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Lessons From The Late '20s - Why Bubbles Abound
Excerpted from Doug Noland's Credit Bubble Bulletin,
They finally did it – 25 bps, for the first rate increase since 2004. Surely it’s the most dovish Fed “tightening” ever. Indeed, it was really no tightening at all. One has to go all the way back to 1994 for the last time the Federal Reserve commenced a true tightening cycle. That episode proved so destabilizing that the Federal Reserve assured the markets that they’d learned their lesson. And this (dovish and market-pandering) mindset was fundamental to the little baby step rate increases that ensured no tightening of financial conditions throughout the historic 2002-2007 mortgage finance Bubble inflation.
This week’s policy move will be debated for years to come. Lost in the debate is how the Fed (along with global central bankers) found itself stuck at zero for seven years (with a $4.5 TN balance sheet) and then saw it necessary to move to raise rates in the most gingerly, market-pleasing approach imaginable.
Traditionally, tightening cycles are necessary to counter mounting excess, including ill-advised lending, speculating and investing. Rate increases back in 1994 exposed what had been a dangerous expansion in speculative leveraging, derivatives and market-based Credit (at home and abroad). With the “bond” market in disarray and Mexico at the precipice, the Greenspan Fed turned its attention to bolstering the markets and non-bank Credit more generally.
Market-based Credit is unstable. This remains the fundamental issue – the harsh reality – that no one dares confront. I would strongly argue that long-term stability in a Capitalistic system requires sound money and Credit (hopelessly archaic, I admit). Over the years, I’ve tried to differentiate traditional finance from unfettered “New Age” finance. The former, bank lending-dominated Credit, was generally contained by various mechanisms (including the gold standard, effective currency regimes, bank capital and reserve requirements, etc.). This is in stark contrast to the current-day securities market-based global financial “system” uniquely operating without restraints on either the quantity or quality of Credit created.
A few data points from the Federal Reserve’s “Z.1” report illuminate why the Credit system had turned fragile back in 1994. After beginning the decade at $6.39 TN, Total Debt Securities (my compilation of Treasuries, Agency Securities, Corporate Bonds and Muni Debt) surged $2.94 TN, or 46%, in four years to end 1993 at $9.33 TN. For comparison, over this period bank (“Private Depository Institutions”) Loans actually declined $169 billion (Total bank Assets rose $137bn to $4.9 TN). Importantly, Total Debt Securities as a percentage of GDP jumped from 113% to 135% in four years, while bank Loans to GDP declined from 57% to 44% (bank Assets 84% to 71%).
Fast-forward to 2014 and securities-based finance completely dwarfed bank loans. Total Debt Securities had inflated to $21.11 TN, or 172% of GDP. At $6.32 TN, bank Loans had increased only marginally to 51% of GDP. It’s worth noting that Equities as a percentage of GDP ended 2004 at 154%, up from 1994’s 86%. Total (Debt & Equities) Securities, at $40 TN, ended 2004 at a then record 326% of GDP. This compares to 1994’s $16.2 TN, or 222%.
The 2008 crisis exposed the incredible leverage that had accumulated over a protracted period of Fed-induced easy money. It’s my view that Fed policies were used specifically to reflate the securities market Bubble in 1998 and then again in 2001-2002. This then precluded the Fed from adopting real tightening measures throughout the mortgage finance Bubble period that would have risked financial crisis.
Importantly, market-based finance did not equate to freer markets. Indeed it was the exact opposite. Policies at the Greenspan Fed evolved from actively supporting the securities markets and promoting speculation to desperate measures to sustain the Bubble. Dr. Bernanke arrived at the Fed in 2002 with an inflationist ideology to use “helicopter money” to reflate Credit and securities market Bubbles. Ironically, market-based finance became the most powerful tool for central bank manipulation - so powerful that the central planners at the Chinese communist party rushed to adopt securities-based finance.
Post-mortgage finance Bubble reflationary measures inflated the global securities Bubble to historic extremes. Here at home, Total Securities ended 2014 at $74.54 TN, or 430% of GDP. Debt Securities ended the year at $38.3 TN, or 221% of GDP, with Equities at $36.2 TN, or 209% of GDP.
There’s no precedence for such a globalized monetary fiasco, though there are a number of historical episodes that provide valuable insight. John Law’s introduction of paper money in France (1716-1720) and the resulting “Mississippi Bubble” is one of my favorites. The basic flaw in Law’s inflationist theories was his focus on the “medium of exchange” attribute to the exclusion of money’s critical role as a “store of value.” Pertinent as well, when confidence in Law’s financial scheme began to wane, he devalued competitive hard currencies in a desperate attempt to sustain demand for his scheme of paper money and securities. Bernanke, Draghi, Kuroda, Yellen and their central bank colleagues inflate central bank Credit as a “medium of exchange” for securities market inflation and apparently don’t contemplate the “store of value” dilemma that has torpedoed inflationism’s grand illusions throughout history.
The late-twenties period provides invaluable insight: The extreme divergence between the trajectory of commodities and securities prices. Benjamin Strong’s 1927 “coup de whiskey” (Draghi’s 2012 “do whatever it takes”). Policymaker confusion about the nature of inflation. How new technologies, a prolonged investment boom and booming global trade fostered confounding price instabilities. The critical issue of productive vs. non-productive Credit. How the Fed sought to promote capital investment, yet the allure of a speculative securities market Bubble proved too powerful. That there was little understanding of how securities market leverage had fostered acute market, financial and economic fragility. Especially late in the boom, the Fed was in no way in control of either inflation or the flow of finance through the markets and real economy. How everyone was determined to hold their ground, yet the ground gave way beneath them.
“In order to believe you should raise rates for financial stability reasons, you have to believe that there’s a serious problem of over-confidence – of bubble formation. And it seems to me that most of the plausible bubbles are no longer plausible bubbles at this point. Perhaps you could have said there was a bubble element in the high-yield bond market at some point, but you certainly can’t say that today. Perhaps you could have said that about emerging markets at some point. You can’t say it today. Perhaps you could have said it about commodities at some point. You can’t say that today. So the notion of raising rates today as a prophylactic against financial instability seems quite odd. I think we’re much more likely to have problems that come from under-confidence in financial markets than problems that come from over-confidence in financial markets.” Former U.S. Treasury Secretary Larry Summers speaking with Bloomberg’s Tom Keene, December 15, 2015
Unfortunately, Plausible Bubbles Abound. Junk bonds are merely the Periphery of a historic Bubble throughout corporate Credit and debt securities more generally. Troubled EM markets are merely the Periphery of a historic Credit Bubble throughout Latin America, Eastern Europe and Asia, certainly including the runaway mega Chinese Bubble (at the Core). Commodities are merely the Periphery of a historic global speculative Bubble, with financial assets at The Massive Core.
And the dilemma for John Law, for the late-1920s period, during 2007 and again these days: easy money policies meant to support a faltering Periphery work generally to exacerbate excess at the Bubble’s Core. As an analyst of Bubbles, the great challenge is to try to recognize when trouble at the Periphery, rather than supporting continued "Terminal Excess" at the Core, begins to lead to risk aversion, de-leveraging and a tightening of financial conditions at the vulnerable Core.
It was a tricky week. To have such an important policy announcement two days prior to a year-end “quadruple witch” options expiration added complexity. The Fed basically gave the markets exactly what they were expecting, providing reason enough to rally. This rally, right before expiration, was fueled by an unwind of hedges and bearish positions. Yet it wasn’t long before deteriorating fundamentals trumped the Fed’s dovish rate increase. I have not agreed with the conventional thinking that global instability has been mainly about the Fed. So I don’t subscribe to analysis that sees the Fed hike now reducing uncertainty and engendering stability.
The Brazilian real declined 2.7% this week. Brazilian stocks sank 3.0%. Devaluation saw the Argentine peso collapse 36%. Argentina’s Merval equities index sank 10.8% this week. Crowded trades and a proliferation of derivative trading ensure some big bear market rallies. But the bursting of the EM and commodities Bubbles runs unabated. It’s as well worth noting that the yen gained 1.1% against the dollar Friday when the BOJ surprised the market with expanded stimulus measures but disappointed by not boosting QE.
December 18 – Wall Street Journal (Aaron Back): “Bank of Japan Governor Haruhiko Kuroda may have thought he was giving markets an early Christmas present. But investors reacted like they were finding coal in their stockings. The BOJ was widely expected not to make any adjustments to its easing program on Friday. So when headlines hit that it was making moves—extending the maturity of its government bond portfolio and introducing a new stock buying program—reaction was ecstatic. The Nikkei 225 surged by over 2% in minutes. But as traders read through the text of the BOJ statement, elation gave way to befuddlement. Japanese stocks ended the day down 1.9%. The new measures don’t amount to extra easing by any significant degree.”
Until recently, markets remained sanguine in the face of downward pressures on commodities as well as general global consumer and producer price indices. After all, “do whatever it takes” central bankers would be compelled to increase QE to reach their so-called “inflation mandates”. Regarding QE and the global drive to increase inflation, it’s been “If it’s not working just do more of it.” And speculative markets have absolutely loved the QE bonanza. At some point, however, central bankers had to face the reality that QE is highly destabilizing – and not all that effective. First it was the ECB. Now the BOJ. Reality is beginning to set in. “Do whatever it takes” has limits, especially when it comes to QE. Suddenly, the bursting EM and commodities Bubbles appear a lot more problematic.
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I suspect some of the more violent C-Section Awakenings will occur in the financial field. Lots of (financially rewarded) denial there. Stay tuned.
So is it going to be 2016 or 2017 crash? Donald Trump predict around that time. With global slowdown, he could benefit from collapse if it happens before elections.
Finance is basically non-linear in many ways. That makes it mathematically chaotic. You get small islands of stability in a sea of big waves and high winds with lots of foam and whitecaps. I am not saying that we are in one of those islands of stability, we are not. Problem is that most folks have not gone on deck to see how bad the weather conditions are. They are pretty lousy and about to hit with hurricane force. Wear a life jacket or have a lifeboat handy you may need both.
I think I've made no secret that I want these bubbles to burst. Not only to show that our bets (gold, silver and cash) were correct but also to make these banksters poor and show everyone these people aren't any good at their jobs. One of my biggest peeves are people in jobs they clearly aren't qualified to do (walk into any shop and see how the staff try to sell you stuff they clearly don't understand).
But part of me doesn't want these bubbles to burst because it will cause damage, misery and worse to many innocent people. People who were just trying to keep their heads down and earn a crust. They didn't do anything wrong.
I wish i could educate them more on this topic, but I certainly don't want to be THAT person (you know what kind of person I'm talking about!).
But irrespective of whether I want these bubbles to pop or not, doesn't change reality. They have to. But the question is, will they ever?
What is bigger than these bubbles is the politcal and financial will to keep them maintained. That's something we, ZHers, can't beat. Well, not directly, anyway. There may be years left in these bubbles.
I'll give you an example, Japan's has been in a funk since the late 90's. It's been near 20 years since then and they are still chugging along. And they are not the world's reserves currency or the world's largest economy. I think the US still has a enough clout and goodwill to keep this going longer and to think this will pop in the next few years is seeming increasingly unlikely.
Now, don't get me wrong, I WANT it kick off (despite my misgivings), the underlying data just seems to point to one conclusion, but I always have to entertain the possibility that I got it wrong. Come on, isn't there a tiny doubt in the back of your mind.....?
"But part of me doesn't want these bubbles to burst because it will cause damage, misery and worse to many innocent people. People who were just trying to keep their heads down and earn a crust. They didn't do anything wrong."
everybody chooses not to see for there own perceived benefit. if we are honest, we probably should be consuming the level of the amish or native indian but fear and competiion pushes us to edge out others and have more than you need.
.? They did everything wrong. They vote don't they?
The merry-go-round will continue turning not just for years, not just for decades, but for GENERATIONS more. You will ALL live out the rest of your lives under the current regime scheme, with uncertainty, anxiety, frustration, and declining quality of life and prospects for prosperity.
The regimes have many, many, many more means of keeping the system operating and not collapsing, and power lust + regime survival as the primeval motivations. So many people leap into the conviction that collapse is inevitable and immanent, but that is because they want it far more than it is necessary.
The future is decline, decay, deterioration, mediocrity, stagnation, and rot, not collapse - a muck pit not a cliff edge.
It all comes down to willingness to accept debasement of a currency.
Bank loans go bad -> transferred to the government -> Government loans start to go bad -> transferred to the currency -> The currency goes bad.
It all depends on the willingness of the world to continue accepting US dollars. The world accepts US dollars because all the major commodities, including the most important - oil must be purchased in dollars. People hold reserves to make sure they can buy the stuff necessary to live.
What if. The biggest oil producers stopped accepting US dollars. Russia? Saudi?.
Why would the world continue to hold them? When they stop. How much debasement can the domestic US market handle?
And look at the points of trouble today. Yemen, Syria, Iraq.
The US just "can't handle the truth"
Really? can you point to market based credit? Can you point to major companies that have gone bust because of their lending decisions?
No.
Because the credit is government subsidised.
Please go home!
Come back in a few days.
When 'your bank' reopens after the mergers, it will be better and stronger than ever.
Thank you for your patients.
Market based credit? WTF? The federal reserve system is a state-backed cartel which has murdered people by the millions to keep their power over the global financial system. There is nothing "free-market" about it.
Importantly, market-based finance did not equate to freer markets. Indeed it was the exact opposite....
The core fallacy of Reaganomics...pumping assets on unfettered credit.
A SELF FULFILLING PROPHECY, you obtain the opposite of what you sought.
No trickle down and ALL goes to runaway speculation. You have opened pandora's box!
Gordon Gekko can shout : greed is good as there is nobody to check a market fed on cocaine! Our regulators are in on the take!
The only rules : NO rules!
The market will regulate itself and to make sure it does we just keep pumping money into it and even offer Zirp ! (Thank you Mr John Galt; I mean Mr Greenspan).
A cocaine injected market understands Moral Hazard???
haha! And now its "every man for himself to the lifeboats"; before the Titanic....
There was a specific “credit related” reason for the 20’s bubble. There was a specific reason for the recent property bubble. There was a specific reason for Japan’s bubble. I’ve discussed all of these events in previous postings.
First of all, Credit is not money. It has its own name…credit. Credit is a type of money that comes into being and also disappears in a time cycle. Credit can circulate beside money as a doppleganger.
The bulk of the money supply today is Bank Credit, about 97%, which originates as private bank loans.
Government also borrows from private banks. So, the wellspring - or source of money is LOANS, not government printing.
In the U.S. government deficit spends by issuing a TBill into the Primary Market. Government grabs existing credit money from money supply. That TBill may then later find its way to reserve loops of private banks.
This point about credit should be more than obvious by now, and should not need to be repeated, yet this reality is not getting across and lodging in people’s brains.
In the past, the money supply had more than just bank credit present; it could also have Treasury money. Going even further back, gold or silver could be dug out of the ground, and then coined – so it literally came out of the ground, and then gained law with its stamp.
During Greenback Era, Bank of England/Rothschild sent their agent, August Belmont to the U.S. The objective of Belmont was to usurp the idea of sound money and confuse people into believing that “good money” was bank credit.
During Greenbacker movement of starting around 1872, people demanded an irredeemable paper currency issued by government, directly to the people. Civil war debt free Greenbacks were already circulating and people then had an idea how they worked.
This would be a type of floating money without a time dimension as in bank credit. It could go on to pay debts public and private. It would not have chains of counterparties and hence it would not collapse in depression panic. It would be low friction and low cost, allowing labor to trade their output cheaply. We don’t have this kind of money today, and hence we are more prone to Credit bubbles than in the past.
With regards to the roaring twenties and its bubble; it should also be obvious that this is post federal reserve period (1913). Roaring twenties are also post WW1 (End in 1918)
The Federal Reserve kept the price of credit low during the 20’s due to a secret deal with European central bankers, especially Britain and France. They did this so these European countries could re-acquire their gold lost to America during the war.
The Federal Reserve came into being almost exclusively from the minds of Paul Warburg and Benjamin Strong.
Strong insisted that Federal Reserve Obligations be made law of the land, NOT U.S. MONEY.
After WW1, Strong and Montague Norman (Bank of England) developed very cordial relations.
Strong and Norman were more than friends, with love letters to each other:
“Whatever is to happen to us, wherever you and I are to live – we cannot now separate and ignore these years…Somehow we must meet, and sometimes we must live together”
Yes, the U.S. Federal Reserve was imposed on the U.S. population by Jews and Fags. Sorry that reality has inconvenient facts …deal with it.
During the roaring twenties, U.S. government expenditure dropped from 8% of national income in 1920 to 4% of national income in 1929.
IT WAS NOT GOVERNMENT SPENDING THAT CAUSED THE BUBBLE.
Federal government debt dropped from 23B to 16B in 1929. Government actually put a drag on private economy by paying down public debts.
The source of the “low interest rate” policy in 1920’s – to drive down the price of Gold, was revealed by H. Parker Willis.
Congressional stabilization hearings of 1928 confirmed that the British controlled U.S. discount rate.
Testimony between Federal Reserve Board Chairman Governor Miller and Chairman McFadden discuss the secret meetings of the bankers and their collusion to keep discount rate low.
All of this was to help the Europeans “get their gold” at the expense of the American people.
In Carrol Quigley’s book, Tragedy and Hope, he discusses the assumptions of the bankers in formation of Federal Reserve.
“The influence of financial capitalism and of the international bankers who created it was exercised both on business and on governments, but could have done neither if it had not been able to persuade both these to accept two “axioms” of its own ideology. Both of these were based on the assumption that politicians were too weak and too subject to temporary popular pressures to be trusted with control of the money system; and accordingly, the sanctity of all values and soundness of money must be protected in two ways: by basing the value of money on gold and by allowing bankers to control the supply of money. TO DO THIS, it was necessary to conceal, or even to mislead, both governments and people about the nature of money and its methods of operations.
Gold, bi-metalism, and private bank credit/debts have all showed themselves to be false standards – rent seeking standards benefiting a few a top of a financial pyramid.
The true nature of money is law. If humanity wants to do away with financial bubble economics, and if it wants markets and prices to work, then it needs lawful money.
Change the money system to match its true legal nature, or the bubbling shit show will continue forever.
www.sovereignmoney.eu
Too many Parasites always kill the Host.
we have way too many Parasites in the financial world
To understand Japan's bubble, watch this movie.
https://www.youtube.com/watch?v=p5Ac7ap_MAY
It is about 1.5 hours long, so find some time.
Pay special attention when they talk about "credit guidance."
This is Industrial CAPITALISM, not Financial Capitalism.
Big difference. Japan is now post industrial due to BOJ maneuverings using bubble economics.
Note: A proper money suppy would consist of floating sovereign money and also some directed credit.
Clearly, Doug Nolan has not watched the movie, and doesn't understand what happened to Japan.