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Translating Greenspeak into Plain English
Posted By Barry Ritholtz On June 29, 2005 @ 5:44 am In Economy | Comments Disabled
Since we have a very special Fed meeting coming up this week, I thought I would give y’all a treat. Its the Peneboscot Princess, all by her lonesome:
The ‘90s were a fast and furious era of huge technological leaps and sweeping political change. These developments yielded more sophisticated investments across countless international borders. And along the way, these developments also mandated capital, which came in three flavors: productive, prophylactic and the kind used for “medicinal purposes only”. But little distinction was made among these varieties. All we know is that we got a boat load of dough and a mandate to spread it all over, like so much manure.
And that we did. Whether to jam the Asian Tigers or re-invent carry trades or ameliorate fall-out from the demise of the Soviet Union or to foster the dot.com frenzy, to expedite the explosion in the use of derivatives or to paperover any difficulty du jour, the FED was there, pump in hand, ready to keep us marinating in a bottomless pool of monetary brine.
Of course, this central bank promiscuity resulted in global excess of every imaginable kind, not the least of which was the stock market bubble which came to an end in 2000. There is no need to delve into any of the gory details.
But we will point out that Mr. and Mrs. America, though suffering 3rd degree burns over most of the portfolio, did become convinced in the existence of a free-lunch program. Therein lies the rub. Keep it in mind as we digress.
And as fate would have it, along came the recession of 2001. Dang it anyhow. You remember this part, right?
They began to slash rates like crazy. Here’s a quote to jar your memory … “Greater uncertainty, in part attributable to heightened geopolitical risks, is currently inhibiting spending, production and employment …”
See? They couldn’t then, just as they cannot now … admit that they had created a great, big mess and had not the wherewithal to either understand it or to even begin to remedy it. So the one-trick pony, the FOMC, under the guise of “heightened political risk” (Iraq), kept pushing on that string until they had FED funds at 1% by the summer of ’03.
So the grease was back in the system, this time with a vengeance. But the economy was not cooperating, no sir. Couldn’t get a pulse. But the stock market? Another story altogether. The S&P 500 (cash) traded at a low of 788.90 on March 12, 2003. The high was marked on March 7, 2005 at 1229.11. Not bad for government work.
Literally. But who was in the driver’s seat? Hedge funds were the first on the food chain to get the fertilizer from the banks/brokers that the FED was intent on doling out. And are the perfect pick when a reflation is needed. So it’s no wonder that trade has became insufferably one-way and maddeningly mechanical for so long as they set about the business of stock market bubble #2. Meanwhile, though some of the Moms and Pops who had visions of recouping, surely did get back into the swing of investing in stocks, the incredibly low rate scene was busy spawning yet another bubble, the one in housing, of course. The stories of the blistering pace of new and existing home sales, median price explosion and the relaxation of lending standards to the point of absurdity are legendary by now but alas, mesmerized anew by the latest get-rich-quick frenzy, all caution has been thrown to the wind.
Now we get to the conundrum part. Where to start, eh?
You can only slam and jam the S&P 500 so much until you get bored, right? So branching out into commodities speculation proved to be a noteworthy diversion for some of the more agile, highly-levered players. Example: On May 27, 2004, prompt Gasoline hit a then-record of $1.47. Example: Copper ticked at .90 on 11/24/03. By August of ’04 it was up around 1.22. Meanwhile, the S&P 500 made the “August ’04 low” on the thirteenth, demonstrating what we knew all along, that the loosey-goosey do-re-mi was being transferred from one asset class to another as the fast players were about the business of squeezing every last bit of opportunity from each venue they descended upon. In droves. Other commodities were likewise in the throes of extremes, one way or another, as they ran around ringin’ the register. Which is their raison d’etre, so more power to these guys. Okay, the commodities gig was the latest craze back then and of course, China, with 9.6% growth was indicted in the mix, make no mistake about it. The great soybean caper of ’04 comes to mind. Anyhow, they reflated us with all those rate cuts which they claimed were done to stave off run-of-the-mill deflation. But what they really meant to say was “we are soiling ourselves thinking about the possibility of debt deflation”. Indeed, things were getting a bit steamy in the speculative world. How steamy was it getting? A big, fat reminder of just how steamy those prices were, comin’ at you right now: ‘Twas during this period of heating commodities that the BLS lost the recipe
for the PPI. Remember that caper? Yee-ha. They couldn’t let us see what we already knew. Alas, it was time to get us to simmer down. Here’s a verbatim example, spoken by Greenspan on June 8, 2004:
…. “Lastly, let me emphasize that recent financial indicators, including rapid growth of the money supply, underscore that the FOMC has provided ample liquidity to the financial system that will become increasingly unnecessary over time. The Committee is of the view, as you know, that monetary policy accommodation can be removed at a pace that is likely to be measured. That conclusion is based on our current best judgment of how economic and financial forces will evolve in the months and quarters ahead. Should that judgment prove misplaced, however, the FOMC is prepared to do what is required to fulfill our obligations to achieve the maintenance of price stability so as to ensure maximum sustainable economic growth.”
See? Vintage Greenspan. Couldn’t admit they had “reflated” us to the point where more bubbles were popping up all over the place. So what he did was to imply that the reflation gambit had worked so well that it is now time to start to reverse course. You gotta’ love the eternal charade, right?
So they were now about the business of jacking rates in order, they claimed, to get us back to “neutral”. The current round began in June of ’04. And all along this course, while the “I” word pops up in regular commentary as well as in those FOMC communiqués, the long-term outlook is always in one shape or another, benign. And on top of this deliberately misleading banter, the FED themselves has contributed even further to the origin of the conundrum by being relentlessly and painstakingly transparent, to the point where, 100% of the mystery having been removed, the Street has no fear of either inflation or a sudden FED move and as the result, feels foot-loose and fancy free to go further out the curve.
And the sheer magnitude of the staggeringly-leveraged fast players who have turned US government bond trading into what one veteran has termed “contact sport” (on days when they are not otherwise “wilding” in that market), has exacerbated the conundrum to the highest degree. Leave us not forget, too, the added joy of front-running by this set of players, of the “real money” accounts who are sporadically forced in to do various types of hedging. So one can see the beginnings of just how the long end of the curve began un-cooperating with the FED’s rate increases.
We also have to bring in the vendor-financing aspect of the conundrum. We’ll make this quick as it is really old hat. All the excess dough and free and easy credit have made us even more gluttonous than usual. And it’s a good thing, too. Who else is gonna’ buy those one billion white dress shirts that the world was said to have in inventories, owing to the excess capacity that was fueled by the monetary largesse of the ‘90s global expansion, eh? Okay. So we keep buying and blowing up our trade deficit. They get dollars which they then lend back to us so that this scam can keep going. You might know this trick as “foreign central bank participation in US Treasury auctions”. Indeed, between the central banks, those “offshore hedge funds” and the govvie dealers, it’s no wonder we aren’t inverted already …. FED rate hike this.
So as you can see, John Q. is not too prominent in the picture is he? Why not? He’s busy flipping Miami condos, that’s why. Indeed, the same free and easy credit which has the leveraged set gone ga-ga looking for new and innovative niches in which to coin profit (latest I guess are the CDOs), has John Q. now believing he is a real estate tycoon as he has just gotten a spot at the table where they’re serving today’s free lunch.
A colleague referred me to the current issue of TIME. Here’s a cut and paste to help make the easy-money/hog wild consumer point: “In 2004, U.S. homeowners took an estimated $139 billion out of the walls and floorboards through refinancings, compared with $26 billion in 2000, according to Freddie Mac. They put about 35% of that money into home improvements, spent 16% on consumer purchases, and used 26% to pay off debt (including credit cards for other consumer purchases), according to the Federal Reserve Board.”
And the banks/mortgage lenders are just as complicit in this disaster-in waiting. And why not? The more the curve disobeys, the more margin compression they feel, the zanier they get. Interest-only, no money down, no doc, no credit-check, no ability to sign your name? No problem. Just put your “X” on the dotted line. And here’s the keys. And as time goes on and this bubble gets even more outrageous, no need to even move in. Just flip it. It’s never gonna’ end. Right.
And Mr. Greenspan himself is complicit in fostering this egregious notion in that last evening, when asked if he thought there would be any change soon in the falling-yields saga, said “I would think not.”
And he continued:
"The pronounced decline in U.S. Treasury long-term interest rates over the past year, despite a 200-basis-point increase in our federal funds rate, is clearly without precedent … The yield on 10-year Treasury notes currently is at about 4 percent, 80 basis points less than its level of a year ago.”
No stuff, Sherlock.
Keep right on “conceiving of hypotheses that are mutually contradictory”. This writer agrees with you. The aberrational path which took us to this juncture with the curve in its current shape, does not necessarily signal that players are convinced we are headed for recession. How we got here is from deceptive jawboning, an ongoing strip-tease which comes to us in the form of FOMC communiqués, a continuous stream of easy money/gimmicks which keeps the US consumer at the trough and the foreign central banks committed to our debt market and the quantum expansion of the hedge fund industry which, well-oiled by the money machine, is perpetually in the business of figuring out how to wring even more out of the system by some very creative/exotic investment strategies. (Those guys control better than a $ trillion at last count.) It all adds up, doesn’t it?
Thus, we can comfortably say that we have been brought to the height of it beginning with a fib that got bigger and bigger. The housing bubble is the latest and possibly most dangerous result. (Also from the TIME article: “At the stock market’s peak, 1% of investors controlled about 33.5% of stock wealth; the top 1% of home-equity holders have only 13% of housing wealth. In other words, a broad drop in home values, should it happen, would affect a far larger cross section of Americans than did the NASDAQ bust.”)
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