he started talking about currencies. The only think he glosses over is housing, which admittedly is a big thing.
prudentbear.com
Reality Check:
The Fed is confused; Washington policymakers are confused; the markets trade confused; and pundits certainly speak as if they are confused. Truth be told, the current fixation on every word and nuance from the FOMC has become a farce - a mere heedless distraction from the critical financial/economic issues of the day. Clearly, the Fed lacks a policy/analytical framework other than mindlessly reciting its commitment to “fight inflation.” It’s institutional “brain” has been corroded by an extended period of concurrent relatively stable “core” inflation and extraordinary asset inflation, not to mention years of Greenspan obfuscation.
The Federal Reserve is simply not institutionally prepared for the unfolding challenging environment, although the same could be said for policymakers and the public generally. The Fed is left floundering in the shallowest of central banking, bereft of any substance as to the key underlying forces driving the economy, the markets and, increasingly, inflationary pressures. At the same time, the Fed’s benign neglect of Credit Bubble excesses is buttressed by the view from the White House to the Halls of Congress that domestic and international growth are the only avenues for rectifying imbalances. It’s quite dangerous dogma, yet the markets are happy to play along.
The Bernanke Fed today plays a dangerous game of sheep in wolf’s clothing, talking tough on (“core”) inflation while praying it can stay soft on excess. Highly speculative marketplaces at home and abroad savor in the gamesmanship. Markets recognize that the Fed will now talk the talk when speculative excess pushes the envelope, although they remain confident that the Fed will obediently retreat when markets come under sufficient pressure. Participants simply wait patiently for a signal from the Fed – as they believe they received yesterday – and get right back to their business.
I do read commentary that the Fed and global central bankers have been “withdrawing liquidity.” I don’t see it. For starters, the vast majority of global liquidity these days emanates from private-sector debt growth and securities leveraging. The Federal Reserve’s balance sheet has become virtually irrelevant to the global liquidity-creation process, and the Fed has not been selling securities to reduce liquidity in the system (and they would have to sell a large amount today to offset record Credit growth!). For central banks to actually “tighten” policy would require an overall global rate environment sufficiently restrictive to induce private borrowing and leveraging restraint. I’m still waiting.
The Fed does, however, hold a potentially powerful “stick” over the marketplace. It maintains the capacity to surprise the markets with more aggressive rate hikes, which would likely entail significant Credit market disruption and speculator de-leveraging. At times, this threat can be quite effective in dousing greed and instilling some fear in frothy global equity markets. But I believe it is important to differentiate this dynamic from the actual tightening of general liquidity conditions for markets and Credit systems. Credit markets are much better indicators of the prevailing liquidity backdrop than equities.
Not only might the Fed’s potential “stick” not cajole lenders and Credit market participants into restraint, it may very well even embolden them with the view that market turbulence will hold the timid Bernanke Fed at bay. Furthermore, the potential “stick” will lose much of its effectiveness over time. The Fed will be less willing to be seen as rattling markets, while inspirited market players will be much more willing to call the Bernanke Fed’s bluff. The stick loses its effectiveness come the perception that it will not be used. And the sophisticated players are definitely keen to Dr. Bernanke’s well-documented repugnance to “Bubble popping,” and they must today relish that initial missteps have spurred the new chairman to kowtow to the markets.
I feel compelled to remind readers of the abbreviated period between when the global Credit markets almost “seized up” in October 1998 and the historic Internet/technology Bubble of 1999/2000. To be sure, powerful inflationary biases had engulfed both the Credit system and the greater technology industry by 1998. But fearing market tumult, the Fed was unwilling to impose sufficient restraint. Speculative markets will invariably take full advantage. And it is worth noting that today’s inflationary biases are more powerful, broader and clearly global in scope, yet the Fed again appears Wedded to Interminable Acquiescence. For the most part, the markets are happy to pretend there is no inflation problem. Amazingly, a few pound the deflation drum as loud as ever.
So, if there were ever a time to step back, take a deep breath, and do a Reality Check - it’s right now. We all read and hear assertions that the Fed is overshooting and inflation is not a serious issue today and certainly won’t be a problem when economy slows (that for some time has been right around the corner when housing markets and consumption weaken). This is a myopic view certainly not atypical in the face of changing environments and key inflection points. It does, however, completely disregard a growing list of potentially momentous developments with respect to the future inflationary backdrop.
I suggest this evening that prospects for an unexpected upsurge in intermediate-term inflation risk is high due to an extraordinary confluence of major developments, including unfolding constraints on supply and rising global demand for energy and other commodities; spiraling healthcare costs, especially for baby-boomer retirees; various wars, including the ongoing “war on terror”; untenable government liabilities; and myriad issues related to global warming - to mention just a few. Unless the Credit system buckles, there are endless sources of demand for finance waiting in the wings, regardless of the housing market.
I certainly won’t be able to delve much below the surface on any of these issues this evening. Yet another week of extraordinary weather catastrophe should help convince a few more global warming fence-sitters. This week from President Bush: “I have said consistently that global warming is a serious problem. There’s a debate over whether it’s manmade or naturally caused. We ought to get beyond that debate and start implementing the technologies necessary to enable us to achieve a couple of big objectives: One, be good stewards of the environment; two, become less dependent on foreign sources of oil, for economic reasons as for national security reasons.”
No matter where readers stand on this regrettably contentious issue, I strongly suggest viewing Al Gore’s “An Inconvenient Truth.” The potential impact of global warming on our economy, financial markets and, most importantly, our lives is at this point simply too important to ignore or dismiss. The film lays out the issues clearly, and a thorough public debate – certainly directed by leading scientists - is much overdue.
The costs of life and property from a single storm can, as Katrina showed, be enormous. Much of this cost will be absorbed by government debt or, more aptly stated, “monetized.” The cost to repair and maintain our gulf energy infrastructure has been and will likely remain enormous on an ongoing basis. Meanwhile, the insurance industry lacks the wherewithal to deal with major weather disasters that could now become “routine”, so the burden will largely fall upon additional government debt issuance. And we are already seeing the surging price of insurance along the coasts, although the much greater potential costs associated with climate change will remain impossible to quantify. As an aside, the warmest Dallas winter on record forced us to run air conditioning throughout the “cold” season, and we now watch the local corn crop succumb to a problematic drought.
Much more problematic than the SUV predicament, millions of super-sized homes have been built in some of the hottest climates. It will now be a case of waiting to see the scope of the financial burden necessary to keep homes and business sufficiently cool. We are already seeing the effects of surging energy costs on the pattern of consumer spending, and it is not out of the question that the economic viability of certain cities (Las Vegas and Phoenix come to mind) could be threatened in the event of a major energy shortage/price spike. The availability of sufficient water will surely become an issue for the Southwest U.S. and elsewhere.
June 26 – Bloomberg (Saijel Kishan and Madelene Pearson): “Jean-Marie Messier lost billions of euros turning the world’s biggest water company into entertainment conglomerate Vivendi Universal SA. He should have stuck with water. The lack of usable water worldwide has made it more valuable than oil. The Bloomberg World Water Index of 11 utilities returned 35 percent annually since 2003, compared with 29 percent for oil and gas stocks and 10 percent for the S&P 500 Index. From hedge fund manager Boone Pickens to buyout specialist Guy Hands, the world’s biggest investors are choosing water as the commodity that may appreciate the most in the next several decades.”
At this point, it appears certain that we are in the early stages of an enormous spending boom to deal with the rapidly changing energy and climate backdrop. The scope of the required research and development could be unprecedented. The investment boom throughout the energy and alternative energy sectors appears poised to rival (and likely exceed) the technology boom. The auto companies will need to gear up to develop and sell smaller, more fuel efficient and cleaner automobiles. Across the board, businesses will be forced to be more energy efficient. Scores of new companies will seek to profit from new opportunities in what could easily end up overshadowing the telecom/Internet Bubble.
Yesterday in an article by Bloomberg’s Edward Robinson: “SolFocus sounds like a typical Silicon Valley startup: Eight employees, big ideas -- and zero profit. Yet in mid-May, the phones at the eight-month-old company wouldn’t stop ringing. The callers were venture capitalists, and they were dangling millions of dollars in front of the Palo Alto, California-based solar panel maker. Ty Jagerson, vice president of business development, says as soon as he’d start talking to one VC, another would call offering money. ‘It was completely insane,’ Jagerson, 35, says. Up and down Sand Hill Road, the venture capital hub south of San Francisco, the financiers who bankrolled the technology boom of the 1990s are chasing their next big thing: alternative forms of energy… VCs haven’t buzzed like this since the Internet captured investors’ imaginations in the 1990s.”
“Ernest Moniz, co-chairman of the Energy Research Council at Massachusetts Institute of Technology, which is researching noncarbon-based energy sources, says the world must come to grips with its appetite for energy and the environmental havoc being wrought by fossil fuels. There’s no time to waste, he says. ‘These are huge issues that have to be grappled with. We’re talking about a transformation of the global energy infrastructure over the next few decades.’”
If this view proves correct – “a transformation of the global energy infrastructure over the next few decades” – it will prove one very tall order for global economies and Credit systems, especially ours due to the U.S.’s insatiable appetite for more energy than we can produce as well as the reality that our overheated Credit system is already severely bloated with mortgage debt. For now, it is safe to assume that the current investment boom in ethanol, biodiesel, solar, geothermal, solar, nanotechnologies, oil and gas exploration, and myriad other energy, environmental and conservation technologies create an almost endless source of demand for financial, human and natural resources. And, importantly, for now the Credit system is able and willing to finance this boom.
Yes, vulnerable Credit systems could falter and the potential for systemic debt dislocation should never be ruled out. But to dismiss what today appears the likely probability of an ongoing massive energy/climate-related borrowing and spending binge is unwise. As a witness to the resurgent Texas housing market and economy, I am willing to suggest that the energy boom is already underpinning income growth that is underpinning inflated housing markets. Clearly, there is a powerful inflationary bias that permeates the expansive energy and energy-related technology arenas that is poised to strengthen as long as finance is forthcoming.
When I contemplate the future, I see a U.S. economy that will have no option other than massive restructuring. As an economy, it appears today that we will have little alternative than to consume significantly less oil, produce much more of various types of energy domestically, use energy much more efficiently and cleanly, consume fewer imports, and produce more manufactured goods for domestic consumption and export. This will entail a radical shift away from the service sector to the more arduous (and surely less “productive”) task of producing real things. Again, this is all a very tall order, even without devastating natural and man-made disasters.
Such a massive economic endeavor would require enormous resources – natural, technological, human and financial. Until I see something to alter my view, I would expect such a huge undertaking to entail great dislocation and pack quite an inflationary punch. This radical change in the nature of spending and investment will ensure that wide swaths of our current economy become uneconomic (and depressing for many). At the same time, the new patterns of the flow of finance will strain limited resources and greatly disturb prevailing pricing dynamics. There will be no alternative to massive government deficits at all levels, and I would expect the federal government will have no viable option other than to guarantee significant amounts of private sector debt (similar to what Fannie and Freddie have done in household mortgages). In such a scenario, we should expect the Federal Reserve and Congress to take extraordinary measure to underpin the Credit market on national security grounds openly stated or otherwise.
And if energy and other resources become in such short supply globally, long-term inflation forecasts must also consider the likelihood of more and larger military confrontations. These would be inflationary, just as the “war on terror” and wars in Iraq and Afghanistan are today.
I have read the argument that Credit Bubbles always end deflation. This is factually inaccurate, and we can look to Argentina and Indonesia as recent examples of bursting Bubbles and the inflationary havoc wrought by collapsing currencies. Any thoughtful prognostication with respect to the future course of inflation must incorporate a view of the dollar’s prospects, as well as global currencies generally. Currency values are always relative, and we’ve already witnessed over the past two years how inflating (devaluing) foreign currencies can stabilize the nominal value of the dollar. We’ve also seen how concerted currency debasement can have a striking impact on oil and commodity prices.
With a structurally maladjusted, energy glutton, and import-dependent “services” economy, along with an overheated Credit system and massive prospective government deficits, one can easily envision the dollar as a structurally weak currency for years to come. And I certainly expect China and Asia to face similar inflationary pressures, ensuring an inflationary bias for imported energy and goods prices for some time.
The least unfavorable course today would be to impose a meaningful slowdown on the highly imbalanced and overheated U.S. economy, setting the stage for a major redeployment of resources. Ironically, a U.S. recession is today seen as absolutely unacceptable, with policymakers (including our new Treasury Secretary) espousing the notion that the U.S. and our trading partners can grow our way out of imbalances. We need Washington to step back - do a Reality Check - and come to the recognition that the current global financial and economic boom is very much the problem and not the solution. I won’t hold my breath. I also won’t be lining up to buy U.S. bonds anytime soon. |
