Swimmers + The Mother of All Price Bubbles

Kimball Corson
11/04/2009, Neiafu, Vava'u, Tonga

On the pier on a rainey, overcast holiday.
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The Mother of All Asset Price Bubbles

Many, here and elsewhere, have argued that the stock market is overbought and due for a correction, but the market has nonetheless trudged along within its narrow band of about 500 DOW points. While its seems unable to climb above its ceiling of about 10,000 for the DOW, it is not collapsing either. Sideways movement largely predominates. But there is a problem.

The level of the stock market is clearly bubbled up. Few seem to doubt that especially given our recent 3Q GDP performance, properly viewed. The reason is the Fed´s current policies of a zero Fed funds rate, quantitative easing and very large purchases of longer term debt.

Together with credit easing, these policies are generating not only a massive outflow of funds into foreign stock and other financial asset markets via the carry trade, but also a massive inflow of capital into the U.S. by means of an accumulation of forex reserves by foreign central banks that are fed by that same carry trade and then used by those banks to purchase U.S. debt and other assets in the U.S.

This capital inflow is making it much easier to fund the federal deficits, but it is also creating and sustaining the stock market bubble. The dollar has not collapsed from the carry trade as those involved in it convert to local foreign currencies to buy foreign assets because foreign central banks have then used their forex reserves they get from that trade to buy U.S. debt and other U.S. assets.

Basically, interest free loans are being spread around the world like crazy and used to push up asset prices here and in foreign financial markets as well.

The stock market bubble is simply a part of an inflation of asset prices world-wide largely created by the Fed's policies and the huge carry trade they have developed. The problem is Washington policy makers seem unaware of what is going on in these regards. They do not recognize the carry trade as being a problem because they do not focus on foreign central banks uses of their accumulation of forex reserves. They don't keep track of foreign asset prices. They do not recognize the problem they are creating in world financial markets. They simply notice that their policies make it easier to finance the federal deficits and seem not to depress the dollar significantly.

This global asset bubble is no more sustainable in the long run than is the U.S. stock market at present levels, absent a strong recovery. The problem will come when the Fed reverses its policies and begins reserve mop-up operations and raises interest rates. The carry trade will all but evaporate; foreign central banks will have their accumulation of forex reserves markedly diminished; the federal government will have a harder time financing its deficit without the Fed monetizing them, and the sea of debt that has been generated by the zero interest rate policy will undermine financial markets worldwide and will place a heavy burden on our government to manage its finances.

Like all bubbles, it will have to unwind. The question is how. If instability develops in world financial markets as the Fed reverses its policies, the likelihood of a crash in world financial and stock markets becomes more probable. As Nouriel Roubini sees it, we have created the mother of all bubbles, world-wide. It is unsustainable. It will collapse, the only question is will it unravel and collapse in a moderately orderly way or will there be a world financial crash.

Ironically, while recognizing that overleveraging substantially lead to the recent financial crisis on Wall Street, the Fed and the federal government have pursued policies which again have created a new tremendous leveraging, not only in the U.S., but in other world financial markets as well. At one level, it would seem that we did not learn much.

Given this mother of all bubbles and its global scope, I see no way that the Fed can effectuate an exit strategy that stands a reasonable chance of unwinding this asset inflation without precipitating a world financial crisis that could well dwarf the one we had on Wall Street with the credit crunch. The likelihood too is that it will clobber the U.S. recovery and compromise the projected recovery of world growth, presently estimated to be turning positive for the European Union (with Spain wobbling) and excellent for China. The IMF just raised its 2009 estimate for China to just shy of 8.5 percent and noted the E.U. should fare better than earlier expected, too, and encounter less contraction.

But all this ignores the mega asset bubble that has been and is still being created.

It seems that, in our effort to escape from one economic mess - the great U.S. recession - we have created another one which threatens not only the U.S., but world financial markets now as well. At the same time, it is not clear that much has been done for the U.S. economy either, aside from pulling it back from the brink at the time of the credit crunch - no small feat.

However, GDP growth in the U.S. is seen to be flagging, once the 3Q number is more carefully analyzed, and the last thing the U.S. economy needs at this time or in the near future is another financial crisis.

But how else do we deflate asset price bubbles?

Posted and published on seekingalpha.com

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Tongan Faintly Dainties + WB and IMF Speak Out

Kimball Corson
11/03/2009, Neiafu, Vava'u, Tonga

Two girls on a wharf. The pretty one afterward threw me a kiss I did not catch, photographically. Shoot, by age, I could be her great grandfather. Ah, to be young again. She is definitely a cutie pie. I have always appreciated genuinely attractive women and they know it instantly.

Note the "I love you" handsign. (http://en.wikipedia.org/wiki/Types_of_gestures)
Both girls spoke English, as do most Tongans here.
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The World Bank and the IMF Speak Out Against World Asset Bubbles

While not viewing the matter as broadly as some of us do, both the World Bank and the IMF are becoming aware of asset prices bubbling up in various parts of the world.

The World Bank warns that the sudden appearance of billions of dollars of investment capital in east Asia is "raising concerns about asset bubbles" in equity markets throughout Asia and in real estate markets in Hong Kong, Singapore, Vietnam and indeed, mainland China.

At the same time, the International Monetary Fund cited the risk arising from a flood of investment capital, particularly in Asia, pushing up asset prices so that they become divorced from the underlying economic realities. The IMF too is focused on asset bubbles.

Our own stock market, well up on its March lows, hovers more at a DOW level befitting a strong V shaped recovery, if not a stable, full employment economy in the middle of a strong growth cycle. While the flow of money against consumer goods worldwide may be waning well below what policy makers would like to see, the flow against financial assets is accelerating, pushing the prices of those assets up, so that now we even have conservative institutions like the World Bank and the IMF speaking up about the matter.

While some deflationary forces exert themselves in regard to consumer goods and services on a worldwide basis, the opposite is true of financial assets. They are undergoing substantial inflation, also worldwide. The flow of funds is strongly away from those in the bottom halves of income distributions with high average propensities to purchase consumer goods and services and concentrated much more in the hands of wealthier families and businesses with lower average propensities to consume and higher propensities to purchase financial assets.

The ultimate source of most of these moneys worldwide is the U.S. federal government and Federal Reserve System, either directly via the carry trade and the zero interest rate policy, or indirectly through various similar means.

Policy makers in Washington, if they are aware of the problem and if they understand it, seem to have no comment and voice no concerns about it.
Indeed, the Federal Reserve just said, in effect, that the zero interest rate policy will be continued.

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The Old Harbor + Where to Invest?

Kimball Corson
11/03/2009, Near Neiafu, Vava'u, Tonga

Just over the hill from Neiafu. Mostly now reefed in, but an area off to the lower right is still accessible by boat at any time. At low tide, as here, wandering pigs go out on the reef and root for edibles. Taken with a 300mm lens.
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The Problem of Where to Invest Now

If, as Nouriel Roubini suggests, we face an asset price bubble worldwide, arising out of the Fed's zero interest rate policy and the carry trade, what assets are safe for long positions in this bubbled up condition?

Not the dollar, if the Fed drops that policy or complications arise. Besides, basically the dollar is going nowhere, neither solidly up nor down. It mirror images the reverse of the stock market, also going nowhere.

Gold and silver? They too are bubbled assets, but silver less so.

Brazil, the emerging markets, China and maybe the BRICs? As I have shown elsewhere, because of trending in the stock market and human nature, ETFs and the like in these areas move or trend with the market, and are therefore are too open to collapse in a deflating price bubble, regardless of underlying real conditions.

No sanctuary there. Foreign currencies? Perhaps, but only if financial assets have not bubbled up in the relevant country, from the mother of all worldwide asset price bubbles.

Perhaps the Brazilian real, as Brazil struggles to isolate itself from these problems and its own economy is relatively healthy. The real has moved above $0.50US recently for the first time and now hovers near $0.58. But such investments are not easy or practical for many. Too, U.S. access to the currency may be subject to the trending problem I identify above. Not too much is left.

If the Fed decides at some future point to reverse its zero interest rate and associated policies, then the threat of collapse in asset prices world wide increases markedly. If it does not reverse its policies, but instead prolongs them, then more worldwide asset prices will continue to rise to accompany those already bubbled up.

However, price rises in assets already bubbled up tend to occur more slowly, as caution and better knowledge of the situation set in, just as in our own stock market. Serious slippage in prices can occur, but has not yet developed in our own stock market. Just understanding the situation and believing the gains of being in the market are not worth the risks can sideline many, but as I will show, they are not really sidelined. There are very few if any sanctuaries from the systemic risks.

Yet short positions entail some danger here as well these days, although mostly minor from small movements to the upside. Shorting anything much can therefore be as risky and profitless as taking long positions. If that is so and we face bubbled prices, is there anywhere left to safely invest?

The quick answer is largely nowhere, on simple long and short positions. Cash, if the dollars slides, is no better than gold if asset prices fall. Few foreign currencies are not similarly vulnerable from their own local asset price bubbles.

The problem is further compounded by most real economies, other than China, several in the far east and Brazil. The real economies of most major national players on the world scene are too much going nowhere. Many, like the U.S., hover at zero growth or worst and that growth is from a lower depressed level that some say is going to be the world's "new normal" because structural problem in the U.S. and in other countries are not being addressed. In short, from these circumstances, we find no immediate and compelling argument, to take long or short positions, especially given the risks and poor returns. We get no help from this quarter either.

We seem to be trending nowhere in real or financial terms at the moment, but simply sit hovered near the apex of too many asset price bubbles. Presently, the Fed's policies are doing more to expand the scope of those prices bubbles worldwide than they are to press existing price bubbles higher. This is because of the risk and return problem I identify here and the higher returns on more remote and less accessible assets in the world that are not so bubbled up. The far corners of the world affected are not so easily reached by U.S. investors who lack ready access.

Gold, silver and other precious metals cease to become a worthy store of value to the extent their prices are also bubbled up and face the prospect of collapse or decline like other prices. Sure, the store of value function might well be restored with a huge collapse, but consider the losses incurred by hold such assets to reach that point. This is the reason more countries have not followed India's example of stock piling gold. Only a Fall of Rome scenario, like that painted by Richard Duncan, gives stock piling gold any real prospect. The more likely prospect is many will simply buy such metals at higher prices and then watch their prices fall.

The perversity of the situation is that not even cash - the classical refuge from the market - is safe. The dollar too is vulnerable, especially if we consider the prospect of inflation. Too many seem not to realize this and think that by being out of the market and into cash they are shielded from risk. Some risks, yes, but not the risk of a declining dollar or the prospect of inflation.

We no longer face, in any particular stock, just the risks of a good company facing an uncertain economy. We have that situation and more. We face in any particular stock now not only market trending risks, but certain serious systemic risks arising out of the policies that have been adopted by those who make them in Washington. The systemic risks have increased markedly and affect us all. They arise largely as a set of unintended and unforeseen consequences by policy makers.

We proceed at our peril. All of us should come to realize that there are no true safe havens left and, regardless of how much we would like to garner a little profit now at minimal risk, few good opportunities exist to do so either, long or short.

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Tongan Buddies + New Economic Indicator?

Kimball Corson
11/03/2009, Neiafu, Vava'u, Tonga

On the stairs near a bar.
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A New Economic Indicator?

The Washington Post recently reported that --

"In a year of job losses, foreclosures and bag lunches, Americans have spent record-breaking amounts of money on guns and ammunition. The most obvious sign of their demand: empty ammunition shelves.

"At points during the past year, bullets have been selling faster than factories could make them.

"Gun owners have bought about 12 billion rounds of ammunition in the past year, industry officials estimate. That's up from 7 billion to 10 billion in a normal year.

"It has happened, oddly, at a time when the two concerns that usually make people buy guns and bullets -- crime and increased gun control -- seem less threatening than usual. . . ."

The reasons for the increased sales are said to be varied, however, the more interesting and common reason voiced is that economic insecurity is now being translated into physical insecurity of possible criminal violence, most likely attending public unrest.

That view turns such sales increases into an economic indicator. One obviously reserved for periods of great economic insecurity, stress and concern.

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A Swimmer

Kimball Corson
11/03/2009, Neiafu, Vava'u, Tonga

At a pier on a rainy day.
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School Girls + 10.2% Unemployment Figure

Kimball Corson
10/30/2009, Neiafu, Vava'u, Tonga

It is significant to realize that the majority of the peoples of the world have large brown feet, that fit less well into shoes, but work much better than ours without them. That is just the way it is . . . White Foot.
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11/6/09
The Official Unemployment Rate Is Now Over 10% and Rising

The government's just released unemployment report now puts the official unemployment rate at over 10%. Actually, the official figure is 10.2%, which is up from 9.8% more recently, and significantly higher than the 9.9% that was widely forecast. This is bad news and the highest unemployment rate since 1982. The true unemployment figure is, of course, considerably higher, given how the government mistabulates the numbers. It is closer to 18%.

Nonfarm payrolls for October fell 190,000. That is worse than the widely forecast decline of 175,000. Worse, job losses for the previous month were upwardly revised to reflect nonfarm job losses of 219,000. Average weekly hourly hours remained the same at 33.

The stock market managed to squeak out a very modest gain the day of the announcement, notwithstanding the news, and did not plumment two or three hundred points as might be expected, given how badly off forecasts were and the downward revision of the earlier employment number. A bubbled up market to be sure.

This new 10% unemployment figure needs to be considered in tandem with the real, non-governmentally generated GDP growth rate, estimated at about .5% for 3Q. The two figures together are truly not what we could hope for and raise the specter of serious trouble ahead for the U.S. economy, especially in light of the world asset price bubble that is developing, thanks to policies of the Federal Reserve.

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God and Water

Kimball Corson
10/30/2009, Neiafu, Vava'u, Tonga

God keeps the cistern full, but it is important that the cross be higher than the cistern. The Creator of this universe is very concerned about such things.

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Church Admin Office

Kimball Corson
10/30/2009, Neiafu, Vava'u, Tonga