Stock Market Shocks, Money Supply Liquidity and the US DollarEconomics / Analysis & Strategy Mar 01, 2007 - 10:13 PM GMT
Events in the last week have certainly caused a stir. Just what precipitated the broad global selloff. Was it the unwind of the Yen Carry Trade, a week delayed? Was it only attributable to the Chinese and their more stern stance against adolescent credit abuses in the Middle Kingdom?
Was it Al Greenspan's comments on an economic recession looming near on the horizon? Was it caution on risk pricing in view of the insane Iran vs USA posturing in the Persian Gulf? Was it Goldman Sachs orchestration with collusion from Beijing, after massive short positions were put in place? Were the GSax powers motivated by the alarms going off in the gold and silver markets, as gold neared $700 and silver passed $14? Methinks all the above, never just one factor in an increasingly complex financial world. The global markets have become a tangled web.
BANK OF JAPAN
Something smelled funny when the Bank of Japan raised interest rates a week ago, yet the USDollar rose, US rates remained quiescent, and the Japanese yen remained moribund. Spin was critically woven by the financial media, that the BOJ offered no forward indication on additional rate hikes. These guys read from the same playbook apparently. Last year, moronic spin was woven by the Euro Central Bank governors that their first rate hike was not necessarily the beginning of a fresh new rate tightening cycle. It was, of course.While the financial system depends upon the cheap yen and the infinitesimal cost of borrowing yen for a powerful speculative engine to operate and provided the idle aristocratic wealthy their easy income source, the Japanese economy must heed the inherent risk extended from cheap money in torrents over years on end. My contention (my gut) remains that the BOJ might hike again, but it will do so very very gradually, in order to preserve the Yen Carry Trade. The YCT stands as the primary perverse pillar to the global financial system.
Harken back to June 2006. The BOJ drained a mammoth 13.2% of yen money supply from the system in preparation for their first rate hike in years, to a paltry 0.25% at that. The shock waves were real and palpable, as every major stock market and especially the emerging stock markets shuddered. Afterwards, the BOJ received a scolding, the US assisted in a CPI doctoring episode (a specialty), and almost another full year passed before the second BOJ rate hike came to pass. More warning was given before this rate hike. For a time it looked as though politicians in Tokyo would keep the BOJ on a short leash. They might still keep BOJ governors on such a shortened leash. The time until the next BOJ rate hike might not be closer to a full year. Rising crude oil prices wield damage to their economy more forcefully than most others, slowing it down naturally, since they import 99% of their oil. One should note that the Japanese economy is twice as energy efficient as the bloated wasteful bulbous US Economy. My gut says the Japanese keep the monetary spigot open wide, even with the current slightly higher official 0.50% rate.
When stocks go down hard, bonds rally, the USDollar drops hard, but gold & silver are also hit, the cause is usually not hard to discern. Massive liquidity drains hit suddenly, taking money out of all long positions except bonds. Safe haven is sought in bonds. Rarely is the initial cause what is reported. This time it was the hard 9% hit endured in Chinese stocks after pressures mounted to curb certain credit abuse among investors. Even condo dwellers in China were borrowing against their equity in order to invest in stocks! One would think such stupidity is the sole province of witless steroid driven Americans. Not so. The most obvious and immediate story to point to as the cause was China. Therefore dismiss it as the actual principal cause. We are approaching the June 2008 Summer Olympic games though, but that date is still far off. Their expansion continues. The showcase is not yet ready for prime time. One must wonder if Goldman Sachs and the US Dept of Treasury won some compromise from Beijing leaders in the vacuous empty Strategic Dialog last late November. Perhaps GSax convinced the Chinese leaders to be more careful with credit abuse in financial markets. Perhaps GSax won a favor from the ICBC stock launch, and they called in a favor in the form of scaring the bejesus out of financial markets, just to keep them in check. It is difficult to properly gauge the sequence of guided events, what with trade protection ratcheting forward, big bank IPO launches occurring, banking reform urged, currency controls pressed to be released slowly, and a brand spanking new $200 billion official "kitty" for investing the gigantic mammoth gargantuan $1 trillion Chinese FOREX reserve account. Perhaps Chinese leaders want to go on a buying spree with that $200 billion only after prices come down on speculative investments. China is a maelstrom of events. My gut says the Chinese keep the game going, since the only constant, it seems, is an uneasy labor force eager to exit rurals and enter urbans in order to improve their lifestyles. Few Americans fully appreciate this powerful political factor.
THE GOLDMAN FACTOR
One can find a safe bet, that whenever gold flirts with the $700 mark, expect the unexpected. Silver was leading the way, moving into the mid-$14 level. Gold investors seem to require assurance to reinforce bravery. The events this week undercut that built bravery. As a result, gold and silver must climb a tougher wall of worry. My view regarding gold and monetary policy (central bank rate decisions) and stock/bond markets, against the backdrop of economic recession threats can be stated here simply. If over the next several months, gold fails to surpass $700, if silver fails to surpass $15, then we will be treated to a whopper recession. Why? Because the USEconomy has become driven by the financial sector in a truly bizarre display of a sick perversion. This is more than a tail wagging the dog. This is a goldman tail wagging a dog sled team. In order to "control" gold, the powers must do irreparable harm to the entire economic system. They will therefore only permit little shocks. This accomplishes a concomitant fear factor to assist in the control of the gold price. My sure bet is that Goldman Sachs is behind the scenes working on the events this week. With Alan Greenspan gone from behind the curtain, Gentle Ben is not up to the task of pulling hidden levers. That job goes to the Team Goldman. The gold price was issuing loud shrill alarms. It will again, but fear must be quieted among the gold players. They must conclude once again, and they will, that gold will rise unless a painful recession is permitted from restricting the monetary spigot. The US cannot restrict that spigot, since its life blood is credit and not legitimate income from the manufacturing or other tangible sector. My gut tells me that the phrase "inflate or die" applies very aptly right now. The powers know it, so they shocked the system. Rates must rise in some global corners. Shocks might occur in other corners. But the flow of money which is constantly reflected in the gold price will remain brisk enough to lift that gold price. Is Goldman playing games, exploiting the cheaper gold price for large new long positions? Methinks probably yes.
An interesting new twist comes to the interpretation of the single mortgage factor. Its acidic effect on the bank balance sheets has begun to do harm, just as my forecast has explained for a year. On the one hand, lower mortgage rates are needed in pressing fashion. The housing market needs lower rates, but that will not save it since the 2004 and 2005 years witnessed lending abuse never seen before in modern history. On the other hand, the bank distress highlights the pressing need for continued liquidity accommodation so as to compensate for the mortgage distress. THEY CANNOT LET THE BANK DISTRESS SPREAD. So easy money will continue. The US money supply is on track to rise 10% this year, a shocking number reminiscent of a Weimar stench. My gut tells me that banks will demand rampant accommodation critically needed to stave off a crisis. That crisis is hidden from view, visible only to the laundry expert technicians converting mortgage backed securities (MBS), whose bonds have contracted serious cancer. The metastasis process took a couple years, once the system took root of the subprime adjustables and negative amortization ARMs and no-doc loans and liar's loans and other goony baroony contracts offered by bank officers in their last gasp to generate fees. Now those practices have generated pink slips and massive bank losses. However, banks still hold about 40% of the portfolios horribly damaged by past abuses. The contagion fully denied will nonetheless continue to spread like a putrid infection. Banks cannot survive with any actual ongoing tightness over time. Delinquencies are high and growing worse. Foreclosures are high and growing worse. Builder option losses are high and growing worse. Job layoffs in the construction sector are contained on the official government tallies, since many workers are paid in cash, off the system, with a scad of immigrants acting as laborers. Why? To do so is cheaper for contractors. Dah!
A note on the mortgage banking mess is overdue. THIS IS GREENSPAN'S BANK CRISIS, ONE HE BUILT, URGED ALONG, EXTENDED FROM HIS DESPERATE DESIRE. Without the housing bubble and linked mortgage finance colossus cancer, the system would have broken down under his watch. He created a housing bubble and bank metastasis in order to buy time and to exit town, leaving Bernanke holding the bag. In time, this bank crisis will bear the Greenspan label. Recall how he urged homeowners to refinance to adjustable mortgages in order to reduce monthly costs.
One good morsel from the recent tumult has been the lower long-term interest rates. Systemic distress, bank problems, housing debacle, destroyed stock perceived wealth, these all conspire to make difficult any decision for the US Federal Reserve to raise rates. In fact, they might lower rates more easily, since the combined effect from things going wrong runs interference for a rate cut. Gold would love such a cut.
One development is hard to digest. The Yen Carry Trade clearly is under a brief assault here. But evidence of its unwind is a rising yen, a falling USDollar, and rising long-term US bond yields. After all, it forces a sale of the USTreasurys in US$ terms and a buyback of borrowed yen loans. That has not happened. A queer curve ball has been delivered. Some wonder if the repayment of other widespread US$-based loans will actually lift the USDollar exchange rate. Don't count on it. Usually US$-based loans are never repaid, but rather extended further. Besides, the USDollar Bear Trade is not one single trade, but rather a mixture of long gold or long crude oil or long euro trades. As long as the US long-term bond yields grossly exceed the Japanese, and as long as they are substantially higher than Euro Bond yields, a carry trade will continue to exist and breathe. The positive bond yield differential keeps the USDollar alive with a bond speculator bid. THAT CANNOT BE TAKE AWAY, SINCE THE BUCK DEMANDS IT. An occasional Bank of Japan rate hike must be endured, for the integrity of Japan, no other reason. When the Euro Central Bank hikes by another 25 basis points later in March, the USDollar will be hit again, and gold will lift again. Maybe the ECB will spin that rate hike as being the last. Don't count on it. The recent shock wave has been convenient. It enables gobs of money to seek safe haven in the USTBond complex, at a time when the USDollar was droopy versus the important euro currency.
GOLD FRONT & CENTER
This here analyst expects gold to rise admidst a number of cross currents. Gold will rise regardless of negatives and with the support of positives. The money supply growth will be relentless, especially given the credit problems and bank debacle underway in its mortgage chambers. The systemic price inflation will return to full gait upward, as energy prices have revived, wage demands will persist (outside Detroit), and an avalanche of liquidity inexorably works its way into the price structures. The advent of Chinese trade protection seems on our doorstep. With less importation will come higher permitted prices, maybe even broad worker pay demands, perhaps even shortages which always are accompanied by higher prices. My gut tells me that gold rose in the past few months quietly and without attributable reason, but in the next few months the list of reasons why will grow to be well understood.
IRAN WILD CARD
Lastly, the Iran wild card cannot be dismissed. A casual observer might believe the United States Military eagerly desires an incident, even with loss of US soldier lives, provided a cause for war is achieved with Iran, for some greater good not easily understood. So far Tehran has not bitten the bait. In the wings is Russia, quietly in control of European energy supply and eyeing its odd bedfellows among the ruling mullahs. Hidden in the hills and along the shore of the Persian Gulf are oodles of Sunburn missiles, supplied by Russia, installed by Iran, aimed at US warships. The Sunburn is one generation ahead of the Tomahawk Cruise missile in the US arsenal, capable of evasive maneuvers. This qualifies as a tinderbox. The fuse is uncertain. The gold price could only love the shrill of geopolitical tensions. We are witnessing reckless boys playing near the gasoline station without adult supervision. These are boys with a long record of lying, who like to blow things up and prefer to pilfer under the cloud of confusion. Too bad the United Nations is such a pathetically weak parental figure!
If all this gives you a headache, you are not alone. Rest assured that unless a global recession led by the crippled USEconomy is desired, gold will thrive in the months ahead. The gold price reflects the abuse of money, and in order to prevent a meltdown on the financial side and on the economic side and within the banking arena, money must flow briskly so as to conceal the damage and to fill the gaps, not to mention restore the losses by insiders on Wall Street. Gold will only falter persistently if the entire system crashes after permitting it to crash. As long as clownish desperate central banks are on the job, at the controls, you can count on monetary inflation. Printing money and perverting the statistics is what they do best. They live to inflate tomorrow's bubble in order to become heros once again. They act as accident event underwriters of last resort in today's accident ridden world. Their jobs will not go away. Gold took a hit as it danced next to the $690 line, but it is stabilizing above the $660 line. That is not a bad place to rest and recover and regroup for the next skirmishes. Fires rage everywhere one turns. Gold rises from the heat.
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