UK Realtors ask Bank of England to Put a Brake on Bubbles

Below is an interesting report stating that in the United Kingdom, beneficiaries of the indirect asset transfer via zero bound rates have been appealing to authorities to put a dampener on an alleged housing bubble.

From the Financial Times (hat tip zero hedge) [bold mine]

Estate agents and surveyors have become so concerned about the dangers of another unsustainable housing boom that their trade body is urging the Bank of England to limit national house price growth to 5 per cent a year…

“The Bank of England now has the ability to take the froth out of future housing market booms, without having to resort to interest rate increases,” said Joshua Miller, senior economist at Rics.

“This cap would send a clear and simple statement to the public and the banking sector, managing expectations as to how much future house prices are going to rise. We believe firmly anchored house price expectations would limit excessive risk taking and, as a result, limit an unsustainable rise in debt.”

The Rics intervention comes as data this week have reinforced a sense of recovery in the UK housing market and sparked warnings that a new bubble could be forming.

Average house prices hit another record high last month, according to figures published on Friday by the LSL/Acadametrics House Price Index, rising 3.2 per cent to £233,776 over the year to August.

It is important to point out how rare it is for beneficiaries of current policies admit to the risks of an inflating bubble. And that their call to contain bubbles signify as Posttraumatic stress disorder (PTSD) or stigma from the previous unpleasant experience expressed through the fear of another bubble bust.

As previously pointed out, a parallel universe exists in UK where asset prices continue to surge even as the economy struggles.

Asset booms in UK has led to a quasi-stagflation where statistical inflation rates have been higher than statistical economic growth rates whether annualized or by quarter.

Yet like in China or elsewhere, once the inflation genie has been let out of the proverbial lamp, hardly any regulatory caps have been successful in taming of bubbles. 

Besides bubbles have been convenient tools to generate statistical growth that embellishes the image of political authorities.

And proof of this is that despite BoE governor Mark Carney’s promise to keep interest rates low via “forward guidance” to supposedly bolster growth, which has rightly been met by skepticism by some of the Members of the Parliament (MP), yields of UK government bonds suggests that the halcyon days in the real estate and the stock markets appear to have been numbered—with or without the BoE’s action.

If the current trends of the bond markets persist, then eventually the bond vigilantes will force the hands of (global) central banks to officially hike interest rates which places all malinvestments forged via a regime of zero bound rates under intense pressure. 

By then, UK realtors will have their demands met, but sad to say that they are likely to endure anxiety relapse from another terrifying episode of a bubble bust. 

US Military Suicides at New Record High

Apparently US foreign imperial policies have been countenanced with an internal blowback (which I earlier called this as the enemy from within) through continuing record rates of military suicides. 

From PressTV

US troop suicides are still maintaining high levels despite years of tracking the effects of mental trauma on soldiers.

With 2012 coming to an end. US officials report that the Army and Navy are already reporting record numbers of suicides.

Similar record numbers are being recorded in the Air Force and Marine Corps--making 2012 the worst year for military suicides since diligent tracking began in 2001. The traumatic effects are war are lasting say experts.

As researchers study the causes of suicides in the military, doctors are evaluating the ratio of suicide rates and frequent deployments.

According to latest estimates, suicides are happening faster than the rate of one per day. Last week, suicides among active military personnel reached 323, breaking the Pentagon's previous high of 310 suicides set in 2009.

Wars have torturous psychological and emotional impact on individuals. Being distant from families can be part of such anguish. However more important is that of the trauma from combat violence. This can bring about the deeply rooted Post Traumatic Stress Disorder (PTSD); common symptoms of which are “combat fatigue” or “shell shock”, that may lead to depression and subsequent suicides. Otherwise, traumatic war experiences could morph into health issues which may exacerbate mental disease that also leads to risks of suicides.

Politicians hardly care about this though. As they relentlessly pursue interventionists policies that always leads to war. It’s not their lives at stake anyway. Besides, wars have always served as justifications for expanding political and economic control over society, which is why the incessant propaganda, abetted by the mainstream media, on nationalism.

As economist Dr. Antony Mueller recently commented,

Clausewitz wrote that war is politics with other means. I say that war is the quintessence of politics. All politics leads to war. War is the ultimate fulfillment of politics. In order to abolish war we must abolish politics. The question is how.

The Road To Inflation

``The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptising it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.”-Ludwig von Mises

As expected, like the dogs in Pavlov’s experiment, US markets passionately cheered on the assurances provided by the US Federal Reserve to provide support to her economy even by possibly resorting to unconventional means or by taking the nuclear option to the table.

In a speech last Friday, Chairman Ben Bernanke[1] said that the Federal Reserve ``is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly”. (emphasis added)

US markets, of late, has been reeling from successive weekly losses giving rise to intensifying anxieties over a re-emergence of another recession or what many calls as “double dip recession”.

And for the mainstream, the prospect of another bout of ‘deflation’ has provided them with the ammunition to demand for more intervention from her government.

Unfortunately, as we have been repeatedly saying, inflationism is simply unsustainable. Like narcotics, it will always have soothing effects that are ephemeral in nature, but whose repercussions would always be nasty, adverse and baneful that would result to capital consumption or a lowered standard of living emanating from the unravelling of malinvestments or the misdirection of resources and on relative overconsumption. And at worst, persistent efforts to inflate could lead to a breakdown of the monetary system (hyperinflation). The 2007 US mortgage crisis had been a lucid example of the boom bust cycles from inflationism yet the public refuses to learn.

And since the time preferences of the masses are mostly directed towards the short term, the elixir of inflationism always sells. The illusion of free lunch policies is just too beguiling to reject.

As Ludwig von Mises once wrote[2], ``The favour of the masses and of the writers and politicians eager for applause goes to inflation.”

And such dynamics is exactly how the present environment operates.

Economic Hypochondria

Figure 1: Danske Bank[3]: Worries Are Intensifying

And as we previously noted[4],

For the mainstream, anything that goes down is DEFLATION. There never seems to be within the context of their vocabulary the terms as moderation, slowdown and reprieve. Everything has got to go like Superman, up up up and away!

The weakening of some economic indicators such as the manufacturing index has led many to envision the same scenario as in 2008 (see figure 1). But this seems more like an economic hypochondria, where the apparent infirmities today seems more like a manifestation of the countercyclical or reactive forces following a V-shape spike in 2009 (right window). The point is NO trend goes in a straight line.

And also this seems to be an extension of the Posttraumatic Stress Distorder (PTSD) which we accurately exposed on the mainstream’s false attribution on the crisis as being prompted by the lack of aggregate demand in 2009[5].

The follies from the same cognitive biases have reared their ugly heads, or perhaps have merely been used to justify government’s actions.

The main mistake of the mainstream is to ignore the interplay of relationships, in terms of stimulus-response action-reaction, between markets or the economy on the one hand and the policy actions from the government on the other.

The mainstream believes that ALL human actions are uniform and consequently discern linearly from such premises. They disregard the diversity of human actions which encapsulates the markets/economy and the political leadership, as well as the bureaucracy which incidentally government is basically run by human beings too. The difference lies in the incentives which drive their respective actions.

Inflationism To Protect The Banking Cartel and Gold’s Status

True, the US housing sector reveals renewed feebleness (left window). But this again is a manifestation of the failure of inflationism or the waning temporal positive effects, where the US government has tried to keep prices from reflecting the natural ‘market’ levels by using manifold interventions such as the manipulation or artificial suppression of the interest rates, quantitative easing (or printing of money), the tweaking of the accounting standards (Financial Standards Accounting Board reversed itself on FAS 157[6]), and the substantial exposure of GSE (Government Sponsored Enterprises) as Fannie Mae and Freddie Mac which currently accounts for $5.7 trillion of the $11 trillion market and provides 75% of the funds in the mortgage market[7].

In my view, whereas the official declaration (propaganda) has always been about the economy (social good), this conceals the true intent, which is to provide support and redistribute taxpayers resources to the banking cartel, whose balance sheets have been stuffed with toxic assets and thus the seeming stagnation in credit conditions.

True, the Federal Reserve has absorbed considerable part of questionable assets via the massive expansion of her balance sheets, but without the sustained redistribution from the US taxpayers to the cartel via more inflationism, this would extrapolate to the collapse of the fractional reserve banking system. Hence, the underlying economic moderation in the economy is sold to the public as requiring more inflationism.

As Murray N. Rothbard wrote[8],

It should be clear that modern fractional reserve banking is a shell game, a Ponzi scheme, a fraud in which fake warehouse receipts are issued and circulate as equivalent to the cash supposedly represented by the receipts

And the market seems to be validating such an outlook (see Figure 2)

Figure 2: Deflation? Recession? Not Quite (from stockcharts.com)

First of all, as said above we don’t believe that the US is anywhere near a recession. The gold market seems to be saying so.

We don’t believe gold is a deflation hedge. The recession of 2008 clearly indicates this phenomenon as gold’s prices materially fell along with the bear market in the S&P 500 and the strength in the US dollar or the obverse weakness of the Euro (green circles).

So gold does not elude the forces of recession, much more the forces of deflation as signified by the collapse of prices of gold along with all the other markets as the effect of the Lehman bankruptcy rippled in October of 2008.

And those making a comparison of gold’s performance during the depression days of the 1930s have only been looking at patterns without noting of the differences in the underlying conditions.

Gold during those days had been part of the monetary system. It was a gold standard then until its temporary suspension following the enactment of the Gold Reserve Act of 1933[9]. Today gold is only part of the assets of central bank reserves. It is only now where gold has seen increasing recognition as ‘store of value’ among global central bankers as gold prices continue with its winning streak[10]. So in accordance to the reflexivity theory, prices changes have been influencing the fundamental factors surrounding gold.

And also today, we have a fiat money standard backed by nothing but empty promises of government to settle.

The Function of Market Prices

Second, those “tunnelling” or obsessively fixated at the treasury markets who scream “deflation” have been misinterpreting markets.

The treasury markets have been the one of key targets of interventionism. The other way to say it is that the prices of US treasury do NOT reflect activities of free markets in relative terms as compared with gold (main window), the Euro (XEU) and the S&P 500. This means prices represent distorted or highly skewed or artificial information.

This seems apparent with indications that small or retail investors have been fleeing the US stock markets and have been gravitating into the bond markets[11]. Yet these are likely symptoms equivalent to the Pied Piper of Hamelin[12] leading the rats to their perdition as they interpret erroneously current price signals to represent reality.

We are reminded of the unwisdom of the crowds[13] which we recently wrote about, and would quote anew Gustave Le Bon who wrote[14] ``The Masses have never thirsted after truth. They turn aside from evidence that is not to their taste, preferring to deify error, if error seduce them. Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusion is always their victim.”

The crowd has been seduced by the siren song of government propaganda called “deflation”.

Remember prices serve not only as information to account for the relative balance of demand and supply, prices are the most essential tool for economic calculation.

According to Gerard Jackson[15],

``Without market prices it is impossible to engage in economic calculation and thus have a rational allocation of resources. Now the market is a coordinating process that assembles fragments of continuously changing information from millions of people; information that can only be known to them personally and expressed as preferences. The market transforms these preferences into prices which then act as signals to producers and consumers. It is this process that enables consumers to achieve the best possible outcome. If a socialist had invented the market it would have been hailed as one of man's greatest achievements. At any time there is always a configuration of prices determined by market data each price is closely interrelated with the others. No price is independent or exists in isolation. It therefore follows that to interfere with one price means interfering with others. Another fact the significance of which ardent price controllers and their supporters cannot seem to grasp. (bold emphasis mine)

Importantly, prices represent property rights which allows for voluntary exchanges between parties to happen that leads to social cooperation.

Bettina Bien Greaves says it best[16],

``Without private property, there would be no private owners bidding for goods and services, and no exchanges among real owners. Without private owners, each guided by the desire for profits and the fear of losses, there would be no market prices to indicate what people wanted and how much they were willing to pay for it. Without market prices, there would be no competition and no profit-and-loss system. And without a profit-and-loss system, there would be no network of interrelated, consumer-directed, independent producers. Without private property, competition, market prices, and a profit-and-loss system, the planners would not know what to produce, how much to produce, or how to produce it.” (emphasis added)

Thus, marginal utility (the cardinal order of want satisfaction or the scale of values), time preferences, rationing, coordination, the dynamic process of spontaneous order in the marketplace and property rights are all jeopardized when government undertakes interventionism or inflationism.

At worst, interventionism represents an assault on private property, which consequently means an attack against civil liberty.

In addition, it is important to recognize that ALL bubbles (boom-bust) cycles have been engendered by the illusion of perpetually rising prices which mainly accounts for the massive systemic distortions built from a variation mix of interventionism channelled via interest rates or monetary policies, tax policies, administrative and legislative policies all of which may combine to encourage irrational behaviour fuelled by credit expansion.

Figure 3: St. Louis Fed: Loan Conditions of US Commercial Banks

Another, I’d be careful to listen to pay heed to experts who claim that the US credit system remains totally dysfunctional (see figure 3).

At this time when the mainstream has been audibly shouting “deflation!”, bank credit of all commercial banks (upper window) seems to be ramping up.

Moreover, while commercial and industrial loans remain depressed, on an annual rate of change basis, we seem to be seeing a bottoming phase (middle window). To add, consumer loans at all commercial banks remain buoyant (lower window).

So in my view, industrial loans still remains problematic or has been the laggard, but may have already bottomed out which could likely see some improvement over the coming months.

Now if all these credit activities advances as I had long expected them to, mainly as a function of the belated effects of the yield curve[17], all the monster excess reserves held by the commercial banks at the Federal Reserve could simply turn into massive inflation. And this would be the rude awakening for the mainstream.

Therefore, deflation, for me, is no more than political propaganda, made by the major beneficiaries—the government and their clique of institutional and academic “experts”, in order to justify inflationism or extend more government control over our lives.

It would be foolish for people to simply read through economics without comprehending the indirect implications of the actions by the incumbent political leaders.

---

[1] Bernanke, Ben The Economic Outlook and Monetary Policy, Speech Given At the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 27, 2010

[2] Mises, Ludwig von The Import of the Money Relation, Human Action Chapter 17 Section 10

[3] Danske Bank, Weekly Focus, August 27, 2010

[4] See Why Deflationists Are Most Likely Wrong Again, August 15, 2010

[5] See What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis, February 1, 2009

[6] North, Gary Translation of Bernanke's Jackson Hole Speech, marketoracle.co.uk August 28, 2010

[7] Laing, Jonathan What's Ahead for Fannie and Fred? Barron’s online, August 28, 2010

[8] Rothbard, Murray N. Mystery of Banking p. 97

[9] Wikipedia.org History of the United States dollar

[10] See Is Gold In A Bubble? November 22, 2009

[11] See US Markets: What Small Investors Fleeing Stocks Means, August 23, 2010

[12] Wikipedia.org Pied Piper of Hamelin

[13] See The UNwisdom Of The Crowds, August 15, 2010

[14] Le Bon, Gustave Le Bon, The Crowd The Study of the Popular Mind, p.64 McMaster University

[15] Jackson, Gerard Are price controls on the way? Brookesnews.com December 29, 2008

[16] Greaves, Bettina Bien A Prophet Without Honor in His Own Land, Mises.org

[17] See Influences Of The Yield Curve On The Equity And Commodity Markets, March 22, 2010

Asia’s Policy Arbitrage, Phisix And The Bubble Cycle

``There is room for investors to start celebrating ‘neither too hot nor too cold’ again, when they stop fretting about tightening and before they start worrying about bubbles again…All roads still point to an asset bubble in China, most particularly if the currency’s appreciation continues to be suppressed.”-Christopher Wood, CLSA (Bloomberg)

The recent Fed’s action had not been well taken by Asian markets.

Although Asia’s markets had been up for the week, they have immensely underperformed their regional and emerging market counterparts.

It looks as if Asian markets may have overestimated on the impact of the US discount rate hikes and may equally underestimated the Fed’s future actions.

Figure 4: Stockcharts.com: Discount Rate Troubles?

The fall of Asian markets, including the Philippine Phisix (main window), Japan’s Nikkei (Nikk) and Dow Jones Asia ex-Japan (DJP2) seem to coincide with the Fed’s ‘surprising’ announcement.

Perhaps it maybe just an excuse to retrench or perhaps there could be other factors involved. The week long absence of China’s market, which celebrated her Lunar New Year of the Tiger, may have also been a factor.

Nonetheless, surging commodities prices appears to have turned the tide for the Baltic Dry Index (BDI) an index which tracks shipping prices for dry goods. As for the latter’s sustainability, this has yet to be confirmed over the coming sessions.

Our guess is that if China’s markets have indeed bottomed as we suspect it has [see last week’s A China Bubble Bust Is Unlikely Yet], then the BDI index we suspect will rise in congruence to rising key stockmarkets worldwide.

Since China’s markets has recently shrugged off the recent second round of increase in reserve requirements for her banks, her markets may have begun to digest the “exit” strategies employed by their local central bank.

For us, Asia and emerging markets are likely to be more receptive to the incentives brought about by the steep yield curve to keep asset prices afloat than to developed economies.

So it seems a bizarre reaction that we read from a local official of our domestic central bank, the Bangko Sentral ng Pilipinas, to extol on the Fed’s increase of its discount rate as helping out local policies by “narrowing of the [interest rate] spread”, “this gives us [BSP] additional space before we implement our own exit plan” said BSP Deputy Governor Diwa Guinigundo.

Figure 5: Asian Bonds Online: Steep Yield Curves

Mr. Guinigundo doesn’t seem to realize that local inflation will likely speed ahead of the US given the domestic market’s likelihood to respond better to low interest (see figure 6), the El Nino problem which will likely aggravate the looming shortages of our agricultural produce already hampered by last year’s Typhoon Ketsana nickname Ondoy and Typhoon Parma nickname Pepeng, and compounded by rising oil prices in the global market.

These factors, which weigh heavily on our local CPI, would likely pivot up the domestic interest rates ahead of the US, perhaps as soon as the local elections are concluded in May.

The basic flaw is to read Fed’s policies as oversimplistically linear, as the case is with most of the practicing aggregatists which tend to pick on select variables to highlight on their desired outcome.

We can’t entirely blame Mr. Guinigundo since as one of the leading technocrat for the banking sector, media publicity demands for “simplistic” replies.

By looking at the internal dynamics of the Phisix as potential measure of capital flows, the past two weeks has seen some substantial inflows from foreign funds. These inflows have been coincidental with the dramatic surge of the Phisix following the “Greek and China” myth induced meltdown during the prior weeks.

Yet compared to the 2003-2007 boom, where foreign funds constituted the bulk of the trades, today’s market attribute reveals the opposite local investors dominate trade.

But given the inflationist approach by major economies in dealing with their local predicament, it isn’t far fetched that the “widening” spreads [and “devaluing” foreign currencies] from which our domestic central bankers seems concerned of may come to fruition (see figure 6).

Figure 6: Money Week Asia [UBS]/ Wall Street Journal: Who Wins In A Liquidity Bubble/Private Capital Inflows

And considering the underdeveloped and relatively small state of the Philippine Stock Exchange, a larger than usual foreign inflow can virtually exaggerate returns that could turn the Phisix into a full blown bubble as it had during the 1987-1994 chart (left window).

Phisix 10,000? That should be peanuts compared to the returns then (the Philippines and Indonesia had nearly 1,000% gains while Thailand had 800%. Argentina and Mexico had even an astounding 1,400% gains-all in US dollar terms.)

It isn’t likely that past performance would exactly repeat, but as shown in the right window, foreign capital flows into emerging markets appear to be accelerating anew and they may contribute to enhanced returns based on global policy arbitrages.

And it is also why the IMF has reverted to its interventionist tendencies and has recently prescribed capital controls for emerging markets, ironically aimed at curtailing inflows. This is in sharp contrast to the past where it recommended capital controls to prevent outflows.

Times have indeed changed.

So while many seem to fear for a reprise of 2008, a dynamic which we see as a remote possibility since most of these fears appear to be predicated on Posttraumatic Stress Disorder (PTSD) [see What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?], we see that excess reserves and the inflationist proclivities of developed economies in dealing with their fiscal woes as risking a supersized global inflation or serial bubble blowing in Asia and or in emerging markets.

In short, while many fear a meltdown, I am concerned of a meltup.

Finally, if gold surpasses its resistance at 1,120-1,125, it is likely that global markets will continue moving against a wall of worry or continually move uphill. This ascent will especially be stronger if both the US and China’s markets chimes in.

What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?

``This pessimistic bias is a general-interest prop to political demagoguery of all kinds. It creates a presumption that matters, left uncontrolled, are spiraling to destruction, and that something has to be done, no matter how costly or ultimately counterproductive to wealth or freedom. This mind-set plays a role in almost every modern political controversy, from downsizing to immigration to global warming.” Bryan Caplan The 4 Boneheaded Biases of Stupid Voters

What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?

-The Pavlovian Response Stimulus Behavior
-Unlike The Bear Market Of 2007
-Posttraumatic Stress Disorder Revisited
-Economic Relativism And Zero Bound Rates
-Authorities Seem Clueless With Bubbles And Operate On Fear

Most of the global financial markets have ended the month mostly in the red. And with momentum appearing to falter, we are seeing marginally more price signal convergence than of a divergence over the past few weeks [both of the prospects we discussed in When Politics Ruled The Market: A Week Of Market Jitters]

By price signal convergence, I mean eerily somewhat similar shades that characterized the bear market of 2007-2008, namely, generally frail equity markets, feeble commodity markets, buoyant US dollar as foreign currencies fumble, lower treasury yields and rising credit default swap premiums, as shown in Figure 1, aside from a higher fear index.

Figure 1: Danske Bank: Negative Interest Rates In US and Resurgent CDS

US T-Bills turned negative for the first time since the Lehman episode in 2008 (left window). However, in spite of the spike in the credit default index of Europe’s most liquid investment grade companies, this has yet to even reach or top its most recent high in 2009 (about 75-right window).

The Pavlovian Response Stimulus Behavior

But does this mean a redux of bear market meltdown of 2007-2008? I don’t think so.

As we have earlier stated, markets appear to be acutely discordant or confused on what has truly been prompting for such apparent broad based weakness.

And as usual, media and mainstream analysts has repeatedly focused on any available current events to ascribe on the possible causal relations: the Chinese government enforcing a curb on bank credit, the Greece debt crisis and or the US proposed enhanced regulatory policies, aside from employment concerns.

Unfortunately, markets have not entirely been confirming such suppositions (see figure 2)

Figure 2: US Global Funds: S&P Weekly Performance

If read from the equity market activities in the US, aside from the Materials and Energy Index, which could be extrapolated as having been influenced by the China factor, it isn’t financials but the Info Tech index that has suffered the worst beating after the China factors this week.

Financials, consumer staples and consumer discretionary, or “economic sensitive” sectors declined marginally relative to its other contemporaries as the US economy registered a faster than expected 5.7% growth mainly due to inventory build up.

Yet following the outperformance of the Nasdaq (44%) and by the S&P 500 info tech (53%) in 2009, it should be natural that any correction should impact the biggest gainers most. The same force appears to have earlier influenced the financial sector, which accounted for last week’s biggest loser but this week’s least affected.

In other words, what we may have been witnessing could be an intrasector rotational profit taking process more than a rerun of the bear market.

And if we are to assess market sentiment (see figure 3) using the Fear index, following 3 successive weeks of decline, the financial markets doesn’t appear to be as apprehensive similar to the 2007-2008 experience…yet.

Figure 3: Fear Index: Not As Fearful

The Fear index has been on a relative downtrend compared to the 2007-2008 patterns where we saw massive contiguous spikes (blue ellipses).

While the surges in 2007 had little impact on the US dollar (USD) which then continued to decline, the recent upswing in the Fear index seems to somewhat replicate on the post Lehman syndrome October 2008 climatic drama, wherein the stock markets collapsed, the US dollar skyrocketed, US treasuries soared and commodities crumbled.

Like the famous experiment known as Pavlov’s dogs, where Nobel Laureate awardee Ivan Petrovich Pavlov successfully proved that dog’s behavior could be shaped by stimulus (ringing of bells)-response (bell ringing means food!), the markets appear to have assumed the same behavior by cognitively anchoring on the post Lehman syndrome as template for any correction: When the US dollar started edging up (or the perceived stimulus), markets have thus interpreted these as signals for “carry trade unwinds” and has equally responded by selling off in almost the same pattern as in the 2008.

In short, a morbid fear from the 2008 meltdown still seems fresh and deeply entrenched into the market’s mind. Yet with fear deeply-rooted into the market’s mindset (even policymakers are fretful of these), it is thus unlikely that the market should experience another bust, until complacency and overconfidence rules anew.

Of course, alternatively, a bust may occur only if the 2006 US housing mortgage crisis meltdown is seen as a continuous process extending until today, where the recent improvements in the markets and economies signify as merely bear market rallies or countercyclical trends.

Well our argument is if this should apply to the US then why should it also plague Asia or the rest of the world? Because the US is the world’s ONLY consumer and Asia is the world’s manufacturer? What nonsense.

Unless the global markets are inferred as sooooo hopelessly and incorrigibly stupid, static and rigid enough to fail to respond to the drastic and dramatic changes in the economic sphere, then this scenario should apply.

But in reality, the only thing rigid is NOT the market but the economic dogma espoused by mainstream analysts whose idée fixee is to resurrect past models and whose prisms of reality is as prisoners of the past. This month we discussed some of these subtle but highly material changes: Asia Goes For Free Trade, Asian Companies Go For Value Added Risk Ventures, Global Science and R&D: Asia Chips Away At US Edge, and Japan Exporters Rediscovers Evolving Market Realities.

The intense fixation on aggregates and on quantitative models which simultaneously ignores the human dimension to adapt to changes and respond to stimulus is the basic flaw for analysts who presuppose omniscience.

Unlike The Bear Market Of 2007

Well, sorry, but it’s not entirely like 2007-2008. Going back to the VIX and the European iTraxx index, both of the current surges haven’t undermined the dominant downtrend trends, and could reflect instead on normal countertrend cycles.

Moreover, while short term yields have admittedly shown some strains, these have not been reflected on the broad yield curve spectrum in the US and abroad.

Figure 4: stockcharts.com: US Yield Curve

The short term rates have indeed been falling but long term rates have held ground in spite of the recent pressures in the market. In short, it seems hardly like the 2007-8 chapter where yields have synchronically fallen.

True, the massive interventions of the US government has helped, but over the past 3 weeks the Federal Reserve has offloaded US treasuries in what some experts see as an experiment to rollback liquidity, aside from some FED activities that may have resulted to negative adjustments in November-December in US money supply (M1) and Adjusted Monetary Base.

But from our standpoint these actions could also be construed as insurance Ben Bernanke underwrote to extend his term [as discussed in Federal Reserve Tightening: Exit Experiment or Bernanke's Confirmation Insurance?].

Think of it, a market meltdown amidst the wrangling over Bernanke’s extended mandate would likely influence positively lawmakers to approve of his stay. That’s because the recent ‘successful’ market actions (money printing) have been correctly attributed to him. Yes, policymakers are not transcendental entities and are also human beings whom are subject to cognitive biases.

Yet, Mr. Bernanke epitomizes the public’s desire for inflationism, as Ludwig von Mises has been validated anew, ``In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about.”

So in effect, the US yield curve appears to have steepened and should incentivize the maturity transformation or conversion of short term liabilities (deposits) to long term assets (loans).

In addition, Asian sovereign yields have not substantially appreciated amidst the recent turmoil. In 2008, except for US treasuries all assets including sovereign debt yields of Asia fell.

Posttraumatic Stress Disorder Revisited

It would also be similarly foolish to assume that following a bust cycle or a recession, especially in the aftermath of a banking crisis, markets would automatically respond to a renewed borrowing spree or rapid revival of confidence, even if they have been supported by governments. (On the contrary, government support could even be the cause of uncertainty, since expectations would have been built on the continual dependency of the markets from government crutches)

Blind believers of the theory that markets operate on “animal spirits” think that this can happen, we don’t. It would take a bevy of spirits to bodily possess a significant segment of the population to enable these to happen. Unfortunately, the concept of animal spirits escapes the fact that people react based on incentives and NOT on some senseless randomness or mood based decisions.

So aside from the hackneyed arguments of overleveraged consumers and capital scarce banking system, the credit markets is likewise subject to Pavlov’s doggy experiment; children burned from touching a hot stove will refuse to touch it anew. Again it is a stimulus-response dynamic.

Airplane traffic fell (response) post 9/11 (stimulus) as people opted to travel in cars even if the latter mode of transportation has been statistically proven to be more fatal. In short, a person traumatized by a specific action (e.g. flying or swimming) due to a certain set of circumstances will most likely refrain from engaging the same activity, even if the circumstances that generated the trauma is absent.

Since markets are primarily psychologically driven then obviously prices reflects on human action based on people’s varied expectations.

So unless people buy or sell financial securities because their “dream” or a “fairy godmother” or their nanny instructs them to get ‘confident’ and buy up the market, we expect people to act on the markets with the expectations to profit or to hedge or to get entertained or to study or to get some needs or wants to be fulfilled from rationally related goals.

We have said this before and we’re saying it again-it’s called Posttraumatic Stress Disorder syndrome (PSTD). [we brought this up last February and has been validated, it’s time to refresh on the idea What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis]

Figure 5: IMF GFSR: Bank Credit to Private Sector In OECD and Emerging Markets

So it would be natural for markets to react negatively to the credit process, in the aftermath of a bust, which had been preceded by an inflationary boom, because the environment turned into a “proverbial hot stove”.

Let’s get some clues from the IMF on its latest Global Financial Stability Report on the state of bank credit to developed economies, ``Bank credit growth has yet to recover in mature markets, despite the recent improvement in the economic outlook. Bank lending officer surveys show that lending conditions continue to tighten in the euro area and the United States, though the extent of tightening has moderated substantially. Although credit supply factors play a role, presently weak credit demand appears to be the main factor in constraining overall lending activity.” (emphasis added)

Again the IMF on Emerging Markets, ``Outside of China, credit growth in many emerging markets has yet to recover appreciably. This suggests that leverage is not yet a key driver of the rise in asset prices. That said, policymakers cannot afford to be complacent about inflows and asset inflation. As recoveries take hold, the liquidity generated by inflows could fuel an excessive expansion in credit and unsustainable asset price increases.” (emphasis added)

We see TWO very important messages from the IMF outlook: one Asset Markets have NOT been supported by credit growth and most importantly FEAR.

This brings to my mind some questions:

If global asset prices haven’t been pushed up by the global credit expansion then how can asset prices materially fall (assuming they’ve been pushed up by savings)? Or how can a bust happen when there has been no preceding boom? Unless the global stock markets are ALL being manipulated by developed governments, which have taken most of the balance sheet expansion these days!

Another way to look at this is from the time delayed impact of the steep global yield curve which obviously hasn’t taken a footing yet.

As we have argued in What’s The Yield Curve Saying About Asia And The Bubble Cycle?, it takes some 2-3 years as in the case of 2003 to generate traction in the credit markets.

``Credit growth can be a powerful accelerator in expansions and usually kicks in strongly in later phases of upswing, but it rarely leads markets or real economy on the way up. Put simply, we do not need a pickup in bank lending to see an economic recovery or pickup in asset prices” comments Morgan Stanley’s Joachim Fels and Manoj Pradhan.

In short, the focus on credit, which is predicated on mainstream ideology, is actually a lagging indicator. Credit lags and not lead the economic cycle. This is perhaps due to the median expectations to see more concrete signs of stability, since everyone’s risk profile isn’t the same.

So while mainstream seems unduly focuses on the state of credit, little attention has been given to market’s ability to adjust based on existing the stock of savings, aside from the repercussions of money printing to the asset markets.

Hence if we go by the feedback mechanism from the previous credit cycle (2002-2006) then a more meaningful improvement could probably be expected by late this year and well into 2011. Yet the impact will be dissimilar.

Economic Relativism And Zero Bound Rates

But the mainstream would object, how about the overindebted consumers and the overleveraged banking and financial system, will they not affect the credit process?

Again the problem is to engage in heuristics or parse from angle of aggregates or oversimplifying problems or issues. For even in the economies that have seen the absorption of extraordinary or excessive leverage, debt assumption is largely a relative sectoral issue. Not all the industries have over expanded by taking up too much debt.

In the US, the technology and communications sectors bore the brunt of the dot.com boom bust cycle during the new millennium which spent the entire decade cleaning up their mess. The recent US boom bust phenomenon was largely a banking-real estate crisis and would likely spend years doing the same, unless government continues to socialize the losses, whereby taxpayers will shoulder the burden.

A similar relative effect should apply to the US households or even on the highly politicized issue of employment (By the way, the employment issue is being politicized as a way to shore up lost political capital following the electoral setbacks by the President and his party. On the other hand the pandering to the masses could also mean a diversionary strategy from a beleaguered political party whose goal is to secure the Senate majority this year).

Yet even if unemployment rate is at 10% or 17% on a broader scale last September, then still some 90% and 83% are presently employed and could possibly take up some form of credit but maybe to a lesser degree.

So the issue of absolutism is totally out of whack. So we may yet see some credit improvements in the future from the current levels (see chart again above) even if they are muted relative to the height of the previous boom.

The same dynamics should be applied to the world, where only some nations engorged on excessive credit. Many haven’t, such as Asians and the BRICs.

Figure 6: CLSA/Zero Hedge: Asia’s Loan To Deposit Ratio

In most of East and Southeast Asia bank loan to deposit ratios are under 100% which translates to generally underleverage in the system (more deposits than lending) except for Korea, Australia and India whose ratios are marginally above 100%.

Thus it would be foolhardy to argue that these economies won’t generate credit improvements when there is low systemic leverage, high savings rate, unimpaired banking system, current account surpluses, a trend towards deepening regionalization and integration with the world economy.

So the low leverage figures as shown by the IMF in figure 5 will likely see major improvements for as long as current policies are skewed towards favoring debtors at the expense of creditors.

Moreover I just can’t foresee a market meltdown given interest rates have been zero bound in major economies.

Figure 7: Japan’s Interest Rate and the Nikkei 225

Japan is a favorite for the mainstream peddling the deflation theme (which implies that money printing has no effect on consumer prices or the ‘liquidity trap’ which is disputed by the Austrian school as the money is neutral fallacy).

Although we believe that present conditions DON’T MEET anywhere near a Japan scenario, there seems no example of markets operating on near ZERO rates for comparison. So even if it is an apples to oranges comparison the point is to prove that a meltdown is unlikely at Zero bound, at current levels.

As you can see in figure 7, Japan’s stock market has basically shadowed the actions of its interest rate. In 2003, Japan’s zero bound rates hit the lowest level which apparently had been in coordination with the US, and these has been followed by a stock market rally. Interest rates then chimed, it moved higher. Today, Japan’s rates remain at near the lowest or near zero even while the Nikkei has modestly advanced. The interest rate chart in the lower window is only until 2005.

In other words, interest rates are pivotal factors in determining relative asset pricing, resource distribution and risk considerations.

In a bubble cycle, a credit boom will force interest rate higher as demand for resources will be artificially buttressed as investors compete with each other to invest in projects with long time horizon and also with consumers, whose consumption patterns will focus on the present. This hasn’t been the case yet.

Hence, ZERO bound interest rates amidst comparable yet depressed treasury yields or even cash will likely favor riskier assets as stocks and commodities.

In addition, major economies have been growing national leverage as the crisis erupted. National leverage comes in the form of government spending. And government spending has been backed by the issuance of these sovereign paper receipts, from which spending results to relative scarcity of goods and services. Hence the relative abundance of government paper receipts over goods and services implies prospective inflation.

And an upsurge of inflation likewise implies that given the loftily priced levels of sovereign instruments or paper receipts, risks appears titled more towards “risk free” instruments, particularly from nations which PIMCO’s Bill Gross calls the Ring of Fire [see Bill Gross: Beware The Ring Of (DEBT) Fire!]

So the risk reward tradeoff should benefit equity and commodity assets more than the conventional “risk free” instruments.

Authorities Seem Clueless With Bubbles And Operate On Fear

The second most important message conveyed by the IMF is Fear.

Again according to the IMF on emerging markets, ``policymakers cannot afford to be complacent about inflows and asset inflation. As recoveries take hold, the liquidity generated by inflows could fuel an excessive expansion in credit and unsustainable asset price increases.”

Even if the stock and commodity markets have gone substantially up, as we earlier pointed out, fear remains a dominant feature in the landscape.

Again the PTSD and or the Pavlov’s stimulus response behavior exhibits that not only many investors but most officials and policymakers have bubbles chronically embedded on their mindsets. The wound is apparently still fresh.

Yet this is one of a policy paradox, policymakers create bubbles by artificially lowering rates in order to boost the credit cycle, aside from other policies as manipulating the treasury and mortgage market via quantitative easing or providing assorted Fed as THE market via an alphabet soup of programs and other forms of fiscal or government spending.

Another implied goal is to see higher asset prices with the implicit aim to recharge confidence or the “animal spirits”.

However, rising asset prices is likewise seen as a bogeyman arising from the previous experience (anchoring) where such officials have excruciatingly learned that a bust follows a boom, ergo a bubble.

Yet, we’re quite sure authorities won’t be able to determine how to distinguish when high prices redound to a bubble. Why? Based on what metric? Who determines when it is a bubble? Since prices are subjective they will always arguable or debatable by some other officials. Besides market based politics will likely influence policymakers. Regulatory capture anyone?

We are seeing signs of such ambiguity or confusion today.

Here is International Monetary Fund chief Dominique Strauss-Kahn who recently warned against ``easing their stimulus programs "too early" before private demand becomes strong enough.”

From the Japan Times, ``"If countries exit too early (from stimulus), and if we have a new downturn in growth, then really I don't know what we can do," the IMF managing director said at the Foreign Correspondents' Club of Japan.

``Although the IMF does not forecast a double-dip recession, he said, "You never know. It may happen."

So the IMF chief wants easy policy to remain, while their GSFR is cautioning against higher asset prices (implying an intervention is required). Are they simply pretending caution? Or are they merely playing safe by offering a contingent clause?

Here is another contradiction, this time from a Chinese official who rebukes US authorities for low interest rates which he believes risks exacerbating a US dollar carry trade bubble. This was when the US dollar was falling last November.

From Marketnews.com ``Liu Mingkang, the director of the China Banking Regulatory Commission, warned a forum here at the weekend that a falling dollar and low U.S. interest rates are providing a vehicle for speculation worldwide, and are exposing risks for the emerging markets in particular as asset prices soar.

"The carry trade in U.S. dollars is huge because of U.S. dollar depreciation and the U.S. government's policy to keep interest rates unchanged and that has had a big impact on global asset prices, encouraging speculation in stock and property markets," he said. (emphasis added)

With the US dollar apparently rising today and where outflows from China’s swooning stock market reached an 18-week high, we see a reversal of sentiment.

From the Telegraph, ``China's deputy central bank chief Zhu Min warned that tighter US monetary policy could spark a sudden outflow of capital from emerging markets, evoking the 1990s Asian financial crisis.”

So China initially smacks the US for low interest rates, easy policies and a weak dollar policy and then currently China censures the US for tightening, which is which?

Have authorities been seeing their shadows (policies) as if it have been chasing them (boom bust cycles)? Or is it a case of a tail (policy errors) that wags the dog (unintended consequences vented on the marketplaces)?

Given the prevailing undertones which reflect on the heightened apprehensions of policymakers, it is doubtful if true tightening would ever take place in the near future. Instead, what would force up interest rates would be the same dynamics that haunt China now, market based inflation from a boom bust process.

At present, global stock markets don’t seem to clearly manifest signals on these yet. Moreover, the dissonance or the incoherence of the opinions of the experts appear to demonstrate a market undergoing a reprieve more than one suffering from a bout of depression based meltdown as alleged by some grizzly bears.

As we have been saying it’s seems mostly about poker bluffing.