``Obviously the thing to do was to be bullish in a bull market and bearish in a bear market.”-Jesse Livermore
We don’t share the view with the Perma bears that this is the return of the bear market.
A technical trend break in chart trends does NOT automatically translate to a bear market. Besides charts are a menagerie of past information which does not suggest any infallible concept about the future outcomes.
And neither was last week about world credits being repriced nor about the adverse debt developments in the US.
Figure 4: Danske Bank: German short-sell ban rattles markets
To the contrary, sovereign debt papers of the US, Germany and Denmark were chief beneficiaries of last week’s turmoil (see figure 4 right window). So while we are seeing some emerging tensions in money markets via interbank funding rates (left window), they are yet substantially distant from the cataclysmic heights in post Lehman episodes of 2008.
Of course the $64 billion question is, are we headed there? My reply is a likely no.
Why?
Because most of adherents to this school sees markets as being immobilized by debt, which is simply not true.
To quote Murray Rothbard[1], (bold highlights mine)
``What deflationists always overlook is that, even in the unlikely event that banks could not stimulate further loans, they can always use their reserves to purchase securities, and thereby push money out into the economy. The key is whether or not the banks pile up excess reserves, failing to expand credit up to the limit allowed by legal reserves. The crucial point is that never have the banks done so, in 1990 or at any other time, apart from the single exception of the 1930s. (The difference was that not only were we in a severe depression in the 1930s, but that interest rates had been driven down to near zero, so that the banks were virtually losing nothing by not expanding credit up to their maximum limit.) The conclusion must be that the Fed pushes with a stick, not a string.”
UNLESS this time is different I simply can’t see how Zero interest rates combined with suppressed inflation will prompt for catastrophic markets.
Throughout Japan’s lost decade, as we previously discussed[2], we haven’t seen her market’s crash when interest drifts at the zero level.
While it may be true that government actions in solving today’s predicaments may be reaching diminishing returns, zero interest rates and dampened inflation provides government extended leeway to conduct activities as noted by Mr. Rothbard above.
And while Eurozone[3] and the UK[4] have been witnessing accounts of rising consumer price inflation to a 16 and 17 month highs respectively, they haven’t reached levels that could stymie government actions.
Moreover, as previously noted[5], the premise of diminishing returns is exactly the main reason why the scale of rescues have been constantly swelling. Unless we see global governments willing condescend to market forces, and accept the limits of central banking, this isn’t likely to happen yet.
But recent events only prove that this is exactly in the opposite direction.
Germany’s Signs Of Desperation
Just last week, the arrogance of trying to prevent markets from revealing the true nature of balance sheet impairments of subprime Europe prompted Germany’s chancellor, Angela Merkel, to slap a ban on naked short selling on credit derivatives, euro bonds and select financial equities[6].
European authorities similar to Filipino voters have little incentives to learn from past experiences. Never mind that the US tried the same approach in the wake of the Lehman bankruptcy that exacerbated if not helped triggered the October 2008 crash.
And we seem to be seeing the same market response.
According to the Danske Research Team[7], ``The reason for introducing the ban on naked short-selling is that BaFin wants to reduce the extraordinary volatility that has been witnessed but the immediate market reaction suggests that the contrary has been accomplished and the euro has weakened further against the dollar. In the credit market, sovereign CDS tightened dramatically (short covering) whereas the corporate indices widened – the reason probably being the uncertainty that has been created in the playing field.” (bold highlights mine)
So regulatory risks has been exacerbating the market’s meltdown.
To wit, there have been accounts of massive capital flight[8] from Germany to Switzerland, which according to some reports, prompted heavy foreign exchange intervention[9] by the Swiss National Bank (SNB).
Moreover, there have also been emerging signs of political schism in the Eurozone, the surprise ban on short sales, which had purportedly been meant to shore up political support for Germany’s approval of the Euro’s bailout, hasn’t been well received by France[10], while other EU nations remain undecided. The following day the Germany approved of the bailout[11].
Earlier much of EU’s actions have been tilted in favour of France; where Germany argued for Greece to solve her own problems while France favoured a bailout and where Germany was initially in favour of marginal support while France’s Sarkozy wanted a “shock and awe”.
According to Gordon Long[12], ``It's in Sarkozy’s interest to fight for a US-like Keynesian solution with excess money printing. This would "kick the can down the road" and avoid an impossible "austerity cuts" war with French unions and workers.”
Obviously we seem to be witnessing public choice theory at work anew, where political self-interest interests among policymakers continue to trump the markets.
So political risks from the discordant and unilateral policies seem to be worsening the uncertainties in the marketplace. And this has led to last week’s market carnage.
Moreover, one can infer that these actions signify as signs of panic and act of desperation by EU authorities. So while governments in panic can be indicative of a bottom or present itself as buying opportunities, the obverse side is that desperate actions can lead to reckless policies that could backfire. The ban in naked short selling is an example.
But as we have long been pointing out[13], politics will be the order of the day. And to this point we are being validated anew.
So until we see signs of restoration of order and confidence in terms of policymaking, the likelihood is for continued volatility in global markets.
But I’d like to reiterate that that this isn’t the 2008 meltdown, where most of the actions from last week seem to emanate from regulatory risks and from political risks rather than from a seizure in the banking system caused by quasi ‘electronic’ bank runs and the subsequent drying up of trade finance.
In short, the nature of market stress has been entirely a different animal.
Even the Federal Reserve’s swap facilities which it has recently reopened, has had less takers, if not entirely “no new demand”[14]. This hardly implies of credit stress but again most likely from political and regulatory oriented strains.
Furthermore, there is a chasm of a difference between administrative politics and the politics in the financial-economic sphere. The latter is where markets have been greatly influenced as the drama in the Eurozone has exhibited.
Contrasting China And EU’s Predicament
Finally I’d like to point out that there’s a big difference between the developments in China and the Eurozone.
In China, governments have been fighting a brewing bubble by attempting to contain surging asset prices, particularly property prices, from credit expansion. (see figure 5)
In Europe, governments have been trying to contain the debt crisis by inflating the system.
In other words, you have two (set of) governments fighting different monsters with slightly opposite measures.
As you can see in the left chart, China’s money supply appears to be shrinking. And this may have prompted for the recent collapse in Shanghai Stock Exchange (SSEC) and a possible easing of her property markets.
And as pointed above, the bubble strains isn’t just being manifested in surging property prices but also in consumer price inflation (right chart).
Hence in my view, the odds of a bust look greater in China than in Europe at the present moment, considering that rising consumer price inflation and asset bubbles are likely to retrain the hand of the authorities. Although markets appear to be saying that both are in a bust now, I wouldn’t bet on it.
As noted above, governments coordinating to pump massive amounts of money into the system will have to go somewhere.
Moreover, austerity measures that should affect economies such as Greece is only a sliver to the economic recovery being seen in most of the Euroland, Spain and Italy included (see figure 6)
Europe’s manufacturing indices PMI appears to be at an upside momentum while business surveys IFO remain positive, in spite of the unravelling crisis.
So unless you expect the markets to suffer from more convulsions out of concerted shrinking of supply of money, which will be the only way for a coordinated meltdown, possibly through simultaneous collapses in the banking system, I highly doubt this scenario would occur.
Especially not with governments putting implicit, if not explicit guarantees, in the banking system, and especially not with governments frantically throwing money at every known social problem.
Of course, the other major risk would be to severely impede or even restrict movements in the capital markets, but that would be opposing the interests of the banking system from which global governments have toiled so hard to save.
As previously shown, governments can put them to public trial for theatrics, but at the end of the day, they’d scamper to rescue once signs of distress emerge.
The recently passed new financial regulation bill in the US will hardly change the politics of banking cartels and the central banking system.
And as the EU drama shows, rules will be bent for political conveniences.
[1] Rothbard, Murray N. Lessons of the Recession Making Economic Sense p.220
[2] See What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?
[3] Bloomberg, European Inflation Accelerates, Exports Increase
[4] BBC.co.uk, UK inflation hits 17-month high
[5] See The Euro Bailout And Market Pressures
[6] See Germany Bans Short Selling, Another Scapegoating The Markets
[7] Danske Bank, German ban on short−selling dampens the mood
[8] Pritchard, Ambrose Evans Germany's 'desperate' short ban triggers capital flight to Switzerland
[9] Alloway, Tracy, Swiss franc intervention cost a billion a day in April, FT Alphaville
[10] Wall Street Journal, Taking the Naked Ban to a New Level
[11] BBC.co.uk, Germans approve euro rescue plan
[12] Long, Gordon T., What Will Come of the Euro Experiment?
[13] See Why The Greece Episode Means More Inflationism
[14] Wall Street Journal, Lack Of Demand For Fed Currency Swaps Plus For Markets
[15] US Global Investors, Investor Alert, May 14, 2010
[16] Danske Bank, China: Solid growth and higher inflation clear the way for revaluation
[17] Danske Bank: Euroland: Between robust data and political risk
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