Reply #27: This Time it is Different [View All]

[54anickel]

Last entry in the credit bubble bulletin page

http://www.prudentbear.com/creditbubblebulletin.asp

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This Time Economic Output Is Different. And I do feel comfortable with the insight that the Character of Inflationary Manifestations is today as Different as the change in the nature of output. If it were today possible to calculate a legitimate consumer price inflation rate, it would still represent only one facet of inflationary processes. And I have no confidence that it is possible to successfully analyze contemporary “output” and worker hours to accurately differentiate “productivity” and quality enhancements from “inflation.” Are doctors, attorneys, real estate agents, mortgage brokers, investment bankers, and hedge fund managers more productive these days, or is it more a case of atypical inflation dynamics prominently at play? As I explained last week, I do not believe there is a “general price level” – hence the notion of “real GDP” is an anachronism from a bygone – tangible output - era. “Real GDP” should be downplayed, with the focus on sectoral and nominal outputs.

Recognizing the changed nature of output does not set the analytical world on fire. Things do, however, heat up when the debate moves on to ponder the ramifications as they relate to the Financial Sphere. This Time It Is Different – the nature of economic output (i.e. services, medical, admin, finance, digital, virtual and media) does profoundly impact the capacity for the economy to “produce” increased “output” (and income) without engendering traditional inflationary pressures (especially for CPI). Importantly, the New Paradigmers contend (mistakenly crediting the Fed for having achieved “price stability”) that the new inflation environment affords the system the luxury of low Fed and market rates. As they see it, there is today little risk associated with extended periods of generally loose monetary conditions. It is my contention that the changing nature of economic output – and the capacity for seemingly non-inflationary expansion – ironically beckoned for judicious monetary caution and restraint.

The financial sector indulges in unrestrained expansion, with basically limitless capacity to create “money” and Credit to fund output growth and the asset markets. And while contemporary output expands quiescently with each year of rising GDP, the associated Credit creation invariably inflates the Financial Sphere and the available pool of (global) finance. Unconstrained financial sector expansion creates the extraordinary capacity to satisfy heightened borrowing demands without the normal corresponding market-based increase in the cost of finance (higher rates).

While Bank Credit growth has been robust, non-bank “money” and Credit creation has been historic. The ABS market has expanded 185% in seven years to $2.9 Trillion, while MBS has almost doubled to $3.5 Trillion. Total GSE Assets have increased 160% over this period to $2.9 Trillion. Broker/Dealer Assets are up 135% to $1.8 Trillion. Outstanding primary dealer repurchase agreements now exceed $3.3 Trillion, while global derivative positions now surpass $220 Trillion. Investments in hedge funds now exceed $1 Trillion. While the analytical focus remains on the seemingly innocuous expansion of GDP, the expanding pool of global speculative finance grows only more unmanageable.

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And while U.S. markets were this week enamored with notions of sinking interest rates and financial and economic paradise, there were some unsettling developments. French and Dutch voters this week sent a message that they are increasingly impatient with the current economic and financial arrangement. The faltering dollar, rising energy prices and an over-liquefied Asia have taken a toll on Europe. And while a wounded euro will be interpreted by the goldilocks crowd as a positive development for the dollar, as well as the U.S. markets and economy generally, I would be cautious. Any loss of euro confidence is an unwelcome blow to a global currency “system” already tottering over its unsound dollar foundation. Moreover, perceptions of a weakened euro appear to be pressuring global interest rates lower, while taking some pressure off the dollar. These are problematic developments in today’s profligate environment, certain to only exacerbate U.S. Mortgage Finance and Credit Bubble excesses.

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And perhaps the Fed is ready to declare quick victory, pack their briefcases and cheekily celebrate after nine effortless little baby-step innings. Yet little do they appreciate that it is a best-of-seven series, and their wily opponent has been happy to spot them game one. The current interest rate, liquidity, speculation, economic and global backdrops are conducive to only greater Monetary Disorder and unwieldy imbalances - both at home and abroad. Would $70 crude, spiking commodities prices and a long, hot summer housing mania catch the Fed’s attention?

Well, I’m sticking with the view that the Fed will be forced to step up and play ball. And it is when times get tough – when unstable markets turn uncooperative – that everyone will be reminded as to why it is so important for a central bank not to fall so far behind the curve. This Time it is Different: In an extraordinarily uncertain and problematic environment, the Fed somehow telegraphed to an extremely leveraged and speculative marketplace that there was nothing to worry about.

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