Marc Faber: "Financial Crisis Don't Happen Accidentally, They Are Inevitable"

Tyler Durden's picture

Authored by Marc Faber, originally posted at The Daily Reckoning blog,

As a distant but interested observer of history and investment markets I am fascinated how major events that arose from longer-term trends are often explained by short-term causes. The First World War is explained as a consequence of the assassination of Archduke Franz Ferdinand, heir to the Austrian-Hungarian throne; the Depression in the 1930s as a result of the tight monetary policies of the Fed; the Second World War as having been caused by Hitler; and the Vietnam War as a result of the communist threat.

Similarly, the disinflation that followed after 1980 is attributed to Paul Volcker’s tight monetary policies. The 1987 stock market crash is blamed on portfolio insurance. And the Asian Crisis and the stock market crash of 1997 are attributed to foreigners attacking the Thai Baht (Thailand’s currency). A closer analysis of all these events, however, shows that their causes were far more complex and that there was always some “inevitability” at play.

Take the 1987 stock market crash. By the summer of 1987, the stock market had become extremely overbought and a correction was due regardless of how bright the future looked. Between the August 1987 high and the October 1987 low, the Dow Jones declined by 41%. As we all know, the Dow rose for another 20 years, to reach a high of 14,198 in October of 2007.

These swings remind us that we can have huge corrections within longer term trends. The Asian Crisis of 1997-98 is also interesting because it occurred long after Asian macroeconomic fundamentals had begun to deteriorate. Not surprisingly, the eternally optimistic Asian analysts, fund managers , and strategists remained positive about the Asian markets right up until disaster struck in 1997.

But even to the most casual observer it should have been obvious that something wasn’t quite right. The Nikkei Index and the Taiwan stock market had peaked out in 1990 and thereafter trended down or sidewards, while most other stock markets in Asia topped out in 1994. In fact, the Thailand SET Index was already down by 60% from its 1994 high when the Asian financial crisis sent the Thai Baht tumbling by 50% within a few months. That waked the perpetually over-confident bullish analyst and media crowd from their slumber of complacency.

I agree with the late Charles Kindleberger, who commented that “financial crises are associated with the peaks of business cycles”, and that financial crisis “is the culmination of a period of expansion and leads to downturn”. However, I also side with J.R. Hicks, who maintained that “really catastrophic depression” is likely to occur “when there is profound monetary instability — when the rot in the monetary system goes very deep”.

Simply put, a financial crisis doesn’t happen accidentally, but follows after a prolonged period of excesses (expansionary monetary policies and/or fiscal policies leading to excessive credit growth and excessive speculation). The problem lies in timing the onset of the crisis. Usually, as was the case in Asia in the 1990s, macroeconomic conditions deteriorate long before the onset of the crisis. However, expansionary monetary policies and excessive debt growth can extend the life of the business expansion for a very long time.

In the case of Asia, macroeconomic conditions began to deteriorate in 1988 when Asian countries’ trade and current account surpluses turned down. They then went negative in 1990. The economic expansion, however, continued — financed largely by excessive foreign borrowings. As a result, by the late 1990s, dead ahead of the 1997-98 crisis, the Asian bears were being totally discredited by the bullish crowd and their views were largely ignored.

While Asians were not quite so gullible as to believe that “the overall level of debt makes no difference … one person’s liability is another person’s asset” (as Paul Krugman has said), they advanced numerous other arguments in favour of Asia’s continuous economic expansion and to explain why Asia would never experience the kind of “tequila crisis” Mexico had encountered at the end of 1994, when the Mexican Peso collapsed by more than 50% within a few months.

In 1994, the Fed increased the Fed Fund Rate from 3% to nearly 6%. This led to a rout in the bond market. Ten-Year Treasury Note yields rose from less than 5.5% at the end of 1993 to over 8% in November 1994. In turn, the emerging market bond and stock markets collapsed. In 1994, it became obvious that the emerging economies were cooling down and that the world was headed towards a major economic slowdown, or even a recession.

But when President Clinton decided to bail out Mexico, over Congress’s opposition but with the support of Republican leaders Newt Gingrich and Bob Dole, and tapped an obscure Treasury fund to lend Mexico more than$20 billion, the markets stabilized. Loans made by the US Treasury, the International Monetary Fund and the Bank for International Settlements totalled almost $50 billion.

However, the bailout attracted criticism. Former co-chairman of Goldman Sachs, US Treasury Secretary Robert Rubin used funds to bail out Mexican bonds of which Goldman Sachs was an underwriter and in which it owned positions valued at about $5 billion.

At this point I am not interested in discussing the merits or failures of the Mexican bailout of 1994. (Regular readers will know my critical stance on any form of bailout.) However, the consequences of the bailout were that bonds and equities soared. In particular, after 1994, emerging market bonds and loans performed superbly — that is, until the Asian Crisis in 1997. Clearly, the cost to the global economy was in the form of moral hazard because investors were emboldened by the bailout and piled into emerging market credits of even lower quality.

Above, I mentioned that, by 1994, it had become obvious that the emerging economies were cooling down and that the world was headed towards a meaningful economic slowdown or even a recession. But the bailout of Mexico prolonged the economic expansion in emerging economies by making available foreign capital with which to finance their trade and current account deficits. At the same time, it led to a far more serious crisis in Asia in 1997 and in Russia and the U.S. (LTCM) in 1998.

So, the lesson I learned from the Asian Crisis was that it was devastating because, given the natural business cycle, Asia should already have turned down in 1994. But because of the bailout of Mexico, Asia’s expansion was prolonged through the availability of foreign credits.

This debt financing in foreign currencies created a colossal mismatch of assets and liabilities. Assets that served as collateral for loans were in local currencies, whereas liabilities were denominated in foreign currencies. This mismatch exacerbated the Asian Crisis when the currencies began to weaken, because it induced local businesses to convert local currencies into dollars as fast as they could for the purpose of hedging their foreign exchange risks.

In turn, the weakening of the Asian currencies reduced the value of the collateral, because local assets fall in value not only in local currency terms but even more so in US dollar terms. This led locals and foreigners to liquidate their foreign loans, bonds and local equities. So, whereas the Indonesian stock market declined by “only” 65% between its 1997 high and 1998 low, it fell by 92% in US dollar terms because of the collapse of their currency, the Rupiah.

As an aside, the US enjoys a huge advantage by having the ability to borrow in US dollars against US dollar assets, which doesn’t lead to a mismatch of assets and liabilities. So, maybe Krugman’s economic painkillers, which provided only temporary relief of the symptoms of economic illness, worked for a while in the case of Mexico, but they created a huge problem for Asia in 1997.

Similarly, the housing bubble that Krugman advocated in 2001 relieved temporarily some of the symptoms of the economic malaise but then led to the vicious 2008 crisis. Therefore, it would appear that, more often than not, bailouts create larger problems down the road, and that the authorities should use them only very rarely and with great caution.

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LetThemEatRand's picture

Disaster capitalism.   The new normal.  Blow up the bubble, pop it, prop up those who created it, blow it again, bail it out again, ad infinitum.

Charles Nelson Reilly's picture

I don't know how the word capitalism gets associated with that? It's more like plunderism or devilbankerism.

EnslavethechildrenforBen's picture

Faber continues to completely miss the point

akak's picture

Then why don't you enlighten us on "the point"?

EnslavethechildrenforBen's picture

Ok.

The Federal Reserve is going to end up owning all the wealth in the entire world, the world is going to end up owning gigantic piles of worthless green paper. The entire world is losing ground to them. There is no way to keep up with them.

The only solution is to get rid of them. Let the Treasury Dept print the shit. Interest free. Reinject it in to the base of the economic pyramid and let it trickle up to the rich that already own way too much.

Like I said, Faber is missing the big picture.

The Mist's picture

Actually I disagree. The FED is buying up worthless treasuries, who cares? The FED ain't buying up assets. They're spreading wealth to their buddies and théy are using that wealth to buy up assets, or well, you know, stocks.

 

The solution isn't to allow the Fin. Dept. to print money instead lol. Only alters the problem slightly.

spanish inquisition's picture

The FED does not matter, they are a tool. The owners of the FED are the banks and they are owned by the 1%. They want to keep the ponzi alive because, they are able to continue to transfer wealth and there is less uncertainty. If I remember correctly, there was a change to bankruptsy law that put derivitives to the front of the line in all proceedings. I wonder who owns the majority of derivitives,  maybe the banks that own the FED? At some point in the economic ponzi, someone will give the order to "just pull it". I wonder if Detroit is in play to see if they need to plug any holes regarding derivitives. 

eclectic syncretist's picture

The Fed will NEVER sell back what it has "bought".  It's buys are perverse forms of debt-forgiveness (MBS) and free-shit giveaways (T-bills) so that the politicians don't get rid of them. 

DoChenRollingBearing's picture

 

 

@ Enslave

No, I do not think that the Fed will wind up owning everything.  What I do see is a period of great financial turmoil that will create many losers and some winners.

Shrimps like us can diversify...  Own some gold, hell even Bitcoin (as most know, I am experimenting with BTC to see if it works for me).  Guns & ammo for the more worried (like me).  Water & food production capability (which I lack).  Assets elsewhere.

I think Faber will be shown to be quite correct in the end.

czardas's picture

It never ceases to amaze me that those on ZH aways prophesying a credit crunch, dollar collapse, market crash, bond bubble burst, etc never seem to advance beyond griping and screaming. I came from a background of obsessive moderation (lol) where common sense ruled.  Things don't go up or down forever, actions eventuallyt have consequences, hard work and preparation pay off, don't live beyond your means, etc.  But most important - beware those prophesying future events once they are proved wrong since the success rate of economic prophecy is about .001%.   Fundamentals rule in the end.

The FED will suspend only if rates stay low - an extremely unlikely scenario.  An extra 300 or 400 basis points would be impossible to cover unless the FED monetize the interest created \ by monetizing debt (repeat ad infinitum) - much the same way Illinois sales bonds to pay the interest on its current bonds.  

Bangin7GramRocks's picture

How do you experiment with Bitcoin again? Let me guess, if it goes way up you keep doing it. It sure sounds like experimenting with craps at the casino. I'll throw $1000 at it and if I get lucky and my gambling pays off, I'll throw another $1000. Same damn thing!

saveandsound's picture

@Enslavethechild

If one extrapolates QE one would come to the conclusion that the FED owns all the assets at the end. However with rising asset prices QE4ever has to expand to keep up. And if the dollar further devalues the FED would have to expand even further. And before reaching the end, trust breaks.

The FOMC is surely aware of such an scenario and is going to tighten sooner or later. Faber (and others like Schilf, etc.) says, at that point the prevailing debt (private, corporate, state) will crush those who can't stand the burden. At any signs of a deflationary collapse, the central banks of the world will have another tantrum. Untapering is going to happen quick and everybody in the world who owns currency is going to flee into assets (except bonds).

For prices to explode (and explode they will, Yoda says) we need to see another collapse (maybe the last one) which puts part of the supply chain out of business resulting in scarcity of goods. At that point Dollars soon won't be accepted any more. I have actually no idea which currency is going to survive since all the big ones are "all in" in this poker game.

I believe, the central banks will own all state-issued bonds (maybe even corporate bonds) at the end, but real wealth will be in the hands of the so-called rich. We are already watching the begin of a disaster bull market. 

And in the hands of the ZH-er of course since most of us are gold- or PM-bugs. ;-) On the other hand, who am I to know the future? Maybe it will be all rainbows and unicorns and Krugman even becomes president? ;-)

pcrs's picture

lol let the government print as much money as they think they can spend, that will work. Then the shitizen will still end up with lots of green paper en the gvt with all the assets. the fed = the government. You counterfeit their money, the police jail you. Don't believe al that seperation of powers nonsense to pretend independence.

Martel's picture

Like I said, Faber is missing the big picture.

No, he isn't. You're misjudging Faber on just one article, where he addressed just one, specific point.

RaceToTheBottom's picture

@Enslave, "Faber is missing the big picture."

 

Faber pointed out that by it's role as the reserve currency, the US was in a position to make decisions that worked for itself, bail out Mehiko, that screwed up Asia big time.  So in effect he is pointing out the disproportionate amount of power the FED has and the risk of it using that power to the worlds demise. 

Sounds like he gets it, regardless of whether he states it in slogans....

scrappy's picture

Thumbs up Enslavethechild....

Stilll wondering HOW MUCH Gold truly exists and who holds it.

But I prefer your solution.

https://libertyrevival.wordpress.com/2012/12/01/deflation-is-theft-simpl...

 

4 wheel drift's picture

what wealth ?

toxic & worthless paper ?

purchased with increasingly worthless fiat ?

-lol

oh and the solution is to have a different entity print freely & give it away interest free ?

brilliant !!

you cannot fix BROKEN, particularly when the entire system is corrupt and founded on misleading premises...

and let's not forget that the control of such corrupted system represents enormous power over lots of people....   and power is not just...   given away for the sake of it.....   the ONLY WAY to get power is by FIGHTING for it.

those in power will never just give it away, and those who want it will have to fight for it....  given that the system is BROKEN...

two choices left:

1.- accept the status quo

2.- fight to change it

either way...   the future is not good....  unless of course you are part of the corrupt system in whichever way you happen to have such membership, in which case, you do so at an enormous risk...  i.e. it is a small club and you ain't in it....

p.s. faber is not missing a damned thing.

Errol's picture

If you wish to know the 'big picture', here is the biggest picture.  Industrial society is irreversably dependent on energy ("the ability to do work").  Net energy available to industrial society is in decline and has been for some time, while population continues to increase.  This mandates a condition of continuous contraction for the foreseable future.

USA conventional oil production peaked in 1970, mandating either contraction or constantly increasing foreign trade deficits for imported oil.  The US response was: close the gold window, institute the Petrodollar policy of propping up the corrupt Saudi regime in return for accepting only dollars for oil, and start running up unimaginable amounts of debt in an effort to maintain the non-negotiable American Lifestyle.  We are in the later stages of that effort.

Japan has almost no internal energy production; once the nukes blew up they entered the next stage of this process.  Look to Japan to try every wack-ass "intervention" in the world to forestall the inevitable.

All else lies somewhere between arguing how many angels can dance on the head of a pin and rearranging the deck chairs on the Titanic.  As someone says downthread, Faber is discussing one very narrow set of responses to the overarching, unending contraction.

MrVincent's picture

Faber has called Bernanke and fed a criminal organziation many times.

LetThemEatRand's picture

"I don't know how the word capitalism gets associated with that?"

Disaster capitalism is fascism.  Fascists use the terms you like, too.  See the Bernays article from earlier today.  "Socialism" as a term commonly used today has a totally different meaning, too.  

IndyPat's picture

Might I suggest...
NeoFeudalAuthoritarianism, with a just a dash of Marxism for color?

LetThemEatRand's picture

I'll call IndyPat any time.  You in Vermont still?

IndyPat's picture

Nope, brother. Smack dab in the middle of Frozen Hoosierville.

LetThemEatRand's picture

Yikes.  Tale a trip to FL. Almost 80 here today (don't tell Drudge).

Yen Cross's picture

 Indy Pat is an "no show" most of the time...

Cast Iron Skillet's picture

I LIKE your term Devilbankerism!! Great word coinage!

Zero Point's picture

Correct LTER.

Imagine the meetings in '09?

Bankster: Do it our way, or seriously, there'll be Mad Max on the streets in a matter of weeks. Who cares if it's our fault.

Elected Imbecile in suit: OK then.

I almost feel sorry for those lame ducks.

The way I feel sorry for spoilt children.

hedgeless_horseman's picture

 

 

Saw a $100 move (up) in 4 minutes tonight on Mt Gox.  $200 in the past 18 minutes.  Must have been that a butterfly in China farted.  Zee price stability.

akak's picture

Oh, come on HH, can't you recognize "growing pains"?

I mean, I can certainly remember my own youth, when, like most other kids my age, I grew from 1'6" to 6'3" in one year, then shrank back to 4'2" in one day before reaching 16'8" a few months later. 

Like I said, just growing pains.

IndyPat's picture

The growing of the pains goes to the very heartness of the mattering. It speaks to the very nature of American citizen citizenism.
Alas, the shrinkage is always the harbinger to the American Citizen just prior to blobbing up.
Only by regular evacuations by the roadside can a society maintain growth and relieve what you Americans refer to as pain of growingness.
A brown baby Mao a day keeps they growing pains away.

akak's picture

You are truly a parangong of monolizing the truthiness means.

scrappy's picture

Yes very stable and trusted.

SOLID DUDE!

frankTHE COIN's picture

Chaos Theory / Bernanke =
ButterFly Effect

remain calm's picture

But if you can bail out some unfortunates it makes you feel good about yourself, like your God (make the blind see, the crippled walk). So central bankers are the righteous and omnipotent Economic Gods of humanity. They will save ourselves from ourselves.

WTF...Go FUCK YOURSELFS Mr/Mrs Central Bankers. You are not God. You are Evil Ignorant Mother Fuckers. You mother fuckers could not run a lemonade stand.

NIHILIST CIPHER's picture

Chaos/ crisic/ fear= Kontrol                  Bring on the farting butterflies.

q99x2's picture

Yes. Reminds me of the London Whale. Eventually the FRAUD ends in catastrophe when the wealth runs out. I was going to say when the debt can't be repaid but we are long past that.

booboo's picture

Obama will issue the 1 googillion Fairyfart balloon and pay it off with a couple of squeaks and we will be off and running again, no problemos.

PT's picture

How many times do I have to tell you?  There will not be "just a few" trillion dollar platinum coins.  There will be millions of coins, made from base metals, in denominations from 1 to 50 trillion dollars.  Then there will be paper notes, in various denominations from 100 trillion to 10 000 trillion dollars.  For a brief, fleeting time, a loaf of bread will cost 300 trillion dollars, but then the price will go up.  And your local ATM will still only spit out 50s, your local bank still won't let you withdraw more than three grand cash, all transactions above ten grand will still get reported, and your minimum wage will still be $7.50 per hour.

;) 

falak pema's picture

Interesting insight provided on Bruno Iksil, the man who became known as the London Whale.

During the 2008 crisis he was ONE of the MAIN traders of JPM who MARGIN CALLED Lehman.

What goes around comes around, as they say in Boomerang town of City. 

Eric Ben-Artzi: How Risky is Citigroup’s New, Improved Version of a Once-Toxic Type of Synthetic CDO? « naked capitalism

Yen Cross's picture

 Faber I like you're concepts. Show me you're balance sheet. Tell me why I should trust you, when I can chop down a tree myself!

JoBob's picture

Yen, I like YOUR concepts. Show me YOUR balance sheet.

You're chopping the wrong tree!

Prairie Dog's picture

"While Asians were not quite so gullible as to believe that “the overall level of debt makes no difference … one person’s liability is another person’s asset” (as Paul Krugman has said), they advanced numerous other arguments in favour of Asia’s continuous economic expansion and to explain why Asia would never experience the kind of “tequila crisis” Mexico had encountered at the end of 1994, when the Mexican Peso collapsed by more than 50% within a few months"

The dumb dawg says: The Krugman quote is taken out of context (of course). KTI was talking only about domestically held debt. What made the Asian crisis so devastating was that the debt was foreign, as Faber himself acknowledges lower down.

He seems to have a bit of a hang-up with KTI, citing him twice more before the end of the article and appearing to blame him for all the global economy's ills since 1990, including resuscitating the old canard about the Invincible One supposedly advocating a housing bubble. KTI has been running the global economy for the past two decades? Who knew!

The dumb dawg thinks that if you need to distort an opponent's arguments to make your case, perhaps you either 1. don't understand your opponent's arguments properly, or 2. lack intellectual confidence in your own point of view. One's own arguments should be sufficiently strong to stand on their own merits. 

I note that KTI was also an early skeptic of Asia's rise and predicted the looming crisis in 1994. KTI's predictions on US inflation and growth have also been broadly spot-on since 2008, while those of the hard-money crowd typified by Faber/Schiff/Rogers/Ferguson (generally hyperinflation and soaring interest rates any day now - five years and still counting...) have all been dead wrong.

 

 

 

 

 

 

 

ReactionToClosedMinds's picture

nothing personal ... but u sure seem pretty smug.

Faber, Felix Zulauf have been more relatively correct than wrong.     If you cannot see that we are all in a careening car hugging a cliff there is not much I or anyone can add.  Feel free to regurgitate Chris Matthews style propaganda to reasure yourself.

No one can predict the future , but one can see what will eventually happen.   2008 was the most widely predicted disaster in my lifetime where my specific economic conciousness recalls the end of Eisenhower years.   At present rate, the next crisis will make 2008 seem like the Boer War in comparison to World War One.   Derivatives are  larger, big banks are bigger, Dodd-Frank was a sham to put a moat around them as a final kiss by scoundrel Dodd for his 'presdiential' campaign contributions.   Wall Street and 1-5% wins, Main Street is barely surviving. 

 And African-Americans are being treated like chattel economically ..... black male youth face zero prospects for employment while our fearless leader blasphemously wraps himself in the mantle of a genuinely great man, Nelson Mandela.  And Chicago remains the United State's largest racially segregated urban area .... and why is that and no 'academic' or law professor or 'jornolist' dares get near that important and penetrating question?  Just askin'

Forward Comrade Prairie Dog!

Prairie Dog's picture

Nelson Mandela a great man? I think you're in the wrong place! (But I agree with you)

Not sure what you mean about propaganda. And who is Chris Matthews? These are facts, unless you subscribe to the conspiracy theory that the inflation figures are manipulated and US inflation is really 10 quadrillion percent or something. 

I'm hurt that you think I'm smug. I'm just a dumb dawg, a humble acolyte of the great KTI!

 

ReactionToClosedMinds's picture

you ask the question you dictate the answer, elementary Watson

there is no velocity .... zero for ZIRP.  But when ZIRP ends .......... unless businesses are on sound footing then they cannot take advantage of the opportunities which are now masked and anesthetized, Plus a lot of commercial public companies are Japanese zombies ....... propped up by low interest rates and liquidity.    High yield is a bomb waiting to go off now.   Risk Parity ...... I got it ......... but no one should be talking about the future until the West gets to some semblance of economic reality.  And PRChina you say ........ Andy Xie and Michael Pettis are pretty good observers of that 'transparent' land.

1994 to 2000 was a great time ..... the Committee to Save the World .... until reality asserted itself and the Rubin induced flight to US Treasuries and US Dollar faded into the DotCom equity madness.  

This time is different ......... I have hesitated doing the Full Monty and going cash totally for over a year..... and so have something to show ...but this is a mighty uncomfortable 'economic' boom ... where are the jobs?     What happened to Recovery Summer?

I'll take one Faber or Zulauf to most any sell-side 'strategist any time or any day ........

 

ReactionToClosedMinds's picture

by the way .... where are your 'facts' you cite?  Just askin'

whenever I hear someone assert their 'facts' I start to laugh ......... facts are like iron filings that one organizes with their ideological or philosophical magnet ........ facts are nothing except in the context of the argument and assertion... Even Keynes the admitted child molester knew as much 

Prairie Dog's picture

The "facts" are that all those using an Austrian model forecast hyperinflation and soaring interest rates imminently as a result of the stimulus and QE. Almost six years on, inflation is still running below the Fed's 2 percent target.

Andy Xie? Would that be the same guy who used to be a sell-side strategist at Morgan Stanley?

Just sayin'