You Can Intimidate Everyone

by Doug Noland

October 05, 2012




“I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.”

James Carville, Clinton campaign strategist, 1993



Intimidating debt markets back in 1993? How about nowadays? When Mr. Carville paid reverence to the bond market, U.S. marketable debt totaled about $16 TN. Non-financial debt was at $13.1 TN, with Households on the hook for $4.2 TN, Corporations $3.8 TN, State & Local governments $1.1 TN and the federal government $3.3 TN. The Fed’s balance sheet ended 1993 at $424bn.



Fast-forward to June 30, 2012. Total U.S. marketable debt ended Q2 at about $55 TN, an increase of 238% since 1993. Non-financial debt increased 212% to $38.9 TN. From 1993 levels, Household debt jumped 207% to $12.9 TN. Corporations have boosted borrowings to $12.0 TN, an increase of 215%. State & Local government debt of $3.0 TN was uponly159%. Federal marketable debt ended Q2 at $11.1 TN, up 231% since 1993.


Total Financial sector Credit market borrowings increased from 1993’s $3.3 TN to $13.8 TN, with ABS up 298% to $1.86 TN, Agency/GSE securities up 295% to $7.54 TN, Broker/Dealer borrowings up 437% to $2.05 TN, and Wall Streetfunding corpsup 593% to $2.29 TN. Total outstanding Corporate and Foreign Bonds jumped from $2.05 TN to $11.96 TN (up 483%). The value of Corporate Equities rose 285% from $6.30 TN to $24.22 TN. The Fed’s balance sheet inflated 580% to $2.88 TN.
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Since 1993, Private Pension Fund Assets have grown 180% to $6.39 TN. State & Local Pensions were up 187% to $1.04 TN. Nothing, however, compares to the growth experienced by the hedge fund community, which grew from about $50bn in 1993 to recent estimates approaching $2.2 TN (growth of 4,300%). And, importantly, the explosion in debt and financial assets management has been a global phenomenon.


I have argued that economic structure matters. I have further posited that a defining feature of contemporary economies (especially with respect to the consumption and services-based U.S. structure) is the capacity to absorb enormous amounts of Credit expansion/purchasing power with little impact on traditional measures of consumer price inflation. Moreover, I have attempted to explain how, when Credit expands, this finance flows into the economy before much of it finds its way out into the “global pool of speculative finance.” I have further argued that this ever-expanding pool of unwieldy finance is this Credit Bubble cycle’s most dangerous inflationary manifestation.
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The Greenspan Federal Reserve sold its soul back during the 1998 bailout of Long-Term Capital Management. Even prior to 1998, Fannie and Freddie had been playing the critical role as liquidity backstop to the hedge fund community in the event of market stress. I wrote some years ago that speculators could take highly-leveraged positions in MBS, confident that the GSEs were at anytime willing to pay top dollar for this paper especially during bouts of market tumult. The Federal Reserve took a decidedly moreactivistapproach to market interventions during the 2001/2002 corporate debt crisis and recession. After reading Dr. Bernanke’s and others’inflationists writings, I recall a CBB about a decade back where I suggested that the Fed was determined to have hedge funds unwind their short positions in Ford and other corporate bonds - and furthermore entice them into going (leveraged) long. And, sure enough, the funds did adjust and made a ton of money. The Fed was subtler back then, but they were sowing the seeds for the recent backdrop where they’ve essentially guaranteed anyone that speculates in MBS or Treasury securities (corporate bonds, municipals debt, equities?) seemingly risk-free speculative returns.
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I was always impressed that ECB President Jean-Claude Trichet would categorically – and repeatedly - state that “the ECB never pre-commits on interest rates.” The Fed has for years now operated otherwise, believing it advantageous to signal its intentions specifically to the marketplace. This has proved quite advantageous for some, but clearly much to the disadvantage of system stability. The ECB seemed to better appreciate that illuminating too much to the speculator community would simply ensure destabilizing speculation – and attendant Bubblesbased on the expected course of ECB policymaking.
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Betting on the predictable path of Federal Reserve policy must by now be one of the more lucrative endeavors in history. In a CBB a decade ago, I made a flippant comment about the financial and economic landscape, writing “The titans of industry run money.” Never did I imagine back then that hedge fund assets were on their way to $2.2 TN, Pimco to $1.7 TN and Blackrock to $3.6 TN. Betting successfully on Fed policy has created billionaires . And, more importantly, those that have played this extraordinary policymaking backdrop most adroitly today control unimaginable sums of financial assets – in the hundreds of billions and even Trillions. There’s been nothing comparable in terms of the concentration of financial power and speculation since the late-twenties.
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Ironically, this historic financial windfall even accelerated following 2008’s near financial collapse, as policy effects on financial markets reached only greater dimensions. Those that played it most successfully amassed only more incredible fortunes. And the stakes over just the past few months have been enormous. And those with the best sense – or, more likely, the best information – of how things were going to play out in Frankfurt and Washington added further to their kitties. And, predictably, additional assets to manage flow to the victors.
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ECB President Mario Draghi is clearly a very intelligent man. He is an MIT trained economist with the most impressive credentials. He has decades of experience as a professor, World Bank official and governor of the Bank of Italy. Mr. Draghi was also a vice chairman at Goldman Sachs for several years (2002-2005). Clearly, Draghi understands markets and the dynamics of speculative finance.


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When he warned against betting against the euro and European bonds the marketplace took notice. Amazingly, the ECB has gone from being adamantly opposed to pre-committing on rates to openly determined to pre-commit to huge open-ended market interventions and price support operations. After holding out, the ECB finally sold its soul – and the speculators have been giddy.

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Bill Gross has been rather open about it: “We’re buying what the Fed and ECB are buying.” And Mr. Gross and others have been buying Spanish and Italian bonds, with a brilliant plan to sell them back to the ECB at higher prices. There’s a very large global contingent keen to place such bets, after similar trades in U.S. Treasuries and MBS have made gazillions.

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In the face of alarming economic deterioration, European debt has become a hot commodity. The euro has become a hot currency. Reuters reported Thursday that the euro zone is considering a bond insurance plan. The idea is for the ESM to “guarantee the first 20 to 30% of each new bond issued by Spain.” Friday from Reuters (Andreas Framke): “The European Central Bank envisions buying large volumes of sovereign bonds for a period of one to two months once its ‘OMTprogramme is launched.

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From those among us questioning how the euro can trade so resiliently in the face of potential financial and economic calamity, I have this thought: The Draghi Plan has been in the process of transforming Spanish, Portuguese, Italian and other problematic debt into possibly the most appealing speculative asset in the world today. After all, all this paper provides a relatively decent yields (especially in comparison to bunds, Treasuries, or securities funding costs), and now at least the 1-3 year debt enjoys a commitment of open-ended liquidity/price support from the ECB. If the Draghi Plan does transform this debt from a fundamentally attractive short to a must have speculative long in the eyes of the powerful leveraged players, well, then the Draghi Plan truly has been a “game changer.”

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There’s a lot that will likely go really wrong in Europe, perhaps even in the short-term. Greece is an unmitigated disaster, and Spain is running a close second. There was further dismal economic news this week, most notably from France. But that hasn’t in the least diminished recent keen speculative interest in European debt. Indeed, after the Fed sold its soul, I’ve often believed that the speculators became adept at recognizing periods of rising systemic stress and market vulnerability as opportunities to load up on Treasuries and MBS. And then it becomes a game: “OK Federal Reserve, make the value of these securities (or spread trades) go up or we’ll dump them.” They haven’t had to dump. The ECB has similarly opened itself up to blackmail. “Be ready with the OMT as promised - or we dump.” “Spanish and Italian politicians, play ball or we’ll dump.” “Mr. Weidmann and the Bundesbank, fall in line - or we dump!” “All policymakers everywhere, play or we dump.” At least in Europe, this is developing into one fascinating multifaceted game of chicken.

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Well, I’ve been ranting for awhile now about the “biggest Bubble in the history of mankind.” At this point, things increasingly remind me of 1999 and 2006. Bubble Dynamics eventually reach a degree of excess that is too conspicuous to deny. Yet the stakes are so much greater today. The amount of global debt is so huge and the quality so poor. It’s completely systemic and global. Dangerous excesses have gravitated to the core of Credit and monetary systems. Policymakers are nowall in” in a desperate gambit to hold financial and economic fragility at bay. And, dangerously, highly speculative markets seem determined to extend their divergent path from economic fundamentals. It’s frightening how enormous and enormously powerful dysfunctional global markets have become.

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