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The Fed and Asset Bubbles

In his speech on April 7 2010 at the Economic Club of New York the President of the New York Fed, William Dudley argued that asset bubbles pose a serious threat to real economic activity.

The New York Fed chief is of the view that the US central bank should develop effective tools to counter this menace.

According to Dudley, it should be the role of the Fed to stop the expansion of the bubble whilst it is still in the making.

By an asset bubble, I mean price increases (or declines) that become unmoored from fundamental valuations.[1]

Dudley is of the view that the way people trade also generates bubbles. On this, he suggests that,

Bubbles may simply emerge from the way market participant’s process information and trade. In many carefully controlled experiments in which the intrinsic value of the asset could be determined with certainty, participants still bid prices up far above fundamental valuations, with the bubbles being followed by sharp declines in prices.[2]

Furthermore, Dudley is of the view that,

A bubble is difficult to discern and, second, each bubble has unique characteristics. This implies that a rules-based approach to bubbles is likely to be ineffective and that tackling bubbles to diminish their potential to destabilize the financial system requires judgment.[3]

In conclusion, the New York Fed President has suggested,

Let me underscore the challenge that central bankers face in combating asset price bubbles. Doing so effectively requires us to be successful in both identifying the incipient bubble and in developing and implementing a response that will limit bubble growth and avert a destructive asset price crash. This is not easy because asset bubbles are hard to recognize in real time and each asset bubble is different. However, these challenges cannot be an excuse for inaction.[4]

The Fed and bubbles – is there any relation?

…click on the above link to read the rest of the article…

The Makings of a 2020 Recession and Financial Crisis

stockbrokerCarl Court/Getty Images

The Makings of a 2020 Recession and Financial Crisis

Although the global economy has been undergoing a sustained period of synchronized growth, it will inevitably lose steam as unsustainable fiscal policies in the US start to phase out. Come 2020, the stage will be set for another downturn – and, unlike in 2008, governments will lack the policy tools to manage it.

NEW YORK – As we mark the decennial of the collapse of Lehman Brothers, there are still ongoing debates about the causes and consequences of the financial crisis, and whether the lessons needed to prepare for the next one have been absorbed. But looking ahead, the more relevant question is what actually will trigger the next global recession and crisis, and when.

The current global expansion will likely continue into next year, given that the US is running large fiscal deficits, China is pursuing loose fiscal and credit policies, and Europe remains on a recovery path. But by 2020, the conditions will be ripe for a financial crisis, followed by a global recession.

There are 10 reasons for this. First, the fiscal-stimulus policies that are currently pushing the annual US growth rate above its 2% potential are unsustainable. By 2020, the stimulus will run out, and a modest fiscal drag will pull growth from 3% to slightly below 2%.

Second, because the stimulus was poorly timed, the US economy is now overheating, and inflation is rising above target. The US Federal Reserve will thus continue to raise the federal funds rate from its current 2% to at least 3.5% by 2020, and that will likely push up short- and long-term interest rates as well as the US dollar.

Meanwhile, inflation is also increasing in other key economies, and rising oil prices are contributing additional inflationary pressures. That means the other major central banks will follow the Fed toward monetary-policy normalization, which will reduce global liquidity and put upward pressure on interest rates.

…click on the above link to read the rest of the article…

Albert Edwards: Why We Are Destined To Repeat The Mistakes Of The Past

With everyone and their grandmother opining on the 10 year anniversary of the start of the global financial crisis, it was inevitable that the strategist who predicted the great crash (and according to some has been doing the same for the past decade) – SocGen’s Albert Edwards – would share his thoughts on what he has dubbed the “10th anniversary of chaos.”

In it, the SocGen skeptic slams the trio of Bernanke, Geithner and Paulson who have been not only penning op-eds in recent days, but making the media rounds in a valiant attempt to redirect the spotlight from the culprits behind the crisis, writing that “they just never recognized beforehand that the economy was a massive credit bubble, just like it is now” and points to central bank arrogance as the “main reason why we should still be scared.”

Of course, just like 10 years ago, as long as the market keeps going up, nobody is actually “scared” and instead everyone is enjoying the ride (just as the legion of crypto fans who are no longer HODLing). The “fear” only comes when the selling begins, and by then it’s always too late to do anything about the final outcome as yet another bubble bursts.

Below we excerpt some of the observations from Edwards’ “A thought on the 10th anniversary of chaos”

Central Bank arrogance is one of the main reasons why we should still be scared. As a former official at the NY Fed, Peter Fisher, recently noted, “The Fed has acknowledged no failures. All the experiments have been successful, every one: no failures, no negative side-effects, no perverse consequences, only diminishing returns.”

…click on the above link to read the rest of the article…

The Next Financial Crisis Is Right on Schedule (2019)

The Next Financial Crisis Is Right on Schedule (2019)

Neither small business nor the bottom 90% of households can afford this “best economy ever.”

After 10 years of unprecedented goosing, some of the real economy is finally overheating: costs are heating up, unemployment is at historic lows, small business optimism is high, and so on–all classic indicators that the top of this cycle is in.

Financial assets have been goosed to record highs in the everything bubble.Buy the dip has worked in stocks, bonds and real estate–what’s not to like?

Beneath the surface, the frantic goosing has planted seeds of financial crisis which have sprouted and are about to blossom with devastating effect. There are two related systems-level concepts which illuminate the coming crisis: the S-Curve and non-linear effects.

The S-Curve (illustrated below) is visible in both natural and human systems.The boost phase of rapid growth/adoption is followed by a linear phase of maturity in which growth/adoption slows as the dynamic has reached into the far corners of the audience / market: everybody already caught the cold, bought Apple stock, etc.

The linear stage of maturity is followed by a decline phase that’s non-linear.Linear means 1 unit of input yields 1 unit of output. Non-linear means 1 unit of input yields 100 unit of output. In the first case, moving 1 unit of snow clears a modest path. In the second case, moving 1 unit of snow unleashes an avalanche.

The previous two bubbles that topped/popped in 2000-01 and 2008-09 both exhibited non-linear dynamics that scared the bejabbers out of the central bank/state authorities accustomed to linear systems.

In a panic, former Fed chair Alan Greenspan pushed interest rates to historic lows to inflate another bubble, thus insuring the next bubble would manifest even greater non-linear devastation.

…click on the above link to read the rest of the article…

ponents.

Warren Buffett Explains Bubbles: But He Doesn’t Know We Are In One

Buffet explains bubbles: “People see neighbors ‘dumber than they are’ getting rich.”

Warren Buffett explains Why Bubbles Happen

Buffett was asked by CNBC’s Andrew Ross Sorkin if he is worried another crisis will happen again.

“Well there will be one sometime,” Buffett said in an interview for CNBC’s “Crisis on Wall Street: The Week That Shook the World” documentary. The documentary airs Wednesday night at 10 p.m. ET/PT.

“People start being interested in something because it’s going up, not because they understand it or anything else. But the guy next door, who they know is dumber than they are, is getting rich and they aren’t,” he said. “And their spouse is saying can’t you figure it out, too? It is so contagious. So that’s a permanent part of the system.”

That last paragraph perfectly explains Bitcoin. Most of those investing in cryptos have little idea how they work, or what they are even buying.

Buffet made no mention of the corporate bond bubble, the equities bubble, or even the crypto bubble. He does not see any bubbles now, at least that he mentioned.

Symptom or Cause?

Buffett confuses a symptom (rampant speculation) with the true cause

  • The Fed (central banks in general), keep interest rates too low, too long
  • Fractional reserve lending
  • Moral hazards like bank bailouts
  • Poor fiscal policies and massive government debt

In short, there is no free market in anything and thus no valid price discovery. There would always be speculation, but Fed policies and fractional reserve lending are the root cause of bubbles.

Blame the Fed — Not Investors — For Asset Bubbles

Blame the Fed — Not Investors — For Asset Bubbles

investors.PNG

In his speech on April 7 2010 at the Economic Club of New York the President of the New York Fed, William Dudley argued that asset bubbles pose a serious threat to real economic activity.

The New York Fed chief is of the view that the US central bank should develop effective tools to counter this menace.

According to Dudley, it should be the role of the Fed to stop the expansion of the bubble while it is still in the making.

By an asset bubble, I mean price increases (or declines) that become unmoored from fundamental valuations. 1

Dudley is of the view that the way people trade also generates bubbles. On this, he suggests that,

Bubbles may simply emerge from the way market participant’s process information and trade. In many carefully controlled experiments in which the intrinsic value of the asset could be determined with certainty, participants still bid prices up far above fundamental valuations, with the bubbles being followed by sharp declines in prices.

Furthermore, Dudley is of the view that,

A bubble is difficult to discern and, second, each bubble has unique characteristics. This implies that a rules-based approach to bubbles is likely to be ineffective and that tackling bubbles to diminish their potential to destabilize the financial system requires judgment.

In conclusion, the New York Fed President has suggested,

Let me underscore the challenge that central bankers face in combating asset price bubbles. Doing so effectively requires us to be successful in both identifying the incipient bubble and in developing and implementing a response that will limit bubble growth and avert a destructive asset price crash. This is not easy because asset bubbles are hard to recognize in real time and each asset bubble is different. However, these challenges cannot be an excuse for inaction.

…click on the above link to read the rest of the article…

Think That Governments Won’t Default? Think Again

Think That Governments Won’t Default? Think Again

The Congressional Budget Office (CBO) just reported that the U.S. budget deficit is widening in a ‘big way’.

And what’s even worse – last month the net interest on public debt jumped 25% compared to last August. . .

I wrote last January about the soaring cost of interest that the U.S. Treasury’s paying on its outstanding debts (you can skim that here). And it looks like things keep getting out of control – especially as the Federal Reserve continues raising rates (which further increases borrowing costs).

Besides this very expensive ‘interest’ problem – the CBO reported that the U.S. budget deficit widened to its fifth highest ever.

And as Trump’s tax cuts continue taking away from Federal revenue, while government spending – including interest payments – keeps growing, we need to ask ourselves some important questions. . .

The next time the U.S. slides into a recession – will they be able to continue borrowing such enormous amounts while maintaining their interest payments? Will they follow the same route that the Emerging Markets are headed today?

We see many talking heads on CNBC and other mainstream financial media tell us that there’s virtually no risk of the U.S. defaulting. Same thing with any other major country.

Even worse, there’s a growing point of view preaching to the masses that aslong as country has a central bank, they can issue all the debt they need without risk of default.

Why would anybody think that?

Because – for instance – if the U.S. didn’t have enough cash flow (tax revenue) to pay creditors (buyers of U.S. bonds). And if they weren’t able to borrow anymore to roll over debt – the Fed would simply print U.S. dollars instead.

…click on the above link to read the rest of the article…

“Monetary Buffers Depleted” Boston Fed: Concerns Over Next Recession Mount

In a recession, the Fed typically slashes interest rates 5 PP. No such buffer exists. A Fed study looks at the impact.

One of the reason the Fed seems desperate to hike rates is they want ammunition to cut rates when the recession hits. Typically, the Fed cuts rates by 5 percentage points, but when the next recession hits, no such buffer will exist.

A Boston Fed simulation shows the central bank’s inability to cut rates by the usual amount would disproportionately hit certain states.

“Monetary buffers have been depleted,” said Eric Rosengren, president of the Federal Reserve Bank of Boston, which sponsored the conference this weekend where the research was released. A decline in rates over the past decade means the Fed’s recent experience of running out of room to cut them after lowering them to zero will not be “a one-time event,” he said.

Mr. Rosengren and his co-authors, Boston Fed economists Joe Peek and Geoffrey Tootell, ran an experiment that shows how a recession might affect states assuming a traditional monetary-policy response, in which the Fed could cut its short-term benchmark rate by 5 percentage points.

Then they looked at two other alternatives. In both scenarios, monetary policy couldn’t fully respond because the Fed had raised rates to only 2% before the hypothetical downturn. But in the last scenario, regulatory, state and local, and federal fiscal buffers were also depleted because they weren’t built up before the recession.

Per Capita Income Growth in Recession

Some Unpleasant Stabilization Arithmetic

…click on the above link to read the rest of the article…

Bernanke, Geithner and Paulson Still Don’t Have a Clue About the Financial Crisis

Bernanke, Geithner and Paulson Still Don’t Have a Clue About the Financial Crisis

NYT readers were no doubt disturbed to see a column in  which former Fed Reserve Board chair Ben Bernanke, Obama Treasury Secretary Timothy Geithner, and Bush Treasury Secretary Henry Paulson patted themselves on the back for their performance in the financial crisis. First, as they acknowledge in the piece, all three completely failed to see the crisis coming.

During the years when house prices were getting way out of line with both their long-term trend and rents, Bernanke was a Fed governor, then head of the Council of Economic Advisers, and then Fed chair. He openly dismissed the idea that the run-up in house prices could pose any threat to the economy. Henry Paulson was at Goldman Sachs until he became Treasury Secretary in the middle of 2006. As the bank’s CEO he was personally profiting from the bubble as the bank played a central role in securitizing mortgage backed securities. Timothy Geithner was president of the New York Fed, where he was paid over $400,000 a year to make sure that the Wall Street banks were not taking on excessive risk.

It is bad enough that these three didn’t see the crisis coming, but they still seem utterly clueless. They tell readers:

“Productivity growth was slowing, wages were stagnating, and the share of Americans who were working was shrinking. That put pressure on family incomes even as inequality rose and upward social mobility declined. The desire to maintain relative living standards no doubt contributed to a surge in household borrowing before the crisis.”

Actually productivty growth didn’t begin to slow until 2006, as the bubble was hitting its peak. Growth was quite strong from 2000 to 2005, which means the cause of wage stagnation in those years must lie elsewhere.

…click on the above link to read the rest of the article…

 

James Grant Responds To The Bernanke-Paulson-Geithner Op-Ed

Wealth defect

Over the weekend, Global Financial Crisis-era policymakers Ben Bernanke, Timothy Geithner and Henry Paulson brought the band back together to pen a New York Times opinion piece. After sharing their self-exonerating analysis of the events of 2007-2009 and subsequent response (which one of the three did the fact checking?), Bernanke et al. argue for greater regulatory powers, or as they put it, “adequate firefighting tools,” to resolve future financial crises.

Blanket guarantees of bank debt by the Federal Deposit Insurance Corporation, the Fed’s emergency lending capabilities and the Treasury department’s guarantee of money market funds are among the mechanisms cited by the authors as necessary for crisis prevention and mitigation.

The trio write:

We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration. We must also resist calls to eliminate safeguards as the memory of the crisis fades.  For those working to keep our financial system resilient, the enemy is forgetting.

Alternatively, the monetary mandarins could take a cue from Peter Fisher, former executive vice-president at the Federal Reserve Bank of New York and senior fellow at the Tuck School of Business. Speaking on policy normalization at the Grant’s spring conference on March 15, 2017, Fisher offered a commanding critique of the crisis-era response led by the authors of this weekend’s Times piece. Written 18 months ago, the below passage could serve as a direct rebuttal to the authors, particularly former Fed chair Bernanke:

Curiously, the Fed has acknowledged no failures. All the experiments have been successful, every one: no failures, no negative side effects, no perverse consequences, only diminishing returns.

…click on the above link to read the rest of the article…

When The US’s Stock Market Bubble Bursts, Inevitable Disaster Will Follow

When The US’s Stock Market Bubble Bursts, Inevitable Disaster Will Follow

Complete and utter disaster will be inevitable and unavoidable when the United States’ stock market bubble bursts. Unfortunately, too many think the high stock market is evidence of a stable economy, but it’s actually an artificial bubble that will end in a disastrous crisis.

This unusual market strength is not evidence of a strong, organic economy, but of an extremely unhealthy, artificial bubble economy that will end in a crisis that will be even worse than we experienced in 2008, reported Forbes.  The current market is highly unstable due to an artificially low interest rate.

Forbes writer Jesse Colombo explained it well. Ultra-low interest rates help to create bubbles in the following ways:

  • Investors can borrow cheaply to speculate in assets (ex: cheap mortgages for property speculation and low margin costs for trading stocks)
  • By making it cheaper to borrow to conduct share buybacks, dividend increases, and mergers & acquisitions
  • By discouraging the holding of cash in the bank versus speculating in riskier asset markets
  • By encouraging higher rates of inflation, which helps to support assets like stocks and real estate
  • By encouraging more borrowing by consumers, businesses, and governments

Another Federal Reserve policy (aside from the ultra-low Fed Funds Rate) that has helped to inflate the U.S. stock market bubble since 2009 is quantitative easing or QE.  Many have warned about the negative effects of QE only to be told by leftists that it was “necessary.” When executing QE policy, the Federal Reserve creates new money “out of thin air” in digital form and uses it to buy Treasury bonds or other assets. That action pumps liquidity into the financial system. QE helps to push bond prices higher and bond yields/interest rates lower throughout the economy. QE has another indirect effect as well. It causes stock prices to surge because low rates boost stocks, wrote Colombo.

…click on the above link to read the rest of the article…

The Fed’s QE Unwind Hits $250 Billion

The Fed’s QE Unwind Hits $250 Billion

Here’s my math when this “balance sheet normalization” will end.

In August, the Federal Reserve was supposed to shed up to $24 billion in Treasury securities and up to $16 billion in Mortgage Backed Securities (MBS), for a total of $40 billion, according to its QE-unwind plan – or “balance sheet normalization.” The QE unwind, which started in October 2017, is still in ramp-up mode, where the amounts increase each quarter (somewhat symmetrical to the QE declines during the “Taper”). The acceleration to the current pace occurred in July. So how did it go in August?

Treasury Securities

The Fed released its weekly balance sheet Thursday afternoon. Over the period from August 2 through September 5, the balance of Treasury securities declined by $23.7 billion to $2,313 billion, the lowest since March 26, 2014. Since the beginning of the QE-Unwind, the Fed has shed $152 billion in Treasuries:

The step-pattern of the QE unwind in the chart above is a consequence of how the Fed sheds Treasury securities: It doesn’t sell them outright but allows them to “roll off” when they mature; and they only mature mid-month or at the end of the month.

On August 15, $23 billion in Treasuries matured. On August 31, $21 billion matured. In total, $44 billion matured during the month. The Fed replaced about $20 billion of them with new Treasury securities directly via its arrangement with the Treasury Department that cuts out Wall Street – the “primary dealers” with which the Fed normally does business. Those $20 billion in securities were “rolled over.”

But it did not replace about $24 billion of maturing Treasuries. They “rolled off” and became part of the QE unwind.

Mortgage-Backed Securities (MBS)

…click on the above link to read the rest of the article…

Interest Rates Need to Tell the Truth

In the middle of July 2018, President Donald Trump said in an interview that he was “not happy” with the Federal Reserve nudging up interest rates and threatening economic growth in the United States. At the recent Jackson Hole, Wyoming, meeting of global central bank leaders, the Federal Reserve chair, Jerome (“Jay”) Powell, said the Fed board would continue to act independently of politics and move interest rates up to ensure a stable economy with limited price inflation.

Lost in the exchange was one simple question: should it be the business of any central bank to be targeting or setting interest rates, or should this be the business of the market forces of supply and demand, as with any other price in the economy?

Market Prices Coordinate Supply and Demand

Let’s recall what it is that market-based prices are supposed to do. First, they are meant to bring the two sides of any market into coordinated balance — that is, to bring the buying plans and desires of willing demanders into balance with the producing and selling plans and desires of willing suppliers.

When a price is too high, it means that the amounts of a good that producers are offering on the market are too high for the buyers to be willing and able to purchase all that is being supplied. Facing a surplus of unsold inventories in excess of any planned levels, sellers competitively reduce the price of the good to entice demanders to purchase more.

If the price is too low, it means that the amounts of any good that producers find profitable to offer on the market are less than the quantities that interested and willing buyers would like to purchase. This shortage of a good tends to bring about a competitive bidding up of the price to induce sellers to produce and market more of it.

…click on the above link to read the rest of the article…

These “Gradual” Rate Hikes Start to Add Up: US Treasury Yields up to Three Years Hit 10-Year Highs

These “Gradual” Rate Hikes Start to Add Up: US Treasury Yields up to Three Years Hit 10-Year Highs

An entire generation working on Wall Street has never seen Treasury yields this high.

The one-month treasury yield rose to 2.0% yesterday at the close and is at about the same level today, the highest since June 10, 2008. It is starting to price in a rate-hike at the Fed’s September 25-26 meeting. This rate hike, the Fed’s third this year, would bring its target to a range between 2.0% and 2.25%.

The three-month yield, currently at 2.14%, has reached the highest level since February 26, 2008. Back then, as the Financial Crisis was taking its toll, yields were going through enormous volatility, as the chart below shows. During that volatile period in mid-2008, the three-month yield spiked for a day to 2.07% on June 16, but never got back to the 2.14% in February that year:

It hasn’t been exactly a whirlwind rate-hike cycle with one-percentage-point rate hikes per meeting, à la Paul Volcker in the early 1980s, but in their “gradual” – as the Fed never tires to point out – easy-to-digest, no-surprises manner, the rate hikes are starting to add up. There is an entire generation working in the finance industry and on Wall Street who has never seen Treasury yields this high. They’re in for a learning experience.

The one-year yield rose to 2.49% at the close yesterday, and remains at about the same level today, beating the 2.48% on June 25, 2008:

The two-year yield closed at 2.66% yesterday and trades at the same level today, the highest since July 25, 2008 (when it closed at 2.70%):

The three-year yield, at 2.73% yesterday, and edging down just a tad at the moment, is at the highest level since August 14, 2008:

…click on the above link to read the rest of the article…

“It Will Get A Lot Worse”: Global Stocks Tumble As EM Contagion Roils Markets

Global stocks tumbled on Wednesday, as a drop in European markets followed a broad sell-off across Asia, as rising pressure on emerging markets intensified concerns of contagion and spillover into developed markets, leading to a sea of red in world stocks.

A day after emerging market currencies tumbled, it was the stock market’s turn in the hot seat, with shares sliding from Japan to Australia, and were crushed in Indonesia, where the nation’s benchmark lost almost 4%. Meanwhile, with no let-up in trade tensions near and new $200bn in US tariffs against China likely to be slapped as soon as tomorrow, the dollar strengthened for a fifth session and commodities slipped, led by oil, while the 10-year Treasury yield eased back to 2.89%.

At the same time, with the Fed showing no signs of slowing its rate hikes, investors are turning ever more cautious on emerging markets. Traders were focused on turmoil in developing nations wondering just how high rates will reach to contain the currency selloff, how acute the resulting economic slowdown will be and whether the volatility will spill into developed markets. Overnight, inflation in the Philippines exceeded 6% for the first time in nine years, joining Turkey and Argentina as another developing economy with soaring prices.

Predictably, the ongoing rout in emerging markets has not only not showed any signs of letting up, but accelerated overnight, with most currencies around the globe sliding against the soaring dollar, while the MSCI index of emerging market stocks heading toward a bear market.

…click on the above link to read the rest of the article…

Olduvai II: Exodus
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Olduvai
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Olduvai II: Exodus
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Olduvai III: Cataclysm
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