Monetary Developments vs. Monetary Aggregates
Doug Noland --- November 10, 2006
prudentbear.com
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To be sure, this dynamic has had a profound impact on general corporate Credit Availability, the cost and availability of Credit “insurance,” Credit creation, marketplace liquidity, and asset market speculation and inflation. And the more Credit that becomes available and the greater the Credit boom, the fewer corporate defaults and the more profits for those selling Credit protection – writing flood insurance during a drought. The greater are speculative returns from writing Credit insurance, the more players and finance that clamor for a piece of the action. This, then, incites a flurry of Wall Street innovation, crafting only more sophisticated (and leveraged) structures that somehow extract greater profits from shrinking “insurance” premiums. And reminiscent of the technology blow-off, those speculating on the end of the Credit cycle – betting on widening Credit spreads – have been forced to run for cover. This has only fanned the mania.
One upshot to this incredible dynamic is an issuance explosion of securities and instruments fashioned with the attributes of “Moneyness,” though backed by increasingly risky Credits. A second is the dangerous marketplace perception of limitless inexpensive Credit insurance. A third is the perception and extrapolation of endless liquidity, “money” to fuel permanent prosperity. The Credit, insurance, and liquidity booms stoke the economy and inflate corporate revenues and earnings. They also flood the spectacular M&A boom with cheap finance, emboldening players to extrapolate both earnings growth and today’s backdrop of unlimited cheap finance. Inflating stock prices then create their own self-reinforcing speculation and liquidity Bubbles, further deflating risk premiums and distorting market perceptions – creating only more intense speculative demand for corporate securities.
The explosion of Credit derivatives and top-rated corporate securities issuance is a Monetary Development of historic proportions. I have written about the “Moneyness of Credit” issue over the past few years, but never did I imagine it would come to this. Marketplace perceptions of safety and liquidity are today being grossly distorted on a scale – multi-trillions of securities from one corner of the world to another - that so overshadow the technology Bubble – that overshadow anything previously experienced in the history of finance.
Following in the footsteps of the technology derivatives Bubble, the mania in Credit “insurance” ensures a collapse. It today feeds a self-reinforcing boom, but when this cycle inevitably reverses, the scope of Credit losses will quickly overwhelm the thinly capitalized speculators that have been more than happy to book premiums directly to profits. Undoubtedly, an unfolding bust will find this “insurance” market in complete disarray. Much of the marketplace today expects that they will - when things begin to turn sour - either obtain Credit “insurance” or hedge/”reinsure” protection already written. But when much of the marketplace moves to offload Credit risk there will simply be no one to take the other side of the trade. As losses mount, the market will then face the harsh reality that minimal “insurance” reserves are actually available to make good on all the protection written. This will have a profoundly negative impact on both Credit Availability and marketplace liquidity – ruining the plans of many expecting – and requiring – that “money” always flow so freely.
A major problem with the current monetary boom – the “Moneyness of Credit Bubble” – is the enormous and widening gulf between the market's perception of safety and liquidity and the acute vulnerability of the actual underlying Credits. Runaway booms invariably destroy the “money” – in whatever form it takes – whose inflationary expansion was responsible for fueling the Bubble. This lesson should have been learned from the late-twenties experience, or various other fiascos as far back as John Law. When current perceptions change – when $ trillions of Credit instruments are reclassified and revalued as risky instruments as opposed to today’s coveted “money” – Dr. Bernanke will learn why a central bank’s monetary focus must be in restraining “money” and Credit excesses during the boom. And the longer this destabilizing period of transforming risky Credits into perceived “money” is allowed to run unchecked, the more impotent his little “mop-up” operations will appear in the face of widespread financial and economic dislocation – on a global scale."
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