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Never Mind the Price Tag, - Gap between the haves and haves nots widens - Part 1

Economics / Articles Jan 10, 2007 - 11:01 PM GMT

By: Adrian_Ash

Economics The gap between the 'haves' and 'have-yachts' keeps growing with the stock market. Watch out for that iceberg!

MORE THAN 1,000 YACHTS went on display last week at the New York National Boat Show. They included the $1.1 million Cruisers Yacht 520 Express.

   But that's peanuts compared with the Sunseeker Trideck, now on sale in Mayfair, London. Complete with a dining table made of American black walnut that seats twelve, it weighs more than 150 tonnes and costs $16 million.


Never mind the price tag. Boat yards expect strong orders for such opulence in 2007, according to Reuters. And why not? Strategists at the top 14 firms on Wall Street all agree the US stock market will rise this year. Up on the sky deck, money shufflers from across the world are sipping cocktails in the hot tub.

   The Dow just made a new all-time high (in Dollar terms, at least). Australian stocks keep hitting fresh record highs. British house prices have trebled in 10 years. The global market in fine art rose 23% last year.

   So it's easy to see where all the money went – even if you can't see where it came from. The flood of liquidity unleashed by central bankers went into asset prices, rather than into the cost of living. Okay, the expense of finding an electrician or plumber might have risen as fast as your house price. But the cost of living billed each week by Wal-Mart, Tesco and Gap has sunk where it hasn't stayed static.

   Here at BullionVault , however, we can't help wondering where all the money came from...and where might it go?

   Consumer debt has been soaring – and asset inflation still surging – even as borrowing costs have risen. Last year saw record new debts for the household sector in the United Kingdom. So says the Bank of England. Yet the Old Lady herself raised base rates to take the heat out the bubble.

   So did the Fed in Washington...the ECB in Frankfurt...and even the Bank of Japan in Tokyo. The orgy of debt and investment continues regardless. How come?

   "New-fangled forms of money were invented that were beyond the reach of central bank control," explain the analysts at Independent Strategy in London. Their report is dated April '06...but as with any unfinished jigsaw, we're glad the missing piece has turned up at last.

   "In a nutshell," it says, "dump your best-loved definitions of liquidity as being some form of measurable money supply. Money left that runway years ago and ascended into a zenith of its own creation."

   Today's money bubble is dubbed 'New Monetarism' by the eggheads at Independent Strategy. They pick up where John Exter's 'Golden Pyramid' of the 1970s left off. And instead of gold at the base – with paper money, bonds, Eurodollars and Third World debt teetering above – the "inverted pyramid of global liquidity" now puts coins and notes at the bottom. No need for gold in this brave new world!

   Next comes broad money – the checking accounts, bank deposits and short-term notes that most people still think of as cash. Above that, and one-fifth larger by value, comes securitised debt – corporate bonds, mortgage-backed assets and credit card debt sold to insurers desperate for income.

   And there...up at the top...which would be the apex if the pyramid weren't upside down...sit derivatives. Three times greater than everything else put together, they're worth a massive $340 trillion in total. No, that's not money you can spend at the shops. But it works just the same for the money shufflers looking to push all assets higher.

   "Using either power money (notes and coins) or broad money (your cheque book), you can do your weekly supermarket run and even buy your car," says Independent Strategy. "With securitised debt (which is what your home loan will become), you can buy a house or you can borrow to invest. With derivatives, you can invest only in financial assets and commodities."

   But my, how you can invest! Derivatives outweigh the world's annual economy eight times over. They account for more than a third of all trades at the London Stock Exchange each day. Why settle for 1,000 shares when a contract for difference (CFD) lets you control 10,000 shares for the same price? And why not borrow against the mortgage-backed bonds you just bought to finance the trade?

   "The higher the asset markets move, the more liquidity asset prices can create," writes Dr. Marc Faber in his latest Gloom, Boom & Doom Report. "Not every owner [of an asset] will use his borrowing power and leverage...But if an asset bull market has been in existence for a while, more and more investors will become convinced that the up-trend in asset prices will never end and, therefore, they will increasingly use leverage to maximise their gains."

   Gearing begets gearing, in other words – and not only because leverage starts to feel safe. A short paper from Pimco, the world's biggest bond fund manager, notes that if some investors use leverage, then all other investors have to join in or lose out. Prices are pushed higher, pushing potential returns lower. Anyone dumb enough to avoid using leverage finds himself chasing riskier assets to increase his yield. But he'll only find that the leveraged investors already got there before him!

   "Unlevered investors eventually begin to realize that leverage constraints are forcing them to hold the wrong securities," writes Vineer Bhansali. "So they begin to relax their leverage constraints either explicitly or implicitly (e.g. with 'packaged' solutions that allow leverage to be had via a structured note)..."

   Unlevered investors, of course, include you, me and everyone else trying to save for retirement. So whether you know it or not, chances are that a chunk of your money has moved out of plain-vanilla mutual funds into higher risk or levered assets...chasing yield like everyone else as bond prices rise and gearing becomes essential.

   Meanwhile, every time a home buyer takes out a new loan...and the debt's sold on to the bond market...and that bond's then sold as part of a structured note playing on interest-rate spreads geared 20 times over...the money shufflers on Wall Street and in London take a bit for themselves.

   Hence the New York National Boat Show and the $40 billion in bonuses paid this month to US and UK money managers. The haves and have-yachts only get richer as the liquidity pyramid grows larger.

   What will happen when it wobbles and falls over? Watch this space...

Adrian Ash is head of research at BullionVault.com , the fastest growing gold bullion service online. Formerly head of editorial at Fleet Street Publications Ltd – the UK's leading publishers of investment advice for private investors – he is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

NOTE - From time to time, The Market Oracle publishes articles from third parties. These articles do not necessarily express the viewpoints of The Market Oracle or its editorial team.


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