From Doug Noland:
I believe the widespread perception that policymakers are prepared to bolster the boom - and will definitely not tolerate a bust - is an integral factor associated with major (throw caution to the wind) Credit System “Blow-offs.” And, as we have all witnessed, the more encompassing the effects of asset inflation and speculation, the more cowering policymakers become with respect to reining in excesses. Importantly, the confluence of late-cycle general Risk Embracement, lending and speculating excess, buoyant asset prices and (inflationary) boom-time economic “resiliency” ensure that only determined policy restraint will thwart the escalating whirlwind of “Blow-off” repercussions. Any timidity and pandering from the monetary authority will be readily rewarded with only greater Monetary Disorder and instability. And, I’ll add, typical monetary policy doctrine (certainly including perfunctory “rules”) is basically inapplicable once major “Blow-off” dynamics take hold.
Administering cautious “restraint” (a.k.a. Greenspan “baby-steps”) may indeed appear a reasonable approach. After all, such a policy prescription might in more normal circumstances actually orchestrate the coveted “soft-landing.” Not, however, during Credit system “Blow-offs.” To accommodate Credit and speculative excesses is only to guarantee a protracted and highly dangerous Credit cycle culmination. Indeed, the intensity of financial and economic excess during major Credit System “Blow-offs” negates the potential for soft-landings. Rather, boom and bust dynamics govern; to prolong the boom is to secure a more problematic bust.
It is a central tenet of Credit Bubble and, more specifically, “Blow-off” Analysis that risk rises exponentially during the late, terminal stage of excess. At some point, Credit creation reaches a crescendo where a major Bubble attains size and scope to create system over-liquidity sufficient to spur the wholesale formation and expansion of myriad individual Credit and asset Bubbles (Mises's “crackup boom”?). Just such a circumstance was realized with the U.S. Mortgage Finance Bubble. Resulting Massive U.S. Current Account Deficits have now become the major impetus for economic and asset Bubbles internationally, as well for as the major inflations throughout global energy and commodities complexes. Confirming Macro Credit Theory, Credit excess begets Credit excess and one Bubble begets the next. Market inflationary expectations have reached the extreme state where virtually all prices are expected to rise – stocks, bonds, real estate, energy and commodities. Both Credit expansion and (leveraged) speculative excess have become all-encompassing.
At this precarious stage of excess, players across the broad array of inflating asset markets perceive unlimited liquidity. And as long as asset markets rise, additional liquidity will be forthcoming (asset Bubbles create their own liquidity). But there is no getting around the reality that to sustain the “Blow-off” phase demands enormous and unrelenting new finance. The nature of the “Blow-offs” ever greater appetite for additional finance leaves it inherently unstable annd highly vulnerable.
It was curious Tuesday and again today to observe the tight interplay between various markets. One can be pardoned for sensing that a rally in the yen was the catalyst for selling in a broad range of markets including energy, precious metals, commodity currencies, bonds, and global equities. There is certainly good reason to suspect that the “yen carry trade” (borrowing in yen and/or shorting low-yielding yen-denominated securities and using the proceeds to finance holdings in inflating markets) has ballooned to massive proportions and has, in the process, become a Seminal Source of “Blow-off” Finance.
To what extent the “yen carry” has been financing the leveraged speculating community, hence the U.S. securities markets, commodities, emerging markets and global M&A, I am in the dark. But the size of The Trade is undoubtedly enormous, while the Japanese recovery is demonstrating impressive momentum. There will be pressure on the Bank of Japan to (belatedly) normalize interest-rates, both increasing the global cost of funds and narrowing interest-rate and asset-return differentials. The BOJ today appears in little hurry to raise rates, but I nonetheless would not be surprised to see the seasoned speculators a bit anxious for the exits in what could be one of history’s most “crowded trades.” If so, we have a first crack in the façade and a potential “Blow-off” antagonist. “Blow-offs” are especially dangerous for their capacity to surreptitiously inundate financial markets and economies with liquidity emanating from leveraged speculation. And they inevitably come to an end with speculator de-leveraging. |
