It’s time to take away the punch bowl
Since last summer, when subprime and other excesses caused the credit markets to seize up, the Fed (and other central banks) have injected well over a trillion dollars of liquidity into the financial system. But the period that began with the Bear Stearns conference call last August and peaked around the time of the bailout of Bear Stearns in March appears to be largely over.
Structural issues remain in credit markets and commodities markets, but those are not primarily issues of monetary policy. Hence, just like Y2K and all the other instances where liquidity was a short term fix, it’s about time for that party to end. It’s time to take away the punch bowl, as Fed Chairman Martin famously said.
The credit crisis produced a very strange world, with evident deflation in certain markets like housing, and runaway inflation in commodities prices due to adding the flood of liquidity from central banks to the already huge and unsustainable unrecycled dollar balances in oil and trade surplus nations. Traders, speculators and investors all hopped on the bandwagon for the free ride being offered by the world’s central banks. Now some sense a change of direction. Trader Todd Harrison in IBD describes “our wishbone world with hyperinflation on one side and watershed deflation on the other,” and makes a few predictions:
I was a commodity bull since 2003, offering that energy and metals would share the leadership baton until energy overtook the financials as the top weighted sector in the S&P. I pulled back those horns into the end of last year, a premature evacuation ripe with opportunity cost. The thought process was predicated on the notion that we arrived at the crossroads of our wishbone world with hyperinflation on one side and watershed deflation on the other.
The government decided to dance with the devil we know (inflation) rather than the devil we don’t (deflation). This affected the dynamic by socializing risk and injecting more than one trillion dollars into the marketplace. The ramifications of these policies will profoundly affect our future, but by design, they pushed out the collective comeuppance…
Toward the end of last week, I began building short-side exposure in the energy realm. Catching cusps is a dangerous proposition, whether it’s grasping at a falling knife or getting in the way of parabolic frolic…
The bull case for energy is loud and proud as a function of the price action. There are supply constraints, emerging market needs, incremental demand from China (following the earthquake), pressure on the U.S. dollar (the price of socialization), unreliable alternative sources, psychology (furthered by a recent Goldman Sachs (GS) report) and perhaps the biggest risk, in my view, the potential for geopolitical tension in Iran.
On the other side of that ride, we have political agendas into the election, incessant (unconfirmed) chatter that margins on crude futures will be raised, faltering demand by an already strapped U.S. consumer and the unfortunate truth that all roads will ultimately lead to debt destruction through deflation…
my expectation is that the dollar (and volatility levels) will lift as equities and energy slip in sync. I say this with a conscious nod that the Bernanke Swap has replaced the Greenspan Put as the backbone of perceived security. Nobody is bigger than the market. That’s a lesson I may soon learn but it’s one that our esteemed Federal Reserve Chairman Bernanke likely will as well.
It appears pretty obvious to us that the liquidity party has to come to an end relatively soon, with inflation emerging as a big problem around the world. For example, inflation is at a two decade high in Saudi Arabia, it is at 8% in India, and it is 8.5% in China, whose leadership has made control of inflation a top priority.
Since inflation is always and everywhere a monetary phenomenon, we should expect to see tighter monetary and credit policies around the globe. It’s hard to see that governments really have another choice. Such policies are notably inconsistent with the effervescent bull markets we have seen in commodities over the last years, which have gotten extraordinarily long in the tooth, by the way. Of course timing of such discontinuities, or cusps, as Mr. Harrison put it, is always a risky business. Still, the main question looking ahead appears to be this: how bad will the hangover be after the punchbowl is taken away?
May 24th, 2008 at 8:16 am
Sure they have a choice, the same choice exercised by every government that has ever had fiat money- continue to inflate the currency. The rate of watering may decrease, as it did in the early 1980s in the U. S., but it will never stop.