Submitted by Jeffrey Snider via Alhambra Investment Partners [10],
I generally remain noncommittal about giving specific predictions about the future because there is simply no way toward predilection. We can think about probabilities as a guide for analysis, particularly in setting investment guidelines, but to offer targets for factors like GDP or some stock index is pointless. Even now, with all that is taking place of economic unraveling, there is still a non-trivial chance that GDP improves and stocks take off; I wouldn’t call that the baseline scenario but it’s enough to not ignore.
That being said, recent indications have darkened the probability spectrum to the point that it may actually be worth examining a worst case scenario. My gut sense is that there is indeed a recession forming, and one that looks worse by the month, so there are numerous relevant factors that demand attention the greater the potential for it. That starts with leverage and any transmission from finance to the economy.
If this is to be the third bubble episode in succession, the prior two do offer at least a useful guide as to potential even if their ultimate resolutions were quite different (to say the least). The dot-com bust that began in April 2000 took nearly three years to resolve itself, but remained suspiciously orderly in how that occurred. For a market event that took almost 60% off the S&P 500 high to low, it was both torturous and downright regular. The economy took its cues from that as well, despite fears of 1929 and asset-driven “deflation” there was no banking element in the reversal, and the recession itself, dated officially from March 2001 until November that year, was about as mild as a recession might go.
Alan Greenspan took the credit for all that, even though he was belated in his response and his monetary monster was responsible for it (denials somehow still persist). If there was a monetary factor in limiting the collateral damage to the economy and larger financial system, it had nothing to do with his expedition with the federal funds rate into “ultra-low” territory, instead the action was all over the eurodollar system. In short, the ascendancy of the eurodollar standard provided a massive cushion against even the largest asset bubble ever seen (to that point) – demonstrating the sheer absurdity of the bubble that took its place.
Convention views the housing bubble as arising sometime around 2003, but it is clear the world was fully engulfed long before then. The eurodollar effects (Greenspan’s idiotic idea of “global savings glut”) showed up as early as 1995 in so many places only a blind ideologue could have missed them. Thus, the dot-com bust was but a sideshow to wholesale finance that gave only partial and temporary pause then.
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In fact, the housing bubble was hit harder (relatively) in its infancy by the Asian flu than the dot-com bust, more than suggesting that offshore “dollar” influence. Greenspan did nothing but sit back and let the eurodollar insanity carve out his GDP mandate year after year, through debt upon debt, all the while the Fed thought its 19th century view of finance was the monetary equivalent of magic and genius.
And that is why the 2008 bubble burst event was so much more dramatic. In these terms, it wasn’t necessarily the asset bubbles that were changing, it was the eurodollar standard that built them. Whereas there was solid financial flow in the 2000-03 period to keep that first bubble’s reversal orderly and far less problematic, starting in August 2007 liquidity underwent two successive reversals that ultimately amounted to total failure by 2008.
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In this context it is easy to see why 2008 was so devastating where 2001 was not. In response to getting everything wrong in 2008, the Fed (almost understandably) by the end of 2008 and into 2009 set about trying to recreate the economy and financial system as it existed at that 2007 peak. It finally evolved into the 21st century by shedding its role as “lender of last resort”, with anachronistic tools like the Discount Window, and belatedly entered the realm of derivative and shadow finance becoming “dealer of last resort [15]” and even “market of last resort [16].” QE’s fell under that regime, both as a means to force spending in the economy and as intended (though ultimately meaningless) assurance to financial agents (the real “printing press”) for the debt-basis that is all that is allowed [17] under activist central banking.
The results of all of this have been far from fruitful, evidenced greatly at the start by the fact that there is still debate eight years later about whether or not a recovery has ever taken place. With that in mind, thinking about what might come next is already deficient just on the economic side (a recession with consumers already in the bunker before it ever began?). But there are also building dangers about financial feedbacks to consider, especially as it relates to the eurodollar standard in structural reverse. As shown above, through TIC flow, which is one meaningful method of presentation, the eurodollar standard has not been reconstituted despite all aimed efforts.
Initially, there seemed great promise to the determination in that area, as late as April 2011 there appeared some likelihood of getting back to at least close to the pre-crisis mode of operation. But the euro crisis that summer, which was in no small way a parallel “dollar” crisis, ended any hopes for revisiting pre-2007 financialism. The Fed, as always, did not get that message and instead opted to simply make it worse by removing the one “pillar” that was holding even that limited rebound in place – tapering QE. Just the threat of doing so has strained and totally sapped global “dollar” liquidity to the point that minor disruptions become major global events (October 15, January 15).
In short, the rebound in the eurodollar standard was never a permanent solution because it was as artificial as the economy it was intended to foster. Dealer capacity was rebuilt solely on the promise of QE-forever and that effect on bond prices as without pre-crisis conditions for gain-on-sale profit through proprietary “hedging” of inventory and providing liquidity through inventory and warehousing, there isn’t any real profit opportunity anymore. Spreads have been squeezed and avenues shut down (this, on its own, would not necessarily be an unwelcome result as financialism is due for several steps back, the problem, however, is where the Fed, again, intends on recreating 2006; in other words, you need the dealers and their activities to get you there, so you either have to accept what they do or stop trying to go back).
As noted yesterday [18], liquidity is bad and getting worse which would seem to rule out the 2001 version of bubble reversions. With the eurodollar standard growing even more precarious, arguably as bad now as in 2008, there is no financial cushion should “risk” shift dramatically.
