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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: glenn_a who wrote (78166)	1/26/2007 2:19:01 PM
From: ahhaha	Read Replies (2) \| Respond to of 110194

1) As a consequence of "massive" credit growth that distorts the cost of credit, such that there is the "illusion" that the cost of money is exceptionally low, if not free, and if as a result asset prices are distorted because the lack of "real" returns on savings encourage holders of financial assets to speculate so as to obtain a real return on their capital, To believe this one would have to believe there isn't a free market in credit. Credit markets are notoriously free. They can't be controlled by the FED. Proof: you don't have to play. 2) In a stable monetary environment, where the "real" cost of money is not artificially depressed, and prices in an asset class rise because of increased scarcity of the asset class relative to the rest of the economy. This claim is ambiguous. The cost of money is never depressed and can never be manipulated even by FED except over short periods of time. Proof: at some terms you would withdraw from the credit market. ((Historically RE rises in price when interest rates fall. This occurred even before there was a Fed to set short term rates or make permanent passes.)) Well, manipulation of the money supply certainly didn't begin with the Fed ... although, they would seem to have perfected the art. FED wished they could manipulate money supply to the extent you imply. They've tried all degrees of excess and dearth and all of them failed to achieve their implied policy objectives. One noteworthy attempt was in the late '80 early '90s when FED tried to implement Friedman's program of money supply targeting. It worked exactly as it should, but FED and Friedman expected something else, something that couldn't ever happen, along the lines of stable prosperity. They got it but they it didn't deliver what they expected, so they abandoned it. Money didn't matter and Friedman tended to agree even though it worked as it should. Nothing like being right and thinking you were wrong. Nothing like losing patience with something that's good but doesn't deliver instant gratification. Regarding the above, I love the following introduction to Chapter 9 of G Edward Griffin's The Creature from Jekyll Island ... "The condensed history of fractional reserve banking; the unbroken record of fraud, booms, busts, and economic chaos; the formation of the Bank of England, the world's first central bank, which then became the model for the Federal Reserve System." Griffin attributes to a credit creation method things that have nothing to do with it. And, by the way, FED wasn't modelled after BOE. There are few similarities between the two. That says it all really. It says nothing. If you disagree, put some claims of Griffin up and I will crush them to within your technical comprehension. Then again, I'm probably as much of a dullard when it comes to economics as I am about history, so perhaps ahah could make an appearance again on this forum and set me straight on these matters. However, he is SO brilliant, I probably won't be able to even BEGIN to comprehend his insightful analysis. I can dumb it down.

To: glenn_a who wrote (78166)	1/28/2007 11:11:09 PM
From: GraceZ	Read Replies (1) \| Respond to of 110194

But don't you think that the "reasons" for interest rates falling are key to this analysis? I think Adam Smith, if he were alive today would clarify and say something like "low real interest rates" or "low real rates of return". In the old days, long term interest rates only fell for two reasons. A fall in the demand for money or a flight out of risk into safety. In the first scenario, you can borrow money at a low rate but you have nothing productive that you do with it. In the second scenario the government borrower gets low rates but the guy who wants to do something that involves any level of risk can't get a loan at any rate even if he has the next best thing to sliced bread. Now long term interest rates rise and fall with inflation expectations because people expect to be reimbursed for the full value when they give up the use of their money otherwise they'd keep their money in a mattress. They can be wrong about inflation, but they lend with a mind towards the future value of that money in regards to monetary inflation. On the risk side, in the present day, the residential RE borrower has been put almost in the same risk class as the government borrower, they are locked together. A flight into government risk free bonds happens in lock step with a flight into RE backed securities. This happened because RE lending has had historically low default rates. Only a sustained period with much higher default rates will change this ingrained perception that residential RE is low risk. The Fed didn't create this perception, the individual bank's computer models did. Of course, models created by individuals with selective knowledge of history and data points covering too short a time span! Do you think it "matters" if interest rates fall (and asset prices rise) when money supply is stable, Money supply is never stable in anything but a theoretical world. In the real world "it is a little bit changing" (as my Swiss friend says about the weather there) regardless of what the Fed does. A money supply target has been theorized for many years and even tried briefly by our own Fed but quickly abandoned. Even in a free market for money, money supply would never be "stable". One could in theory hold the supply of currency constant but if there was a demand that outstripped the supply of money needed for transactions people would create money out of something, scrip, markers, credits, etc. You could even have price inflation in such a regime. or if interest rates fall (and asset prices rise) because there is an explosion in credit growth??? Interest rates fell because after the big capital expansion of the late 90s turned to bust credit imploded, or better said, business credit imploded. C&I lending from 2000 'till 2004 was in free fall, every time I thought it couldn't fall any further it did. If you had a going concern, you could borrow all you wanted but no one could figure out how to make money with the money they already had let alone borrow more money. Institutions with money to lend went in search of someone anyone who would pay them a return. I'm guessing you got and still get the numerous solicitations from banks trying to lend you money, even unsecured at low rates. RE was the only bright spot for those with capital to lend. Corporations replaced bank lending with bond offerings. In 2000 RE was coming out of almost a decade of stagnant prices. There was pent up demand in places where new housing was severely limited by "smart growth" initiatives. In the most desirable locations there had been a structural deficit in new housing units for decades. Pent up demand meets cheap borrowing and what gives is price. Price does wonders for bringing on supply and in the later stages, a strong movement up in prices attracts speculative demand. You can fault the mortgage banks for not doing a very good job of distinguishing between higher risk speculative borrowers and people buying individual homes for themselves (speculators did a lot of lying and banks looked the other way), but you can also fault the guys (that would be us out here putting money in brokerage money market funds and pension funds etc.) who were buying up every package of MBS no matter what kind of toxic sludge was in there. What fed the machine was huge amounts of capital moving out of the stock market into bonds. I'm betting you can look in your cereal and find MBS. They are in everything now because it was the only place for these money managers to get yield. When everyone and their brother decides to get out of the stock market (or short the market- what happens to those cash balances?) but still expects to make double digit returns on their savings, that money ends up in high yield bonds, leveraged bond funds and Ginnie Mae funds. If you want to know who created the RE boom, we all did. The smart money went long bonds/short stocks/long cash and the dumb money went long RE/short cash. The dumb money used the smart money to buy RE. It's a marriage made in Heaven. 1) As a consequence of "massive" credit growth that distorts the cost of credit, such that there is the "illusion" that the cost of money is exceptionally low, if not free, and if as a result asset prices are distorted because the lack of "real" returns on savings encourage holders of financial assets to speculate so as to obtain a real return on their capital, or You'd have to assume everyone is stupid, some are but certainly not everyone. Increasing the money supply to lower interest rates (to as you say, fool people into thinking credit is cheap and available) has the opposite effect because long term interest rates are positively correlated with inflation expectations. Just about everyone in the world of money knows this. Long term rates are set by the market, short ones by the Fed and frankly I trust markets far more in terms of price discovery than a room full of bright guys. Is it so hard to understand why the Japanese (big buyers of our Tbills and Tbonds )might have low inflation expectations? On a worldwide basis, the rate of inflation (along with interest rates) has been on a down trend since 1982. Interest rates are one of the few but notable financial measures that do not exhibit reversion to the mean, they are more likely to continue on trend than they are to change trend and revert to some mean value. What we could debate is whether we're at one of those rare trend changes. I think that the jury is still out as to whether we've entered into a period where the rate of inflation trends up or we're still stuck in the low predictable level of monetary inflation promoted by the Fed: finance.yahoo.com Numerous times I've stated that people could adjust to moderate levels of inflation or deflation, that the Fed chooses a policy they believe will produce inflation at a low predictable rate. They choose this because the people demand it. I think that the free market would do a much better job of setting the price of money. Unfortunately almost no one in power believes this because they fear the great unwashed crowd. So in turn we get this systemic inflation. In the days of Adam Smith they had inflation, one of my favorite paragraphs in his book is about how throughout history Kings and Sovereigns have reduced the amount of silver and gold in their coinage in order to pay off their debts with less valuable currency. People did a lot of biting of coins back then as well.