He's Back

by Doug Noland

May 30, 2014 


A synchronized melt-up in global risk markets.

May 30 – MarketNews International (Brai Odion-Esene): Former Bank of England official Adam Posen believes there is undue worry about how the Fed will tighten monetary policy and withdraw stimulus when the time comes, saying the limited powers the Fed now has to deal with credit issues should be of greater concern. If you are talking about uncharted waters, I’d be much more emphasizing the financial stability aspect and the institutional issues for the Fed,’ Posen, now president of the Peterson Institute for International Economics, said… Speaking on the sidelines of a Cleveland Fed conference on monetary policy and inflation, Posen - a former member of the BOE's Monetary Policy Committee - said all the concerns about winding down the Fed's large scale asset purchase program and potential inflation is ‘unnecessary hand-wringing.’ He said he is much more concerned about the ‘institutional limitations’ on the Fed. ‘I'm not worried that there is an imminent financial stability problem for the U.S.,’ Posen added. ‘Once you’ve had a bubble, you are less likely to have one soon afterward.’”

May 29 – CNBC: Investors should not fear any of the kind of catastrophicMinsky moments’ that fed the recent financial crisis, despite the reappearance of easy credit in the home mortgage markets, [Paul] McCulley said. McCulley is credited with inventing termMinsky moment’ to describe a sudden crash in asset values, usually following a period of extreme speculation using borrowed money… ‘We don't have to be worried about the Big One. We had the Big One, and you don't have another Big One after you have had the Minsky moment,’ he said.”

Paul McCulley, May 29, 2014, appearing on CNBC: “I don’t think the world is upside down. I think the world is pricing in and coming to grips with the fact that post the ‘Minsky Moment’ – which was 2008 – and post five years’ worth of healing in the economy and in the financial markets and in the banking system – that we’re on the cusp of emerging from a liquidity trap. And that the Fed and other central banks around the world are going to be exceedingly low on short-term interest rates. This is a brand new regime. We are calling it here (Pimco) the ‘New Neutral’ and I love the phrase; I’ve been writing about it for ten years. And ultimately we had to get to this point where the marketplace broadly definedall asset classes are accepting that risk-free cash trades at par – you get it back tomorrow should not provide a real rate of return. It’s preservation of capital - period. If you want to have a real rate of return you have to be in assets. So we’re having a once-in-a-lifetime revaluation of assets. I think it’s kind of cool.”

Bubbles and financial manias are just incredibly fascinating. Unfortunately, they’re also exceedingly dangerous; something that somehow goes unlearned

Having studied past manias, for me it's invariably a case of “how could they have fallen for that.” In hindsight, bouts of financial euphoria always look ridiculous. Having now worked through twenty-five years of serial booms and busts, I have come to appreciate how the “analysisalways follows the direction of the markets. And the crazier the (late-cycle) market excesses the more creative the bullish propaganda. Of late, it’s turned ferventlycreative.”

In the nineties there was all the “New Era” and “New Paradigmhype. There was the so-called productivity miracle”. Our nation was going to pay down the entire deficit and run surpluses. Our financial system was incredibly effective at allocating our limited amount of savings. The collapse of the Soviet Union and fall of the Berlin wall were to usher in a golden age of Capitalism and global prosperity. Meanwhile, a historic financial Bubble was unleashed that continues to this day. Along the way, there were various serious financial Bubbles and collapses, including Mexico, SE Asia, Russia, LTCM, Argentina and the U.S.techBubble. Not much talk these days about the heyday of global Capitalism and prosperity – at least outside the securities markets.

The post-tech Bubble reflation inspired additional creative bullish propaganda including “the global savings glut,” “Bretton Woods II,” and “the great moderation.” These notions were largely obliterated by the collapse of the mortgage finance Bubble.

It is a truism that manias spawn sophisticated justification and rationalization. Analysis and theories will inevitably flourish in support of inflating Bubbles. It’s also true that bullish analyses and theories will garner powerful followings. Inflating asset prices will “prove” the genius of the bullish proponents, while the naysayers will be crushed and discredited. This, however, doesn’t change the reality that Bubbles do leave a trail of evidence for those willing to stick diligently with the analysis.

Bubbles are invariably fueled by Credit excess. There will be prevailing market misperceptions, along with resulting mispriced Credit and asset markets. Major Bubbles invariably are nurtured by government and central bank market interventions/manipulations. As always, Credit excess begets Credit excess – and asset price inflation begets speculation and greater asset price inflation. So long as Credit flows freely – and misperceptions persistit all will look viable or better.

The views espoused above from (inflationists) Adam Posen and Paul McCulley epitomize today’s bullish thinking. From Posen: “I'm not worried that there is an imminent financial stability problem for the U.S. Once you’ve had a bubble, you are less likely to have one soon afterward.” And from McCulley: “We don't have to be worried about the Big One. We had the Big One, and you don’t have another Big One after you have had the Minsky moment.” “So we’re having a once-in-a-lifetime revaluation of assets. I think it’s kind of cool.”

I generally don’t pull content from previous CBBs. But since He’s Back, I couldn't resist. As background, for years I referred to Paul McCulley as a leadinginflationist” as well as my “analytical nemesis.”

CBB 12/2/2005: Bill and Paul’s Wild Analytical Adventure.“Mr. McCulley is an especially clever Fed watcher/proponent. Now plainly in the Bernanke camp, he blends insightful analysis with really creative rationalization for today’s flawed American experiment in central bankingMr. McCulley remains firmly entrenched in his hypothesis that the Fed has attained the promised land of price stability, and it is this postulate that provides the foundation for his analytical framework. He goes so far as to link the achievement of price stability to the collapse of risk premiums and the propensity for Bubbles. I take very strong exception to this analysis, and there really can be no reconciliation between his “price stability view and my assertion of the polar opposite, Monetary Disorder none. It is the foundation of my analysis that the “evolution” to an unrestrained capital markets and asset-based Credit system has, not unpredictably, nurtured a highly unstable monetary environment.”

It’s interesting. I argued against the inflationists (including McCulley) throughout the post-tech Bubble reflation. Having chronicled the mortgage finance Bubble on a weekly basis from 2002 through its 2008 collapse, there was a time when I actually thought my analytical framework had decisively won the debate. But like the irrepressible Credit Bubble, the inflationists have come Back more emboldened than ever. I also believe their frameworks are more flawed and dangerous than ever.

It’s actually rather fitting. In a now heated déjà vu all over again Bubble backdrop, some of the old inflationists propaganda is recycled anew. One of these opposing analytical frameworks is going to be right and the other completely wrong: Central banks have either won the battle against inflation or they’re losing the war against speculative finance and Bubbles. We can either relax with the view that we’ve already had the “Big one” - or we ought to be damned worried that we’re in the midst of history’s biggest Bubble.

All the bullish propaganda during the nineties didn’t change that the GSEs and “Wall Street finance” were distorting Credit and the markets – while fueling major Bubbles. GSE holdings expanded $151bn, or 24%, in tumultuous market year 1994. GSE and Fed liquidity and liquidity backstops ensured flourishing speculation and market Bubbles. The 1998 crisis saw GSE assets increase an unprecedented $305bn, or 27.7%. The GSEs were back for another $317bn in 1999. In all, GSE assets expanded $1.092 TN, or 173%, in the six years ended 1999. New Paradigm, indeed.

It is worth noting that total GSE securities (debt and MBS) expanded $431bn in 2000, $642bn in 2001, and $547bn in 2002. While conventional opinion was fixated on deflation risk, I began warning of the unfolding mortgage finance Bubble back in 2002. In the nine-year period 1994 through 2002, total GSE securities increased $3.63 TN, or 190%.

Why are GSE data from a decade ago relevant to today’s global government finance Bubble”? The GSEs were integral to a historic distortion in the expansion and pricing of U.S. Credit. The 2008 crisis wasn’t at its core about Lehman or even structured finance. The GSEs were instrumental in fueling a Bubble that would inevitably collapse. There was an enormous amount of problematic debt that only appeared sound so long as Credit was mispriced and issued in enormous quantities (ensuring inflating home and asset prices). Integral to this Bubble was the market assumption of an implicit Federal backing of GSE debt and obligations. This could have been clarified, but Congress, the Fed and several administrations simply looked the other way. Without the implicit federal guarantee, the GSEs would not have been able to operate as the Bubble-fueling liquidity backstop, especially during crisis periods.

My thesis is that the overwhelming reaction to the collapse of the mortgage Bubble – from the Fed, U.S. Treasury, global central banks and governmentsunleashed even greater and far-reaching financial and economic Bubbles. 2008 was not the “big one.” Rather, it was the crisis response that was the biggest ever, setting the stage, I fear, for the really problematic crisis. And if our policymakers had learned anything from the terrible mortgage boom and bust experience, they’d be especially careful with these implicit market backstops (and the distortions they promote).

Indeed, the danger of “open-endedQE goes way beyond the $1.5 TN of market-distorting Fed liquidity. The marketplace took QE3 (and concerted global monetary stimulus) as a signal that the Fed and global bankers were willing to provide boundless market backstops. It is this implicit guarantee of unlimited central bank liquidity – and notstable prices” – that has led to a dramatic revaluation of asset prices. QE3 was an absolute Bubble game-changer one a responsible central bank would today be eager to rectify by adopting specific rules to limit future Federal Reserve balance sheet growth.

The “Granddaddy of All Bubblesthesis rests on the premise of a deeply systemic Bubble throughout debt and equities markets and asset prices more generally, on a globalized basis. In contrast to GSE market distortions that impacted pricing most significantly in mortgage Credit, today’s global central bank distortions impact virtually all asset prices. Market risk distortions now basically permeate all marketsstocks, bonds, Credit and any asset that provides income/yield virtually anywhere in the world. Assets include collectible art, Manhattan apartments, farm property and NBA franchises.

Importantly, it is the character of policy-induced market distortions and speculative excess that dictate the risk of future crises. It’s nothing more than wishful thinking to claim the protracted cycle of booms and busts miraculously ended in 2008/09. Typically, one would not expect another Bubble to begin inflating immediately after a major bursting. But 2008-2014 policy measures have been the most extreme and atypical.

The 1994 GSE backstop and Mexican bailout altered risk perceptions and helped spur destabilizing excess at home and abroad. The 1998 LTCM bailout and Fed reliquefication stoked only more virulent speculative excess. The aggressive post-tech Bubble reflation and Dr. Bernanke’s talk of “helicopter money” and the government printing press unleashed a much larger and dangerous Bubble throughout mortgage Credit. As such, the critical question that should be asked today is whether the unprecedented global response to the 2008 crisis set loose only more pernicious global market distortions, Bubbles and economic maladjustment? Despite all the bullish propaganda, the answer is an emphaticabsolutely.”

As I’ve attempted to explain in the past: 2008 was essentially a private debt crisis. It was resolved through massive deficit spending, central bank Credit, zero interest rates and an assortment of government guarantees and assurances. “Too big to failevolved to encompass securities markets around the globe.

Following the Credit Bubble data trail, Treasury debt issuance jumped to $1.239 TN in 2008, $1.444 TN in 2009, $1.579 TN in 2011, $1.067 TN in 20012, and $1.141 TN in 2013. After doubling mortgage Credit in just over six years, outstanding Treasuries jumped 140% ($7.2TN) in six years. Looking at Federal Reserve Credit, the Fed’s balance sheet increased $1.319 TN in 2008, was about unchanged in 2009, increased $186bn in 2010, rose $494 bn in 2011, increased $8.0bn in 2012 and then jumped $1.119 TN in 2013. By the time QE3 runs it course, the Fed’s balance sheet will have grown 400% (about $3.6 TN) in six years.

The “global government finance Bubblethesis rests on the premise that an unprecedented simultaneous expansion of government debt and central bank Credit has basically distorted risk perceptions, market pricing and resource allocation everywhere. The appearance of "stability" is a huge deception.

Euphoric global markets have certainly been enjoying immunity to negative developments. Global bond markets have been in melt-up, perhaps bolstered by heightened disinflationary pressures and geopolitical risks. After all, in the face of ongoing zero rates, incredible central bank monetization and market inflationrecent data around the world indicates economic vulnerability. Expectations for imminent additional monetary stimulus have pushed European market Bubbles to dangerous extremes. Highly speculative global equities markets have been bolstered by the notion of abundant cheap liquidity as far as the eye can see. General market enthusiasm (and short covering) has stoked a significant rally throughout the emerging markets.

As I often quip, “Bubbles go to unimaginable extremesthen double!” These days I have to remind myself that markets are in the midst of the greatest Bubble in history. And we today see what I believe is a dangerous synchronization of global risk markets. Most markets demonstrate similar dynamicsit’s basically become one big global risk ontrade. And as fundamental prospects darken, some players begin to position for a transition to more of a “risk offbackdrop. This shorting and buying of derivative hedges then provide the fodder for another round of squeeze-induced market rally. And in an environment with unprecedented scope for performance-chasing and trend-following trading, these rallies have a tendency to take on a (speculative) life of their own. Bubbles just turn more unwieldy.

The consensus view holds that market risk is currently extremely low. I would counter that the VIX index (at multi-year lows) is low not risk. These days the VIX (measure of equity market volatility) is a better barometer of market complacency. Below the surfacewhere folks work diligently to pick the right stocks and sectors – the marketplace is really tough. As a Goldman official stated this week, markets are “abnormal.” And I would suggest that this abnormality just keeps forcing more players into (“closet indexing”) the S&P 500 index – in the process fueling the “marketmelt-up. It all seems rather late-cycle dysfunction to me.

With market Bubbles inflating all over, analysis will focus on relative performance and stability. Which Bubble will falter first? Where are excesses the most egregious? Where are securities prices most disconnected from fundamental prospects/reality? Well, bullish propaganda proliferates these days. But the bullish view of the “brics” in the face of fragile underpinnings strikes me as particularly susceptible. Brazil, Russia, India, China and South Africa (and throw in Turkey) all suffer from faltering economies in the face of ongoing rapid Credit growth. It’s worth noting that the South African rand dropped 2.6% this week. Russia’s ruble fell 2.1%, the Indian rupee 1.0% and the Brazilian real 0.8%. The Thai baht declined 0.9% and the Turkish lira lost 0.7%.


Our Last Chance for a Safe Planet

Jeffrey D. Sachs

MAY 28, 2014
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Newsart for Our Last Chance for a Safe Planet


MELBOURNE Humanity has just about run out of time to address climate change. Scientists have pointed out that a rise in temperature of 2º Celsius above pre-industrial levels will put the Earth in dangerous, uncharted territory. Yet we currently are on a path toward an increase of or more this century. The last chance for action has arrived.

That chance lies in Paris in December 2015, when the world’s governments meet for the 21st annual United Nations climate-change meeting. But this time will be different. Either governments will agree to decisive action, as they have promised, or we will look back at 2015 as the year when climate sanity slipped through our fingers.

In 1992, the world’s governments adopted the UN Framework Convention on Climate Change, promising to avoiddangerous anthropogenic [human-induced] interference in the climate system” by reducing the rate of emission of greenhouse gases, especially carbon dioxide. But, though the treaty entered into force in 1994, the rate of emissions of greenhouse gases, including CO2, has actually increased.

In 1992, global combustion of coal, oil, and gas, plus cement production, released 22.6 billion tons of CO2 into the air. In 2012, the most recent year for which comparable data are available, emissions were 34.5 billion tons. Humanity has accelerated, rather than controlled, human-induced climate change.

This is now the greatest moral issue of our time. Global fossil-fuel use gravely threatens the poor, who are the most vulnerable to climate change (though the rich are the main cause), and future generations, who will inherit a planet that has become unlivable in many places, with food supply subject to massive shocks.

We are causing this harm in an age when technological breakthroughs enable the world to shift from dangerous fossil fuels to low-carbon energy sources, such as wind, solar, nuclear, and hydro, and reduce the impact of fossil fuels by using carbon capture and storage (CCS) technology. Pope Francis recently put it just right: “Safeguard Creation,” he said. “Because if we destroy Creation, Creation will destroy us! Never forget this!”

Yet, for the many powerful interests, climate change remains a game, with the goal being to delay action for as long as possible. The giant fossil-fuel companies have continued to lobby behind the scenes against the shift to low-carbon energy, and have used their vast wealth to buy media coverage designed to sow confusion. Rupert Murdoch’s media empire in the United States, the United Kingdom, Australia, and elsewhere stands out as playing a particularly cynical and harmful role in spreading anti-scientific propaganda.

Even so, the politics of climate change may be changing for the better – a change reflected in the Pope’s forceful message. Here are six reasons why the stalemate might soon end.

First, the world is waking up to the calamity that we are causing. Though the Murdoch propaganda machine churns out a daily stream of anti-scientific falsehoods, the public also sees prolonged droughts (now in parts of Brazil, California, and Southeast Asia, to name a few places), massive floods (recently in Bosnia and Serbia), and lethal heat waves (in many parts of the world).

Second, the world’s citizens do not want to go down in flames. Public opinion has so far succeeded in blocking the construction of the Keystone XL Pipeline, which would accelerate the production of Canada’s oil sands – a shocking prospect, given that neither Canada nor the US yet have committed to a climate plan.

Third, more severe climate shocks may lie ahead. This year could prove to be a major El Niño year, when the waters of the Eastern Pacific warm and create global climate disruptions. A big El Niño now would be even more dangerous than usual, because it would add to the overall rising trend in global temperatures. Indeed, many scientists believe that a big El Niño could make 2015 the hottest year in the Earth’s history.

Fourth, both the US and China, the two largest emitters of CO2, are finally beginning to get serious. President Barack Obama’s administration is trying to stop the construction of new coal-fired power plants, unless they are equipped with CCS technology. China, for its part, has realized that its heavy dependence on coal is causing such devastating pollution and smog that it is leading to massive loss of life, with life expectancy down as much as five years in regions with heavy coal consumption.

Fifth, the Paris negotiations are finally beginning to attract global attention from both the public and world leaders. UN Secretary-General Ban Ki-moon has called for political leaders to attend a special summit in September 2014, 14 months ahead of the Paris meeting, to launch intensive negotiations. The UN expert network that I direct, the Sustainable Development Solutions Network (UN SDSN), will issue a major report in July on how each of the major economies can successfully decarbonize the energy system.

Finally, technological advances in low-carbon energy systems, including photovoltaics, electric vehicles, CCS, and fourth-generation nuclear power with greatly enhanced safety features, all help make the transition to low-cost, low-carbon energy technologically realistic, with huge benefits for human health and planetary safety.

Starting this fall, the UN SDSN will create a platform for all global citizens to participate in the hard work of saving the planet. The SDSN will offer a free, online introductory course to climate change, and then host a global onlinenegotiation” of a global climate agreement.

We expect that hundreds of thousands, perhaps millions, of interested citizens worldwide will participate online, showing the way for the politicians. The control of climate change is a moral imperative and a practical necessity far too important to be left to politicians, Big Oil, and their media propagandists.


Jeffrey D. Sachs, Professor of Sustainable Development, Professor of Health Policy and Management, and Director of the Earth Institute at Columbia University, is also Special Adviser to the United Nations Secretary-General on the Millennium Development Goals. His books include The End of Poverty and Common Wealth.