The repricing of global bonds continued, despite escalating tensions in Syria and soft payroll data.
The latest G20 meeting was dominated by deep divisions over Syria in an increasingly divisive global backdrop. The Middle East is precariously divided. In Europe, leaders remain deeply divided over how best to deal with Eurozone issues. The American population is deeply divided on political, social and economic issues. Congress is deeply, deeply divided on seemingly everything. The Federal Reserve is divided on the merits of unconventional measures and the future course of policymaking. The emerging markets (EM) see developing world monetary policy as highly destabilizing, with QE having stoked “hot money” inflows and “tapering” risking problematic outflows.
[Hear More: Neil Irwin - The Alchemists: Three Central Bankers and a World on Fire]
Within the G20, common interests have been largely supplanted by mistrust and, seemingly, irreconcilable differences. Members these days lack even a European crisis response to try to rally around. I believe the “G” conferences have basically lost the capacity to have real impact on very serious ongoing global financial and economic issues. One could argue that traditional frameworks for myriad key policy decisions – from monetary policy to crisis response to acts of war – are being transformed before our eyes. This ensures added uncertainty in an already uncertain world. Markets see only QE.
The “Credit Bubble Bulletin” focuses (ok, fixates) on Credit. I strive to keep my analysis close to home, steering clear of political debate and geopolitical pontification. Yet Credit – sound or, more pertinently, otherwise – has a profound impact on wealth (creation and destruction) and wealth distribution. Protracted Credit Cycles – with their attendant booms, busts and destruction - have momentous impacts on societies and geopolitics. I work to provide an accurate chronicle of relevant events.
It’s been my thesis that we’re at the late phase of a historic global Credit boom. During much of the Bubble’s upside, the global economic pie was getting bigger. This provided powerful impetus to mutual interests, cooperation and integration. There was the capacity to forge international consensus on various pressing financial and economic issues – as well as even the ability to muster a “coalition of the willing” for major military operations.
The world is transitioning into a quite different environment. Despite desperate measure after desperate measure, a most over-extended global Bubble is convulsing erratically. The economic pie is stagnating - and on its way to contracting. This dynamic ensures an increasingly powerful pull of diverging interests, disagreement, fragmentation and confrontation.
The world has turned increasingly skeptical of U.S. policymaking, certainly including monetary policy. Round the globe, citizens and their leaders have grown tired of cooperating on just about everything - from finance to climate change to global policing. This runs up against heightened need for all of the above in an increasingly disorderly and hostile - faltering Bubble - world.
I have argued that desperate monetary inflation stoked a dangerous divergence between inflated global securities prices and deteriorating fundamental prospects. With U.S. equities near all-time highs, the market and media focus remains on Mr. Brightside. The cautious and darn right skeptical have been discredited and shoved out of the way. It has been easy to disregard the unstable global geopolitical backdrop. It’s been easy to ignore the rapidly deteriorating situation in the Middle East. With the Fed injecting unprecedented amounts of liquidity into overheated markets, it has been effortless – and highly profitable – to ignore risk more generally. Indeed, the bullish view holds that we’re in the initial phase of a new bull market – and, surely, a return to robust global growth, prosperity and cooperation.
There will come a point where the divergence between Bubbling securities markets and a sobering reality is narrowed. The longer massive monetary inflation extends this gap, the more destabilizing the eventual market dislocation. The greater the global market dislocation the greater the strain on economies, societies and alliances. And, in contrast to conventional thinking and that of the Fed, a lot of damage can be wrought in relatively short order when finance is running amuck. It’s reached the point where QE has minimal benefit, while dilly dallying and “tapering” bear great costs.
Yet with global markets having come to wield unprecedented influence on Credit, perceived wealth, economic activity and overall cohesion, the temptation for central banks to continue sustaining market Bubbles is just too great. This dynamic creates great uncertainty, while at the same time further opening the window of opportunity for destabilizing speculative excess.
Understandably focused on economic issues at home, American public opinion is strongly opposed to intervention in Syria. Understandably focused on economic and domestic interests at home, few in the global community are willing to join the U.S. on Syria. President Obama has very Difficult Decisions Ahead.
The Federal Open Market Committee faces its own Difficult Decisions of its own making. It’s notoriously difficult to withdraw monetary accommodation. Central banks are invariably late in removing the punchbowl. Perhaps more pertinent, there is never a painless path to ending aggressive monetary inflation. And that’s precisely why history demonstrates that once the process of “money” printing (currency or “virtual”) is embraced it becomes nearly impossible to dis-embrace. The past five years (or, if you choose, go back 20) have illustrated how one bout of seemingly innocuous monetary inflation invariably begets proliferation and, in the end, intransigent monetary disorder. The big unknown is how this historic global experiment in central bank management of unrestrained, market-based electronic “digital” money and Credit plays itself out.
This is an inopportune time for the emerging markets to face any moderation of Federal Reserve accommodation. But this dilemma was inevitable. When the U.S. and the developed world moved aggressively with post-mortgage finance Bubble reflationary measures, EM was the “fledgling Bubble” poised to be on the receiving end of unparalleled liquidity flows. Global Credit systems and economies diverged. In time, interests would diverge. For going on five years now, loose money and increasingly aggressive QE pushed EM financial and economic Bubbles to precarious extremes. Meanwhile, developed world recoveries badly lagged. The “money” flowed and latent global fragilities mounted.
Over the past year, incredible measures by the ECB, Fed and BOJ have had major effects. EM “terminal phase” Bubble excess was granted a bonus year to wreak havoc. In the U.S., stock prices inflated about 30%, as speculation went into overdrive. Throughout the U.S. corporate debt market (and only to a somewhat lesser extent globally), Bubble excesses ran wild. In the real economy, rapid price inflation reemerged in housing markets across the country. Quite simply, powerful Bubble conditions intensified, and an expanding number of sectors within the economy began to participate.
Considering the backdrop, $85bn monthly QE is inappropriate – I would argue reckless, a 7.3% unemployment rate notwithstanding. But both the global financial and economic spheres have grown addicted to aggressive monetary inflation. EM Bubble fragility has turned conspicuous. There is the global securities market Bubble, most obvious in mispriced bond markets around the world. There are less appreciated Bubbles in global equities and the “global leveraged speculating community” more generally. All in all, there is ample global financial and economic fragility to ensure the most timid rendition of monetary policy restraint imaginable.
On the one hand, I believe a global re-pricing of debt securities has commenced. On the other, there remains sufficient global monetary inflation and emboldened “animal spirits” to beg the question: How crazy do things get?
Syria is a frightening place. It’s in a tough and rapidly disintegrating region. The situation has regressed into the much feared “proxy war” on too many fronts. And it doesn’t take a wild imagination to see Syria as a catalyst for escalating global tensions that could stumble into a major confrontation. The Russians and Iranians are staring President Obama down.
Meanwhile, outside of crude oil, global markets show minimal concern. After all, analysts suggest it could be up to two more weeks – a veritable eternity for a speculative marketplace - before the President might act. Besides, non-farm payroll data were soft. This is expected to only further embolden the dovish contingent that was already pushing against any move to reduce accommodation (this week from Kocherlakota and Evans). It was another week that illuminated dichotomies. The reality is that the world is in the midst of far-reaching – I’m convinced troubling - changes. The market reality is that primary focus remains on the monetary backdrop.