Thursday, September 27, 2007

U.S. Economy Entering Twilight Zone

A very clever and interesting post by Gary Dorsch, Editor, Global Money Trends on the possibility of hyper-inflation in the U.S. Calling it the Twilight Zone.

Nowadays, there are numerous signposts indicating that inflation in the United States is getting out of control. The US M3 money supply is 14% higher than a year ago, its fastest growth rate in 35-years, the US Dollar Index is plunging to 15-year lows, gold is surging toward $725 /oz, a 28-year high, crude oil is cruising above $80 /barrel, wheat prices have doubled to $8.75 /bushel, an all-time high, and the Baltic Dry Freight Index has zoomed 300% higher to stratospheric levels.

It’s like entering “a fifth dimension beyond that which is known to man, that lies between the pit of man’s fears and the summit of his knowledge. It is an area called “the Twilight Zone,” Mr Serling explained.

Could it be - the fifth dimension that lies ahead is hyper Inflation, and the re-ignition of the “Commodity Super Cycle?” Money is still pouring into commodity indexes to diversify portfolios, amid recent financial market turmoil, reaching $120 billion at the end of the second quarter, up 50% from a year earlier.

Food and energy prices are sharply higher from a year ago, and this time, the surge in these “volatile components” of inflation is not a flash in the pan. But remember, you’re in the “Twilight Zone,” where perception is more important than reality, and emotions often trump logic. Putting it another way, “there is nothing so disastrous as a rational investment policy, in an irrational world,” explained JM Keynes.

Thanks to the global monetarist policies adopted almost a year ago. The impact of hyper-inflation was made clear by Japan and what happened to them after their market overheated. They only recently pulled out of their economic spiral.

And the reason for the worry well gee this super cycle occurred in the past like 1937. That was how long the 1929 crash impacted for. And of course to get out of that crisis there was a war. There is a war now but rather than pulling America out of economic crisis it is dragging it down.

Commodities in middle of rare 'super-cycle'

Friday 30th March 2007: 08:00
By Scott Sinclair
Commodities should be on every investor’s wish lists as the sector is in the middle of a ‘super cycle’ that occurs only once every 50 years, according to BlackRock Merrill Lynch.

The firm says the cycles are driven by huge structural changes in the global economy – such as the European industrial revolution – and that strong growth and industrialisation in countries such as India and China has signaled the start of another. - Commodity Super Cycle to Last Several Decades

Many people are wondering: Is the commodity bull market intact?

David Fuller:
Absolutely, beyond a shadow of a doubt. This is a commodity super cycle, and it will be the biggest commodity super cycle in history to date. This could go on for several more decades – thirty to forty years.

The longest timeframe we’ve been told about is through the year 2020.

Ah yes just in time for Peak Oil! Hubbert's curve coincides with the
Kondratieff and Elliot wave theories.

At the beginning of the Industrial Revolution,
only Britain staked its future on coal. Other
countries, even in Europe, accepted industrialization
as the predominant way of life in the aftermath
of the 1848 European revolutions, with
the technological package of railroads already
fully refined. During the K-wave of the first half
of the 20th century, coal reigned supreme. Only
the fourth K-wave, the last discernible one, from
the 1950s to the Oil Shock of the 1970–80s5, announced
the true start of the Oil Age.

One might suspect this wasn’t random. The
opinion that a K-wave marks a dependence on
a single resource and fades as this resource is
exhausted seems corroborated by the existence
of the so-called Hubbert’s curve. As early as in
the 1950s the latter predicted that, in about 20
years, the US oil deposits would be exhausted
How General is the Hubbert Curve? - Ugo Bardi
The Hubbert model of crude oil production can describe several regional cases, but it is not yet generally accepted as being of validi for all cases, especially for the worldwide case of oil extraction. The present paper shows that the model is of general validity to describe cases in which a resource is depleted faster than it can be replaced, as in the case of biological resources. In some cases, historical fishery data appear to be relevant for understanding the present price trends of crude oil.

The Fifth Kondratieff Wave - The Fossil Fuels Apogee - João Matias

Bearing in mind these data, there are no doubts
that the primary energy sources are associated to the
major technological transformations and consequently
associated to the structural long waves (frequently
known as Kondratieff Waves or simply Kwaves).
Coal began to substitute wood in the eighteenth
century (1st technological transformation,
responsible for the economic expansion of the 1st Kwave),
being diffused in the nineteenth century (it
surpassed wood in the peak of the 2nd K-wave),
reaching the stagnation (beginning of the decline) in
the twentieth century (it reached the maximum point
in the peak of the 3rd K-wave). During the period
from 1800 to 1920, coal went from providing around
10% to over 60% of the word’s total commercial
energy requirements, being linked to the iron and
steel industries, being the primary energy source of
the first and second technological transformations.
However, the non-solid fossils (NSF - oil and natural
gas) began to substitute coal in the nineteenth century
(3rd technological transformation, responsible
for the economic expansion of the 3rd K-wave),
being diffused in the twentieth century (they surpassed
coal in the peak of the 4th K-wave), being
foreseen the reach of stagnation in the present century
(the maximum point (turning point) in the peak
the 5th K-wave). During the period from 1920 to
1973, the oil market share grew from 10% to around
50%, being mainly linked to the automobile industry,
being the primary energy source to the 3rd and
4th technological transformations.

Commodities super-cycle - how much longer will it last? - Money Week

You would have to have been living on a desert island for quite a long time now not to be aware that something has been going on in the world of commodities. Oil increased in price sevenfold between 1999 and 2006. Copper did almost the same in 4 ½ years from its low at the end of 2001. The precious metals have also soared in this new decade. Now it’s the turn of the grains, where wheat and particularly corn have exploded higher on the US futures exchanges.

What is a super cycle?

This has all given rise to much loose talk in investment circles of a commodities super cycle which will stretch several years into the future. But what do people mean by a super cycle? Over the years some economists have observed that there are phases of economic activity, where waves of expansion and growth are followed by slowdown and recession, and that these phases can be quantified in terms of duration.

Kondratieff was probably the most famous exponent of this approach in the 1920s, while in the US Dewey and Dakin took up the theme in their book “Cycles – The Science of Predictions” published in 1947. In both cases, a long wave (or super cycle) is posited as lasting between fifty and sixty years in which we move from trough to peak to trough again. Within the long wave there are deemed to be smaller waves, in which activity ebbs and flows in briefer time periods. All of these studies focused as much on the historical analysis of commodity prices as on interest rates, trade, inflation and the rest of the available economic data.

The equivalent in the technical analysis of markets is to be found in the wave theory of R.N. Elliott, in which he breaks down the trends in bull and bear moves into cycles that last from minutes through to decades.

Of course, the value of all these cycle studies lies in their supposed predictive power. And here is where the problems begin. Even as convinced a believer in the commodity bull cycle as Jim Rogers points out that the shortest boom lasted 15 years, while the longest lasted 23 years. His conclusion is that we have much further to go, but don’t expect a great deal more precision than that. Oh, and don’t forget that we’ll endure some huge corrections along the way.

The big event of the moment is clearly China. I could run through endless statistics indicating the dramatic nature of the new industrial revolution that is taking place there – its double digit annual growth rates, its spectacular leap up the league tables to become the world’s fourth largest economy and so on. In focusing on China, we shouldn’t forget about India – it is the second fastest growing major economy in the world, with GDP growth up just under 10% - or Korea (up 5%) or countless other booming countries. It’s just that the sheer size and scale of everything Chinese makes it stand out and suits it to the role of representing the emerging market economic boom as a whole.

The staggering numbers on Chinese economic growth are matched by equally impressive figures in relation to its consumption of commodities. The International Monetary Fund reports that its share of the overall growth in global consumption of industrial commodities between 2002 and 2005 was massive – 51% for copper, 48% for aluminium, 110% for lead, 87% for nickel, 54% for steel, 86% for tin, 113% for zinc, and 30% for crude oil. On the subject of oil, the Energy Information Administration (the US government’s provider of official energy statistics) envisages a 47% increase in global demand from 2003 to 2030, and that non-OECD Asia (including China and India) will account for 43% of that increase.

And two years ago China was pointed out as being the source of the hot commodity market boom.

China - The Engine of a
Commodities Super Cycle
Commodity Update

31 March, 2005
! We believe a super cycle is underway, driven by materials
intensive economic growth in China.

! A super cycle is a prolonged (decades) trend rise in real
commodity prices, driven by the urbanization and
industrialization of a major economy.

! There have been two super cycles in the last 150 years: late
1800s-early 1900s, driving economic growth in the USA; 1945-
1975, prompted by post-war reconstruction in Europe and by
Japan’s later, massive economic expansion.

! High and rising intensity of metals use is the most useful
indicator of a super cycle. In China, intensity of use is now
three times that of the USA, with demand driven by
urbanization, industrialization and fixed capital formation.
Importantly, the domestic market drives China’s metals
demand, not exports.

! In past super cycles, supply has increased to meet higher
demand growth.

! In the present super cycle, increased supply will come at
relatively higher costs. Lead times are also increasing,
contributing to extended periods of market tightness.

! Under these circumstances, higher long-term commodity
prices should be used.

But China cannot save America from a crash at worst and stagflation or deflation at best.

The Business Cycle and Politics
The business cycle discussion can get you killed. Just look what happened to poor old Kondratieff in the fomer Soviet Union. He dared to discuss how the business cycle's ups and downs could theoretically be fine tuned and possibly be controlled. This was anathema to Marxist ideololgy since it portended a 'perfecton' of capitalist economics. Kondratieff was executed for this heresy see and also

Nowadays if you dare to point out that we are at a peak of a Kondratieff Wave in his description of the world economy's cycle, you are just as likely to be "taken out" (maybe not literally but figuratively !) by a rabid capitalist neocon.

Thomas Frank's book "One Market, Under God" gives a great outline of this populist market ideology which the media is selling us. Too bad the myth of the populist stock market is common knowledge nowadays (see "The myth of the populist stock market" which contains this gem: "At the height of the boom, however, the bottom three-quarters of American households owned less than 15 percent of all stock. Barely a third of households hold more than $5,000 in stock. Most Americans have more debt on their credit cards than money in their mutual funds." )

These business cycle theories play nicely with Kevin Phillip's "Wealth and Democracy" ideas. In his book he shows that concentrations of wealth within the empire du jour (he discusses the Dutch, Spanish, English economic empires with a finger pointed at the US today...) as the leading cause of its demise. He might also have just as well looked at Leviticus 25 and the fifty year cycle of Year of Jubilee where all debts and wealth was reallocated !

Today, we are faced with another Kondratieff Winter (depression) when the majority of the world anticipates economic expansion. Each individual needs to weigh the risk of depression in light of Kondratieff's work.

Accumulation and Consumption

U. S. wholesale prices dating back to 1800 show several periods of accumulation followed by periods of over consumption. Because these periods are statistically difficult to measure our outline follows historical events, pinpointing major changes in trend. During periods of relatively cheap prices, assets accumulate. As prices increase, the consumption of assets are necessary to maintain a standard of living. When new production fails to keep up with consumption, due to relatively high prices, the economy begins to decline to another period of cheap prices, and a new growth cycle begins.

Four Phases of One Cycle

A Kondratieff cycle consists of four distinct phases, or distinguishable, dramatic mood changes, the tone of which determines the actions of individuals involved in the economy. The awareness of these characteristics allows for the anticipation of the change in the economy and the psychological mood that will prevail.

SPRING - Inflationary Growth Phase

A common premise among business cycle economists supposes inflation as an inevitable part of growth. Government becomes a passive participant in the inflation cycle. Growth begins from a depressed economic base and expands in an ever-increasing spiral. The interaction of the participants within the economy causes wealth, as represented by savings, and the production of capital equipment to be accumulated for the future. The expansion of production and affluence causes prices to rise, and the increased volume of goods requires a higher velocity of money, thus creating a higher price structure.

Historically, the growth phase requires 25 years to complete. During this time, unemployment falls, wages and productivity rise and prices remain relatively stable. The mood of the growth phase is one of accumulation and the desire for new product manufacture.

Accompanying growth is a shift in social demands. As wealth is accumulated and new innovation introduced great upheavals and displacements take place. The process of social unrest builds with growth culminating in massive shifts in the way work is defined and the role of the participants in society.

SUMMER - Stagflation (Recession)

Eventually, the continuation of exponential growth reaches its limits. Excess capital produces a shortage of key resources and the economy enters a period where growth creates a shortage of resources. An economy will only support expansion to the limits of its resources, both human and material.

The mood of affluence also brings a change in attitude towards work. As an economy gets closer to its limits inefficiencies build up

The imbalances of this period have been historically exaggerated by what can be labeled a "peak war". Examples such as War of 1812, the Civil War, World War I and Vietnam, came at the end of a very affluent period. These Wars produce strains on the economy increasing the impact of inflation. A dramatic drop in output, rapid rise in unemployment and unusually severe recession characterize this period. Although this primary recession is short lived lasting only three to five years, it is key in altering perceptions and the structure of the economy. No longer does excess create an abundance. The "Limits to Growth" now define a maximum level of economic activity that traps the economy into consolidation and tight bounds for the next 20-25 years. With the change comes a conservative shift in the popular mood reinforcing the limits..

AUTUMN - Deflationary Growth (Plateau Period)

The primary recession occurs out of an imbalance forced upon the economy by real limitations. The rapid rise in prices and changes in production correct this imbalance -- at least temporarily. The change in price structure, along with the mood of a population used to consumption accompanied by the vast accumulation of wealth from the past 30 years, causes the economy to enter a period of relatively flat growth and mild prosperity. Due to structural changes and the limits of the existing paradigm the economy becomes consumption oriented.

Excesses of an unpopular war, along with fiscal liberalism, cause popular reaction toward stability or normalcy. A mood of isolationism permeates . The plateau period generally lasts seven to ten years and is characterized by selective industry growth, development of new ideas ( both technological and social ) and a strong feelings of affluence, terminating in a feeling of euphoria. The inflated price structure from the primary recession, along with the desire for consumption, produces a rapid increase in debt. Eventually, wealth consumption expands beyond all practical limits, and economy slips into a severe and protracted depression.

WINTER - Depression

Excesses of the plateau period effect a collapse of the price structure. This exhaustion of accumulated wealth forces the economy into a period of sharp retrenchment. Generally, the secondary depression entails a three year collapse, followed by a 15 year deflationary work out period. The deflation can best be seen in interest rates and wages that have shown a historic alignment with the timing of the Long Wave - peaking with and bottoming at the extremes.

Kondratieff viewed depressions as cleansing periods that allowed the economy to readjust from the previous excesses and begin a base for future growth. The characteristic of fulfilling the the expectations of the previous period of growth is realized within the Secondary Depression or Down Grade. This is a period of incremental innovation where technologies of the past period of growth are refined, made cheaper and more widely distributed. Incremental innovation consolidates industries.

As increment innovation narrows profits and increases

The Down Grade sees one final period of recession before transitioning to a new period of growth. The final recession is mild with very low inflation and appears far more severe than it will be remembered for later in the Growth Cycle.

Within the Down Grade is a consolidation of social values or goals. Ideas and concepts introduced in the preceding period of growth while radical sounding at the time become integrated into the fabric of society. Often these social changes are supported by shifts in technology. The period of incremental innovation provides the framework for social integration.

It is important to realize the Long Wave as global. While global issues are of prime importance today with increased air travel and communication, the Long Wave defines a time table for geo political events. The Growth Period is one of political stability. Staring a the peak old alliances become challenged. Through the process of the Down Grade old alliances fail and new alliances are formed. The final stages of the Down Grade is a period of coalescing or "quickening" of the alliances that will govern the next period of growth.

The current 4-year stock cycle is coming to an end. Some thought it ended last September 21, 2001. It may still be in play and could bottom in early July 2002 although we suspect it will, following a summer rally, bottom later in the fall of 2002. That should set up a decent run in 2003, which should allow for graceful exits for those still caught in the malaise of the first big drop. That would set the next cycle bottom for around 2005/2006, which could be the ultimate low for the markets. Time of course will tell.

The Winter of the K-wave is a dangerous period. But it will be eased for those holding gold or gold stocks. That new bull market is still in its infancy and may yet face a significant shakeout to make its final bottom. But we would all be wise to hold at least a little gold. The winter of the K-wave is upon us.

THE KONDRATIEFF WAVE. Peaks and troughs are associated with major political or cultural events.

1893, 1929, 1973, 2007: Echoes of Rolling Thunder

Let's start a re-cap of the week's theme--the Great Unraveling--with a brief look at The Panic of 1893:

"The Panic was the worst economic crisis to hit the nation in its history to that point. The National Cordage Company (the most actively traded stock at the time) went into receivership as a result of its bankers calling their loans in response to rumors regarding the NCC's financial distress. A series of bank failures followed, and the price of silver fell. The Northern Pacific Railway, the Union Pacific Railroad and the Atchison, Topeka & Santa Fe Railroad all failed. This was followed by the bankruptcy of many other companies; in total over 15,000 companies and 500 banks failed (many in the west). About 20%-25% of the workforce was unemployed at the Panic's peak." Hmm, calling in loans, 1893, calling in busted CDOs, 2007... and did you notice the 40-year cycle of recession/depression? 1890, 1930, 1970, 2010. Let's look at the similarities between then and now: 1. 1893: Massive debt-fueled speculation. Railroads and other speculative ventures (yes, they overbuilt railroads in the late 1800s, just like they overbuilt the Internet in 2000) were all financed with debt-- heavily leveraged debt. No money down, no assets, just paper and promises. Sound familiar? 2. 1929: Massively leveraged speculation. In the Roaring 20s, you could buy $1,000 worth of stock with only $100--a 10% margin requirement. Now, CDOs and other derivatives are leveraged 10 times or even 20 times. A drop of only 5% in the underlying security/mortgage/bond thus spells ruin for the 20X leveraged derivative. 3. 1970: Rising energy costs, deficits and inflation, war, stagflation. The "guns and butter" policies of the late 60s and 70s (paying for a horrendously expensive foreign war and a global Cold War, while lavishing massive Federal entitlements on millions of citizens) created unprecedented deficits and inflation which despite various manipulations (the Feds started the bogus practice of "core inflation") began to run away from policy makers and consumers alike until interest rates were ratcheted up to 16% in 1981. The oil shocks of 1973 and 1980 sent energy costs to multiples of previous costs--just as oil has risen from $10/barrel in 1998 to $74/barrel today. This combination of inflation, spiraling energy costs and business cycle slowdown created a decade of malaise and stagflation. 4. 1970s: Nowhere to hide for investors. The 1970s were a decade of decline for both stocks and bonds, especially when adjusted for inflation. Real estate faired better, as did gold, as "tangibles" were viewed as hedges against a sinking dollar. However, with the World's Greatest real estate bubble now deflating, real estate is not the "undiscovered hedge" it was in the 70s. To see chart, please visit 5. Unprecedented bubbles in all asset classes. Stocks, bonds, derivatives, real estate, art--you name it, it's in a bubble. Interestingly, the best returns of the stagflation years were made in precious metals (a hedge against inflation and a dropping dollar) and plain old cash, which was eventually earning 15% per annum in money market accounts. The root cause of all financial panics and depressions is of course runaway borrowing/skyrocketing debt, risk and leverage. Is the U.S. economy heading for a Great Unraveling? This chart suggests there is no other possible outcome for a debt/leverage/risk expansion which now far outstrips the stupendous imbalances of 1929.

The reality is that the housing boom, the liquidity of the mortgage market that just had its global meltdown is not a unique American problem. It is a global problem as this post from Australia shows. Its not just the problem of easy credit, but of high interest payments on that credit. And as the recent very British Bank Run showed the bad old days of 1929 are repeating themselves.

Back in the good old days (1999) the repayments on your home could only be 1/3 or about 30% of your total gross income. I remember this clearly as it set the borrowing limit for our first and only house (about $130,000 at the time).

Now when I go to Suncorp and put in some figures they say I could repay 43% of income towards the loan (P&I) that is a stunning 59% of after tax income.

-Gross 1 $60,000
-Gross 2 $20,000
-net household $3500 + $1333 = $4833/m
-2 kids
-$6000 credit cards
-interst rate 8.5%
-25 year term
-no other loans

Loan Offered
-repayments approx $2890/m
-interst $2543/m

Even better the Interest portion of the loan is 52% of net income.


I think that banks have increased the amount they will let you borrow to keep up with rising prices - instead of loosing business. God only knows what tricks they play with valuations.
Total in relation to GDP has moved in a predictable cycle over the past century. We have still not seen the peak last visited in the mid '30s

In the trough of deflation between two K-waves,
this causes intense global competition
between the contenders, each pursuing a different
economic and social model, based on their
unique adaptations and the resources of their
relative niches. A massive clash, homologous
with World War II, ends with a definite victory
and marks the “second coming” of the winning
technology (Perez, 2002), a generally prosperous
era of standardizing the winning lifestyle and radiating
it to the close periphery. Example – mass
society became the standard not only in the US
and the so-called developed countries, but also
in the USSR and its satellites. This victory marks
the start of a massive technology transfer (the
Marshall Plan, etc).

After the inflationary peak of the next even
wave, the innate growth potential is exhausted.
The dominant society has to reach beyond its
native zone and collect its main resource from
far and wide while radiating its technologies in
exchange. Far from being unique for our times,
globalization manifested itself at the end of each
known historic civilization. Thus, the Romans
lost their competitive edge after outsourcing
most of their production to the outskirts of the
empire, from Cologne to Damascus. After the
1860s, the English outsourced their industries
overseas. Now, this is happening to the US.

We have seen this movie before in the Seventies at the end of the post war industrial reconstruction of Europe and Asia. The Keynesian boom ended in a long slow whimper as the neo-cons and monetarists dug its grave through their influence on Reagan, Thatcher, Howard, Mulroney, etc.

Stagflation is simultaneous economic stagnation and inflation, and it last emerged in the '70s, following the sharp oil-price rises and a poor decision by the Fed to allow money supply to balloon.

The appointment of Paul Volcker as US Federal Reserve chairman in 1979 was the beginning of the end of stagflation. Under his leadership, the Fed stopped targeting interest rates and started targeting money supply. Money supply plunged and America's economy went into recession — but by 1983 inflation was back under control, and US interest rates were down to just over 3 per cent, from a peak of more than 13 per cent.

In a report just out, "Aussie stocks and the stagflation scare", Citigroup strategists Adrian Blundell-Wignall and Alison Tarditi say inflation risks are definitely elevated. But as long as China's industrialisation continues and the US economy controls inflation and posts solid productivity gains (and it is — productivity growth is running an annual rate of 2.5 per cent) "we have the two conditions for a commodity super-cycle, akin to the 1950s and 1960s", the duo say.

Citigroup's London-based strategy team has separately examined similarities between the current market correction and the October 1987 crash — and there are quite a few.

The 1987 slump came little more than a month after the appointment of a new Federal Reserve chairman. Bernanke replaced Alan Greenspan as Fed chairman on February 1 this year, 10 weeks before the current slide began. Interest rates and bond yields were rising ahead of the 1987 crash as central banks bore down on rising inflation, and they are rising again now for much the same reason (although the inflation threat was bigger in 1987). As in 1987, the prospect that higher European rates will push the value of the US dollar down is a concern, as are the size of America's domestic and external deficits. The US current account was raising eyebrows in 1987: the current account deficit had risen to about 3.5 per cent of of the economy's annual gross domestic product in 1987 — a record high. It is now running at 7 per cent of GDP.

The Citigroup reports notes also that the severity of both downturns has been amplified by automatic or quasi-automatic trades — in 1987 as "portfolio insurance" software initiated a tsunami of stop-loss selling, and in this slide as equity derivatives, such as variance swaps, that trade price movements rather than the shares themselves generate selling volume.

Why Stagnation?

by Paul M. Sweezy

This is a reconstruction from notes of a talk given to the Harvard Economics Club on March 22, 1982, and is reprinted from the June 1982 issue of Monthly Review.

I suggest that the answer is to be found in analyzing the long period—twenty-five years or so—which followed the Second World War, during which we did not have a problem of stagnation. In fact during that time the incentive to invest was strong and sustained, and the growth record of the economy was perhaps the best for any comparable period in the history of capitalism. Why?

The reason, I think, is that the war altered the givens of the world economic situation in ways that enormously strengthened the incentive to invest. I list in very summary form the main factors: (1) the need to make good wartime damage; (2) the existence of a vast potential demand for goods and services the production of which had been eliminated or greatly reduced during the war (houses, automobiles, appliances, etc.): a huge pool of purchasing power accumulated during the war by firms and individuals which could be used to transform potential demand into effective demand; (3) the establishment of U.S. global hegemony as a result of the war: the U.S. dollar became the basis of the international monetary system, prewar trade and currency blocs were dismantled, and the conditions for relatively free capital movements were created—all of which served to fuel an enormous expansion of international trade; (4) civilian spin-offs from military technology, especially electronics and jet planes; and (5) the building up by the United States of a huge peacetime armaments industry, spurred on by major regional wars in Korea and Indochina. Very important but often overlooked is the fact that these changes were in due course reflected in a fundamental change in the business climate. The pessimism and caution left over from the 1930s were not dissipated immediately, but when it became clear that the postwar boom had much deeper roots than merely repairing the damages and losses of the war itself, the mood changed into one of long-term optimism. A great investment boom in all the essential industries of a modern capitalist society was triggered: steel, autos, energy, ship-building, heavy chemicals, and many more. Capacity was built up rapidly in all the leading capitalist countries and in a few of the more advanced countries of the third world like Mexico, Brazil, India, and South Korea.

In tracing the causes of the re-emergence of stagnation in the 1970s, the crucial point to keep in mind is that every one of the forces which powered the long postwar expansion was, and was bound to be, self-limiting. This indeed is part of the very nature of investment: it not only responds to a demand, it also satisfies the demand. Wartime damage was repaired. Demand deferred during the war was satisfied. The process of building up new industries (including a peacetime arms industry) requires a lot more investment than maintaining them. Expanding industrial capacity always ends up by creating overcapacity.

To put the point differently: a strong incentive to invest produces a burst of investment which in turn undermines the incentive to invest. This is the secret of the long postwar boom and of the return of stagnation in the 1970s. As the boom began to peter out, stagnation was fought off for some years by more and more debt creation, both national and international, more and more frantic speculation, more and more inflation. By now these palliatives have become more harmful than helpful, and to the problem of stagnation has been added that of a rapidly deteriorating financial situation.

Does this mean that I am arguing or implying that stagnation has become a permanent state of affairs? Not at all. Some people—I think it would be fair to include Hansen in this category—thought that the stagnation of the 1930s was here to stay and that it could be overcome only by basic changes in the structure of the advanced capitalist economies. But, as experience demonstrated, they were wrong, and a similar argument today could also prove wrong. I do not myself believe that a new war could have the same consequences as it did last time (or as it did on a lesser scale after the First World War). If a new war were big enough to have a major impact on the economy, it would probably become a nuclear war, after which there might be little left to rebuild. But no one can say for sure that there will never be other new powerful stimuli to investment, such, for example, as were provided by the industrial revolution, the railroad, and the automobile in earlier times. What one can say, I think, is that nothing like that is visible on the horizon now. For those who understand this, the lesson is clear enough: rather than wait around for a miracle (or an irretrievable disaster), it is high time to dedicate our thoughts and energies to replacing the present economic system with one which operates to satisfy human needs and not as a mere byproduct of the presence or absence of investment opportunities attractive to a relative handful of socially irresponsible capitalists.

Let me close with a few remarks about the relevance of the foregoing analysis to a subject to which economists have been devoting increasing attention in the last few years, i.e., whether or not the history of capitalism has been characterized by a long cycle of some fifty years’ duration (what Schumpeter called the Kondratieff cycle). First, we should be clear that the issue here is not whether capitalist development takes place in an uneven fashion with periods of rapid expansion being succeeded by periods of slow (or even no) expansion and vice versa—what have often been referred to as long waves. The empirical existence of long waves in this sense is undeniable, and the ingenuity of statisticians operating with an almost infinite variety of possible statistical sources can be counted on to make out a case for a time sequence of accelerated and retarded growth rates compatible with the existence of an underlying cyclical mechanism.

But compatibility with the existence of a cyclical mechanism is entirely different from proof of the existence of such a mechanism. The reason for our acceptance of the idea that relatively short cycles exist (i.e., cycles of less than ten years’ duration, Schumpeter’s Kitchin and Juglar cycles) is that the mechanisms at work can be elucidated analytically as well as verified empirically. The important point is to be able to demonstrate that the two basic phases of the cycle, expansion and contraction, can each be shown to contain the seeds of its opposite. This principle lies at the core of all modern business-cycle theories. To quote what was long a standard textbook on the subject:

Business cycles consist of recurring alternations of expansion and contraction in aggregate economic activity....The economy seems to be incapable of remaining on an even keel, and periods of expanding activity always and all too soon give way to declining production and employment. Further, and this is the essence of the problem, each upswing or downswing is self-reinforcing. It feeds on itself and creates further movement in the same direction; once begun, it persists in a given direction until forces accumulate to reverse the direction. (Robert A. Gordon, Business Fluctuations, New York, 1952, p. 214)

The key phrase is “until forces accumulate to reverse the direction.” This occurs in both the expansion and the contraction phases of the normal business cycle, but the symmetry breaks down when it comes to long waves. As we have already noted in the case of the long expansion following the Second World War, the reversal does indeed take place: it is the nature of an investment boom to exhaust itself. But it is equally clear from the experiences of the 1930s and the 1970s that the stagnation phase of a long wave does not generate any “forces of reversal.” If and when such forces do emerge, they originate not in the internal logic of the economy but in the larger historical context within which the economy functions. It was the Second World War that brought the stagnation of the 1930s to an end. We still do not know what will bring the stagnation of the 1970s and 1980s to an end—or what kind of an end it will be.

Labor and the Imperialism of Finance
by William K. Tabb

October 1999

Since the end of the postwar period (the late 1960s or early 1970s, and with greater intensity since the 1980s), the pressure for financial deregulation has grown stronger. The international financial institutions (IFIs)—most importantly, the International Monetary Fund (IMF) and the World Bank—have focused with singular intensity on neoliberal goals that erode the political weight of National Keynesianism, social democracy, and socialism. New financial institutions reflect this changed emphasis. The European Central Bank's mandate is solely price stability, for example, with not even rhetorical support for growth and employment, which is assigned by law in the United States to the Federal Reserve. The Euro, the Maastricht convergence criteria, and newer attempts at international institution reformation (such as the proposed Multilateral Agreement on Investment [MAI]) are all premised on this logic. International governance becomes the conduit for the greater dominance of finance capital.

The class recomposition of recent decades has reinforced these developments. In what has been called the third world, local elites no longer pursue state-led nation development strategies, but welcome their new role as regional agents of international capital, and work to integrate their economies into globalized networks. In the advanced countries, too, the growth of information-communications sectors—tied to the globalization process—changes the consciousness of many technical professional workers. The attack on public pension provision and the growing commitment by better-paid workers (who have seen their retirement nest eggs grow in mutual fund portfolios) have given them a significant material interest in speculative investments tied to rapid restructuring.

At the level of macroeconomic policy, the unreasonable focus on inflation stems from the influence of financial markets. The banks and financiers do not like inflation because it devalues their bond holdings in real terms. They prefer a redistributive growth in which subsidies flow from working-class taxpayers (who are geographically less mobile) toward capital, which has substantial mobility and demands incentives to relocate or to stay put. The growing power of financial markets thus has serious consequences, a drop in effective taxation of capital and on the rich, combined with falling real wages for working people and lower social-welfare spending.

The pressure of financial markets to raise returns leads not simply to the closure of unprofitable operations but also to the sale of units that make lower-than-average profits. The number of direct employees of Fortune 500 companies has declined precipitously as a result of relentless pruning, contracting out, and a greater use of part-time and other contingent employees. It is by abrogating implicit (and even written) contracts, stripping of assets, and using debt in place of equity that returns to owners have been enhanced. The growing use of stock options has made the singleminded pursuit of profit for owners coincide with incentives of top executives. The pressure on corporate executives who tried to defend their traditional prerogatives came from institutional investors, corporate raiders, and restructuring buyout advisers. Companies that do not aggressively maximize shareholder value have been taken over by those willing to throw out the old managers and downsize the workforce. The momentum has been relentless and hardly limited to restoring past profit margins. It has been about maximizing returns to owners, regardless of the impact on workers and communities.

The world economy currently depends on a peculiar and unsustainable mathematics of capital flows. The top tier of U.S. consumers spends lavishly, in significant measure because of the wealth effect of rising equity prices. Working-class consumers go deeper into debt. Spending has been exceeding income—an unsustainable pattern. The U.S. imports the equivalent of three percent of our gross domestic product (GDP). Global excess capacity means bargains for U.S. shoppers, and foreign money pours into U.S. financial markets seeking secure returns. Global crisis forced the Fed to keep U.S. domestic interest rates low, fueling stock market expansion—a situation which reminds many of the political economy of Japan a decade earlier (if not the United States itself in the late 1920s). Wall Street worries that recent interest-rate increases will bring their decade-long party to an end. If it does, the one-sided nature of the expansion will be brought into stark relief. Surely the United States cannot continue to consume beyond its means forever, and run balance of payments deficits the size of the current one.

Of course, the international system has long had problems with financial crises. They are not new to our time. The problem is experienced both as uncontrolled capital movements (which destabilize economies) and as the difficulty of developing adjustment mechanisms. The problem can be understood in the framework of the Mundell-Fleming model, which shows that governments, their economic policymakers, central bankers, and treasury officials cannot simultaneously maintain monetary policy independence, a stable exchange rate, and unrestricted capital movements. Two of these three are possible—not all simultaneously. Free capital flows and stable exchange rates can be achieved by allowing interest rates to move in line with external pressures. It is possible (by controlling capital movements) to have exchange rate stability and to control domestic interest rates and, of course, if exchange rates are allowed to adjust to market forces, then capital mobility and monetary autonomy are possible.

Fiscal policy (taxation and government spending) is also captive to international monetary pressures, because flexible exchange rates and capital flows can make such policies ineffective. An open economy, subservient to market forces, reduces state economic policy independence and forces decisionmakers to adjust rather than to lead and constrain markets. If they attempt activism without national controls (and in the absence of an international governance structure which places social purpose ahead of profit maximization), market pressures can be destabilizing and regressively redistributional. Of course, this is a matter of degree. Public pressure on governments can be important. The greater the class consciousness of working people, the harder it will be for amoral capital to prevail. But without controls and social regulation of what is fast becoming (in Keynes' words, describing an analogous situation in the interwar years) "a parliament of banks," we will continue to face the need for painful adjustments and costly bailouts of financial speculators.

Inflation and Deflation

Today's issue is not inflation but deflation. Yet, while there has been little sign of inflation since the early 1980s, when Reagan-Volker policies raised interest rates (and unemployment) while cutting taxes for the corporate rich, we have seen—for the last two decades—monetarists of different stripes continue to press for the elimination of inflation. The evidence does not, in fact, show that inflation is harmful to growth.

Inflation below 40 percent a year has no discernable effects on economic growth. Working people are better off with some inflation and full employment. In that case, their real incomes after inflation have tended to go up. Indeed, the pursuit of lower inflation now threatens global deflation, which has consequences that need to be better understood. Deflation, a drop in the general price level, makes it more difficult for debtors, including countries and corporations, to pay back debt, which is fixed in nominal terms. When this debt is in a foreign currency, as is usual in the global periphery, depreciation of the national currency makes it even more difficult to pay debts.

Globalization, as it has proceeded, has reversed price movements, and while it is too early to say that future historians will find IMF efforts to impose austerity to have created a dangerous deflationary situation, there is mounting evidence that this is becoming the case. The logic of financial hegemony has been to reduce government expenditures and state intervention through privatization and contracting out, and to do away with capital controls. The demand for greater transparency and free trade reflects a superstitious belief in an idealized market mechanism that automatically achieves optimal external and internal equilibria, as in the textbook utopias of neoclassical economists. Orthodox policies once again, as before the Great Depression and the advent of Keynes, assert that interventionism by governments concerned about creating jobs and adequate living standards will do more harm than good. It all has a familiar ring.

It is important to distinguish between two very different types of deflation. The good kind comes from technological change, which lowers the cost of production. Computers, for example, get cheaper and more efficient over time, which spreads their adaption. Cost declines but sales go up. The speed of the product cycle in a number of areas has such characteristics. A second, and very different type of deflation, results from inadequate demand. Bad deflation results from excess capacity, growing inventories, rising unemployment, falling incomes, and lower consumption, which together cycle downward and can result in depression. Overcapacity intensifies competition, leading to lower profits, plant closings, and more job loss. As consumer confidence weakens, workers (even those not losing their jobs) grow pessimistic, and companies see no reason to invest in the face of excess capacity and a bleak outlook.

Economies can stagnate, as Japan's has done for a decade now. There are limits to how long a country (even one as rich as Japan) can go on this way. The excess capacity (in everything from semiconductors to steel) leads producers to lower prices, but consumers expect still-lower ones and so are in no hurry to buy. In an aging society, retirement worries compound lower present consumption. While all nations try to increase exports, most restrict imports. (The exception to this rule is the United States, the consumer of last resort for a world substantially in recession.)

By the advent of the new century the problems of stagflation, inflation, mini recessions etc. were seen as being leveled off by globalization. But that would have meant more market Keynes than Friedman.

Regimes of differential accumulation: mergers, stagflation and the logic of globalization
Review of International Political Economy, Volume 8, Issue 2 June 2001 , pages 226 - 274

The paper offers a new approach for analysing capitalist development and crisis, tying together mergers and acquisitions, stagflation and globalization as integral facets of accumulation. The framework builds on the concept of differential accumulation, emphasizing the power drive by dominant capital groups to beat the average and exceed the normal rate of return. Four regimes of differential accumulation are articulated: internal breadth by amalgamation, external breadth through green-field investment, internal depth via cost-cutting, and external depth through stagflation. The complex relationships between these different regimes, as well as their broader societal implications, are analysed in light of the US experience over the past century. Several broad conclusions emerge. (1) Of the four regimes, the most important are amalgamation and stagflation, which tend to oscillate inversely to each other. (2) Over the longer haul, amalgamation grows exponentially relative to green-field investment, contributing to the stagnation tendency of modern capitalism. (3) The wave-like pattern of mergers and acquisitions reflects the progressive break-up of socioeconomic 'envelopes', as dominant capital moves through successive amalgamation at the industry, sectoral, national, and, finally, global level. In this sense, the current global merger wave is an integral facet of differential accumulation. (4) Periodic lulls in amalgamation tend to be compensated for by stagflation, which appears as a crisis at the societal level, but which contributes significantly to differential accumulation at the disaggregate level. An end to the present worldwide merger boom could therefore trigger global stagflation. (5) Stagflation crises have been previously 'resolved' when dominant capital broke its existing envelope, pushing to amalgamate within a broader universe of takeover targets. Given that there is nothing more to conquer beyond the global envelope, future stagflation crises may prove much more difficult to tame.

But the reality came home as the market in easy money the same market we saw in 1893 and again in 1929 returned with a vengeance. Money was making money, capital was speculative instead of productive, and savings disappeared into credit card and mortgage debt.

The Austrian school of economics tells us that economic imbalances and distortions caused by excessive credit creation will be balanced by economic imbalances and distortions caused by credit contraction. The iron clad rule that growth caused by debt creation will be balanced by economic contraction caused by debt servicing is at the core of our economic situation in my humble opinion. We can continue the foolish process of creating more debt, or we can bite the bullet and begin to deal with the fundamental reality of excessive debt and its implications for our nation and world. Unfortunately, the current political and economic leadership is incapable of telling the people the truth, much less offering a coherent plan to deal with what's coming down the road. So be it. The storm is upon us; the ship is unprepared for it. It will not be pretty, but balance will be restored eventually. I'm just not sure if people understand what that simple sentence implies. People, as well as nations, reap what they sow. In economic terms, we have built a huge edifice based upon the ideals of economic growth fueled by debt and financial hocus pocus. That edifice is now sending chunks of itself crashing all around us with increasing frequency. In my opinion, the officially sanctioned doomer one that is, the entire debt based economy will come crashing down to earth.

"Are we headed for another Great Depression". My talks with Elaine Meinel Supkis "The blue collar class which is the backbone of any society, is so oppressed and crushed under debts here in the US, they see no hope, being hired for a lifetime in some industry, they have been told, they must fend for themselves and be rootless, moving from job to job across the country or if displaced, removing themselves entirely via crime or death. No longer being asked to be part of a specific community, they are told; they must be more flexible and move from region to region, a leaf in a thunderstorm in the gutter of life". Elaine Meinel Supkis, "Culture of Life New"

Question: Consumer spending is 70% of US- GDP, and yet, workers wages have not kept pace with the real rate of inflation. This has led to increased borrowing on the part of the American consumer. Now that housing prices have flattened out; consumers can no longer draw on their home equity for their spending. This has resulted in a huge spike in credit card spending. For example, “first-quarter profits at MasterCard surged 70% to a record $214.9 million following a 19% jump in transactions.” (Peter Schiff) As the weary American consumer is forced to curtail his spending, GDP will shrink and foreign investment will dry up. Are we likely to see “capital flight” from American markets or are foreign investors still confident in America’s resilience?

E.M.S.: In most places, housing prices are falling by 30%! All the people who responded to ads about getting cheap loans are now discovering they can't use their homes as ATM machines and simply re-finance over and over again. The house is supposed to be an asset: if you have to sell it to pay bills or move because of a job situation, if the debt is greater than the selling price, you go bankrupt. And this is happening all over the place now. And it will impact on buying.
Last year, Americans took out half a trillion in extra loans on the house! The surge in MasterCard (gads, Snidely Whiplash!) charges is because banks are no longer giving loans to people who are too deep in debt. The money that flowed there is flowing into the stock market just like it always does during the first half of an inflationary binge. The second half is when the stocks collapse like they did in 1974. Then we see a 5 year bear market. Housing markets ALWAYS take 5+ years to recover from a bubble. But this last bubble launched by 1% Fed interest rates will take 20 years to recovery in most places.

No need for Marxist preaching here, we will simply ask the experts, those who speculate in the market.

Black Holes & Revelations

Sean Corrigan is Chief Investment Strategist, Diapason Commodities Management, Lausanne & London.
“Glaciers melting in the dead of night/And the superstars sucked into the supermassive.”

“…If monetary policy has played a dominant role [in the recent benign financial conditions], the rise in inflation that has been observed recently in many countries and the likelihood of a further tightening of global monetary conditions suggest that the current episode of low interest rates and tight spreads could end quickly. This could have an adverse impact on interest rate sensitive sectors of the economy and lead to a withdrawal of liquidity from precisely those markets that have benefited the most from low interest rates.”

Malcolm Knight, BIS General Manager, June, 2007

To the casual observer, the recent behaviour of financial markets is surely a cause for wonder.

Trading volumes and M&A activity sets new records with every passing month; buy-out targets become more and more ambitious (and the leverage taken on to achieve them grows and grows); hedge funds proliferate and - no longer content to pick over such mundane assets as stocks and bonds - branch out into buying rare earth metals, art works, footballers and violins; emerging market equity indices trade on higher multiples than Western ones; US margin debt hits new records both outright and as a percentage of market cap despite a sputtering economy; equity mutual fund managers signal their endorsement of the view from the bucket shops by allowing liquid asset ratios to hit new lows.

Then there’s the increasingly bullet-proof mentality among risk takers who reacted to an emerging market fall in May 2006 by slashing positions so deeply across the board it took six months for some of them to recover the loss; who then responded to a mini-China crisis in February with not so much a flight- as a feint-to-quality that only took six weeks to shake off; and who then greeted the latest Shanghai shake-out with such a yawn that new highs had to wait less than six days from a sell off which lasted not a great deal more than six hours!

Finally, there’s the fact that emerging market and junk bond spreads, as well as CDS premiums, are hitting new lows even though the investment grade universe is tracking inexorably higher from the generationally low real and nominal yields set as recently as this year (e.g., in the case of the UK).

In fact, the key to understanding all these marvels – which are part of a wider phenomenon also made manifest in the record prices being set for drab Modernist daubings, French wines, Swiss watches, and all the other Hyper-Bling accoutrements of the nouveaux riches – and also the clue as to what may bring an end to this Bacchanalia is to be found in a careful re-reading of that last paragraph.

We say this because the great, gaudy merry-go-round to which we nowadays so precariously cling is powered by a vast surplus of credit which is being extended – not so much by banks who might, after all, be subject to some restraints on their lending activities, however notional - but by virtue of such exposures being floated off largely to an unregulated non-bank sector whose own liabilities the banks do fund, since they are theoretically fully-collateralized by the over-priced assets they have bought.

That the carousel spins so fast is because these non-bankers have also been instrumental in financing both the private equity boom and the knock-on flurry of acquisitions, spin-offs, and share buy-backs carried out by the nervous executives of vulnerable public companies. Their complicity has arisen both because the non-banks have participated actively in the LBO mania and because they have depressed yields and spreads in general (by writing ever cheaper insurance on ever more issued debt, if in no other way).

Like all good asset-collateral spirals, the volume of cash flooding into both institutional coffers and private pocket-books as a result of all this debt-based buying has left the recipients scratching around for places to re-invest their windfall and so - Hey Presto! – they have come to cultivate an avid taste for ‘alternative’ assets as replacements.

Apart from sounding impressively à la mode over the dinner table, this has meant in practice that they have rushed to buy stakes in the same private equity and hedge funds who initially relieved them of their former, more traditional holdings. Amazingly, this seems to take place in the expectation that the bought-out will enjoy greater future returns just because they have surrendered charge of their assets to the buyers-out (instead of exercising firmer shareholder control over the pre-existing management, in the first place), regardless of the damage wrought to the targets’ balance sheets and despite the eye-watering levels of fees involved in playing the game.

Thus refortified with ‘equity’ returned from those they have just borrowed to buy out, the non-banks can now go scoop up another fistful of assets, financing a hefty slice of the purchase with yet another slug of margin extended by their eager prime brokers.

Thus, the inflationary screw takes yet another turn to the cry of Come back, Signor Ponzi, all is forgiven!

To get a sense of the scale of but one aspect of all this, consider the findings of a recent Fitch Ratings survey which revealed that assets of ‘credit-oriented’ hedge fund had exceeded $300 billion as far back as 2005, since when CDS outstanding have doubled to $35 trillion, suggesting a substantial increase in the tally of those assets, too.

As the agency points out, even that sum represented a gross understatement of these funds’ influence since the typical financial leverage they employ is of the order of five to six. Moreover, on top of this figure of $1.8 trillion-and-counting, we must not forget to reckon with the extra economic leverage intrinsic to the fact that these funds also tend to concentrate their buying on the more risky tranches created much lower in the capital structure when loans are sliced, repackaged, and sold on by their originating banks.

Given that Fitch reckons that 60% of the trading volumes generated in the CDS market can be attributed to such funds, we can get a sense of the thinness of the ice upon which the whole bootstrapped edifice is being built.

But we mustn’t be too parochial here for, in addition to the internal distortions being wrought by the unholy alliance of hedge funds, LBO merchants, and prime brokers via securitization and through the use of structured products and derivatives, all of this has also brought about significant real world effects, far beyond the fairy tale realm of the financial markets themselves.

Though much of the world’s upsurge in economic activity (and the concomitant rise in commodity prices) these past five years has a genuine foundation in the modernisation of Asia and Eastern Europe, among others, there is also a large, if unquantifiable, overlay of that excessive or misplaced investment which has only arisen because the markets and the central bankers who oversee them have ensured that the real cost of financial capital has remained far too low for far too long.

Here it is that we see the first signs of danger, for, in a world which has come to define ‘risk’ as the avaricious angst that one could be missing out on a fabulous gain if one is not fully committed to the pot, the whole whirligig of financial speculation and industrial hyperactivity depends upon one thing and one thing only – non-threatening bond yields.

Here we must track back a little to set matters in context.

For well over eighteen months, it has been our view that the inflation genie has been fully let out of the bottle (taking ‘inflation’ in the misleading modern sense of a rise in a consumer price index which a central bank finds it hard to ignore) and that, as a result, we would see nominal short-term rates move successively higher, while real short-term rates lagged behind.

Then, we felt, there would be some weakness evident in some over-extended, interest-rate sensitive sector or other - and housing, thanks to the enormities of this cycle, was always a (sub) prime candidate to fulfil that role. Then, a pause for breath would ensue, that hiatus itself being taken as a sign that the next move in rates would inevitably be downwards, paradoxically setting the market up for another anticipatory move to the upside.

Absent a direct financial contagion from some parts of, e.g., the housing market (worries of which were certainly an accessory factor in the February wobble), we have also long contended that the heady mix of solid, secular and shaky, cyclical global growth would be sufficient to tide things over and would not let any material amount of slack back into the system - and that nor could it until the credit tap was further considerably tightened.

We have also argued that, due to the peculiarities of the energy market – a heady cocktail of the CB policy of ‘ex’-ing their price indices, the public ownership of oil & gas resources, and the politics of petrodollars – high fuel prices were acting as a monetary pump, not as a picket line to hobble output. Lo and behold, Brent crude is back at $70/bbl and we have been off to the races again, these past few months.

We further warned that the biofuel movement would have far-reaching effects, not just for commodity investors, but for the ordinary householder and – at length – for the central bankers anxious to keep his wards’ ‘inflation expectations contained’.

Finally, we thought that the balance of probabilities favoured a scenario where the move which broke the uneasy cease fire on rates would be up not down.

So far all of this has just about come true – though in a world riddled with self-installed vulnerabilities at every level, our fingers are still firmly crossed when we say so.

So far, the only thing missing is the next upward shift from the central banks which did go dormant, though New Zealand, for one, has gratified us. In Australia and Canada, we can see that the wider market (if not yet the monetary authority) has come round to our viewpoint, since futures are clearly pricing in such an imminent resumption. In the UK, Sweden, and the EU, too, where official rates have continued to rise, futures are, if anything marching further away from them as they do.

Ominously, too, the violent sell-off in Eurodollars has even begun to push the red months up above the funds rate and back towards a more normal premium which would signal the dispelling of the last lingering hopes of a cut. Additionally, the far end of the US curve is starting to resteepen with the differential between Fed funds and 10-year Libor, for example, moving from a negative 35bps in December (a six-year low) to an 11-month high of +48bps and, to cap it all, break-even inflation rates are also starting to move higher, not just Stateside, but in the EZ and the UK, too.

Finally, the sell-off has seen US T-notes at last break the downtrend which has capped the classic, long-term distribution built since the ’87 Crash, meaning Treasuries have joined the angry-looking charts for Bunds, Gilts, Canadas, Ozzies, et al.

Here, too, we could see another feedback come into operation – this time one far less helpful to the speculative herd – for rising long bond yields are likely to be viewed by central bankers as a sign that either their self-proclaimed anti-inflationary stance is being questioned or that the implied rate of return on capital has risen. Either way, bond yields could rise for fear of more CB tightening and the CBs could tighten more because bond yields are rising.

All it would need then would be for a little mortgage convexity to kick in, or for some other from of dynamic hedging on all that derivative product to take place, and we could see the asset-collateral spiral swirling rapidly into reverse.

If so, it is a matter of reasonable conjecture to suggest that, given the sheer mass of positioning involved – as well as the unfathomable interlinkages between its innumerable component parts - we could well see a good part of the present, self-supporting nebula of ‘liquidity’ rapidly vanish over the event horizon.

What price then the ‘global savings glut’ or the worldwide ‘asset shortage’ so beloved of US academia and how large a quota of disastrous malinvestment will be exposed once the impressive divide between the employment of means and the satisfaction of ends is no longer disguised by the anti-gravitational force of over-abundant credit?


Purdy Crawford Rescues the Market

Sub Prime Exploitation

Canadian Banks and The Great Depression

Wall Street Deja Vu

Housing Crash the New S&L Crisis

US Housing Market Crash

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