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Arms Race in Bubbles

By: Doug Noland | Saturday, October 21, 2017

The week left me with an uneasy feeling. There were a number of articles noting the 30-year anniversary of the 1987 stock market crash. I spent "Black Monday" staring at a Telerate monitor as a treasury analyst at Toyota's US headquarters in Southern California. If I wasn't completely in love with the markets and macro analysis by that morning, there was no doubt about it by bedtime. Enthralling.

As writers noted this week, there were post-'87 crash economic depression worries. In hindsight, those fears were misplaced. Excesses had not progressed over years to the point of causing deep financial and economic structural maladjustment. Looking back today, 1987 was much more the beginning of a secular financial boom rather than the end. The crash offered a signal - a warning that went unheeded. Disregarding warnings has been in a stable trend now for three decades.

Alan Greenspan's assurances of ample liquidity - and the Fed and global central bankers' crisis-prevention efforts for some time following the crash - ensured fledgling financial excesses bounced right back and various Bubbles hardly missed a beat. Importantly, financial innovation and speculation accelerated momentously. Wall Street had been emboldened - and would be repeatedly.

The crash also marked the genesis of government intervention in the markets that would evolve into the previously unimaginable: negative short-term rates, manipulated bond yields, central bank support throughout the securities markets, Trillions upon Trillions of central bank monetization and the perception of open-ended securities market liquidity backstops around the globe. Greenspan was the forefather of the powerful trifecta: Team Bernanke, Kuroda and Draghi. Ask the bond market back in 1987 to contemplate massive government deficit spending concurrent with near zero global sovereign yields - the response would have been "inconceivable."

Articles this week posed the question, "Could an '87 Crash Happen Again." There should be no doubt - that is unless the nature of markets has been thoroughly transformed. Yes, there are now circuit breakers and other mechanisms meant to arrest panic selling. At the same time, there are so many more sources of potential self-reinforcing selling these days compared to portfolio insurance back in 1987. Today's derivatives markets - where various strains of writing market insurance ("flood insurance during a drought") have become a consistent and popular money maker - make 1987's look itsy bitsy.

The record $3.15 TN hedge fund industry barely existed in 1987. The $4.1 TN ETF complex didn't exist at all. The amount of trend-following finance dominating present-day global markets is unprecedented. Moreover, the structure of contemporary finance has already (repeatedly) proven itself conducive to financial dislocation. Over the years - and especially post-2008 reflation - boom and bust dynamics have turned only more forceful. Central bank fixation on countering the bust has precariously propelled the latest boom.

The '87 crisis response fatefully unleashed the "Terminal Phase" of Japanese Bubble excess - the consequences of which persist to this day. Decades of exceptional development flushed away with a few years of recklessness. Chinese officials over the years claimed to have learned from the dismal Japanese Bubble experience. Clearly, they did not. The 2008 crisis was multiples of 1987. The recent post-crisis reflation, as well, has been at an incredibly grander and prolonged scale. This has ensured that China's Bubble and "Terminal Phase" have inflated so far beyond Japan's eighties fiasco.

Bubble mirage had Japan's economy and banking system poised to lead the world. Now it's China. In contrast to Japan's beleaguered post-Bubble political class, China's communist party won't have to agonize over elections.

China faces extremely serious issues - and I'll assume enlightened Chinese communist party officials are not oblivious. Beijing was the leading culprit behind my disquiet this week. Most focused elsewhere. The Trump administration's tax package made initial headway in the Senate. There was also market-friendly reporting that Federal Reserve governor "Jay" Powell may be Trump's leading candidate for Fed chairman. With securities markets rising ever higher into record territory, who cares about some communist party gathering? Heck, is communism even pertinent in today's tantalizing New Age? Did you see the cryptocurrencies this week?

Chinese President Xi Jinping has a plan. China will be the world's super power. The great communist party, with its progressive system of meritocracy, is the only mechanism to adroitly guide Chinese "new era" development. And President Xi is the master - the modern-day Emperor - with the depth of experience, the vision, the charisma, the power to ensure China's rightful place on the world stage. He embodies the benevolent dictator for the masses; the resolute commander for an increasingly hostile world; the deity to guide and protect an insecure society. Spooky stuff.

October 20 - Financial Times (Tom Mitchel): "'Government, military, society and schools -- north, south, east and west -- the party is leader of all,' Mr Xi proclaimed in a three-and-a-half hour speech... to the party congress. Next week the congress will appoint a new Politburo Standing Committee stacked with Xi loyalists. One person who advises senior officials attributes Mr Xi's now seemingly unassailable dominance of Chinese politics to a Machiavellian insight. 'Because of the economic prosperity of the reform era, almost everyone in officialdom was corrupted,' he says. 'Xi used this fact as leverage to scare everyone. They have to follow him because everyone is vulnerable. All you have to do is investigate them.' In his marathon address to the congress this week, Mr Xi positioned himself not just as modern China's third great leader after Mao and Deng, but also the heir to a glorious Communist tradition stretching back to Russia's Bolsheviks. 'A hundred years ago, the salvos of the October Revolution brought Marxism-Leninism to China,' Mr Xi said, noting that the Chinese Communist party was founded just four years later. 'From that moment on, the Chinese people have had in the party a backbone for their pursuit of national independence and liberation, prosperity and happiness.' According to Mr Xi's arc of history, China is only three decades away from resuming its traditional and rightful place as the world's dominant economic and cultural power, with the US caught in a downward spiral accelerated by Mr Trump's election."

Xi's speech was said to have left young devotees sobbing (and previous leadership yawning and checking their watches). Xi is moving aggressively forward with a consolidation of power - assiduously crafting a cult of leadership. He has shrewdly perched his government's skill and competence up on a high pedestal, with its leader the unassailable "man now regarded as China's great centraliser and most powerful ruler since Mao Zedong, the party's revolutionary hero."

October 17 - Bloomberg (Ting Shi): "President Xi Jinping warned of 'severe' challenges while laying out a road map to turn China into a leading global power by 2050, as he kicked off a twice-a-decade party gathering expected to cement his influence into the next decade. In a speech that ran for more than three hours on Wednesday, Xi declared victory over 'many difficult, long overdue problems' since he took power in 2012. He said China would continue opening its doors to foreign businesses, defend against systemic risks, deepen state-run enterprise reform, strengthen financial sector regulation and better coordinate fiscal and monetary policy. 'Right now both China and the world are in the midst of profound and complex changes,' Xi said. 'China is still in an important period of strategic opportunity for development. The prospects are very bright, but the challenges are very severe.'"

Xi and Chinese leadership are battening down the hatches. Recall that less than two years ago the Chinese Bubble was at the brink. It was Xi and his "national team" that took incredible measures to reverse a dynamic of collapsing markets and exodus from the Chinese currency. In short, confronting an inconveniently time bust, they resorted to stoking their historic Bubble. Why not - everyone else has gotten away with it.

The upshot has been two additional (fateful) years of rapidly inflating apartment prices and economic maladjustment. There has been as well a couple more years of historic compounding Credit growth. It was only fitting that Xi's overstated exultation elicited a shot of sobriety from China's respected central bank chief (from his catbird seat).

October 19 - Financial Times (Gabriel Wildau): "China's central bank governor has warned in unusually stark language of the risks from excessive debt and speculative investment, as he used the Communist party congress to caution that the country's fast-growing economy faced a possible 'Minsky moment'. 'When there are too many pro-cyclical factors in an economy, cyclical fluctuations will be amplified,' Zhou Xiaochuan, governor of the People's Bank of China, said at a meeting on the sidelines of the Communist party gathering in Beijing. 'If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a 'Minsky Moment'. That's what we should particularly defend against.'"

Credit growth accelerated into the communist party congress. Chinese Total Social Financing (total non-governmental Credit) expanded a stronger-than-expected $277 billion during September. Year-to-date Total Social Financing growth of $2.375 TN is running 16.3% above last year's record pace. Lending was led by booming demand for household real estate purchases. Total Chinese Credit could surpass $4.0 TN in 2017, easily surpassing U.S. Credit growth at the height of our mortgage finance bubble. Despite all the talk about excessive debt levels and the need for deleveraging, Chinese officials have yet to get their arms around a historic credit bubble.

Xi spoke of a focus on financial stability. His comment "Houses are built to be inhabited, not for speculation" reiterates official concern for housing prices. Past efforts to counteract apartment inflation with added supply failed to dampen enthusiasm to speculate on ever higher prices. At this late stage of such a prolonged Bubble, only harsh medicine will suffice. Prices will need to fall and speculation punished for the spell to be broken.

Bubbles are always about a redistribution and destruction of wealth. Its unparalleled global scope makes the current Bubble is so concerning. Xi now owns the Chinese Bubble, and there would appear little prospect that he'll ever be willing to take responsibility for the damage wrought. Fingers will be pointed directly at foreigners, foremost the U.S. and Japan.

I believe the global government finance Bubble - history's greatest financial boom - will conclude this long Credit cycle going back to the conclusion of WWW II. As the "granddaddy of Bubbles," it is fitting that things turn really crazy during an exceptionally prolonged "Terminal Phase." We're at the point where no one is willing to risk bursting the Bubble, certainly not timid central bankers.

There's so much at stake. Importantly, from the global Bubble perspective, a faltering Bubble would risk surrendering power on the global stage. Xi certainly doesn't seem willing to see a faltering China retreat from global ascendency. The same can be said for Shinzo Abe in Japan. Here at home, making America great again gets no easier with a bursting Bubble. And while there's no President of Europe, Mario Draghi has assumed the role of defender of European resurgence with an interminable windfall of free "money."

It's all quite unsettling. Global finance has run completely amok. This has been unfolding for so long now that few are concerned. Most revel in asset inflation drunkenness. Instead of safeguarding sound finance and stable money - the bedrock of civil societies and peaceful global relationships - governments and central banks around the world are harboring Bubble excesses like never before. This ensures catastrophic consequences when Bubbles burst. It has reached the point where these Bubbles have become part and parcel to global power, with countries not willing to risk being left behind. It's as if it has become An Arms Race in Bubbles.

Three decades of serial booms and busts begat An Age of Government Strongmen - and weak central bankers. It would only be fitting for President Trump to opt for the milquetoast Jerome Powell to shepherd Fed inflationist doctrine, perhaps even trying to placate his base with a slot on the FOMC for John Taylor. Apparently, there are more urgent fights these days than reform at the Federal Reserve. Everywhere, it seems, various fights are taking precedence over stable finance. It just makes one dread the kind of conflicts that could break out when this historic global financial boom buckles. But, then, who on earth cares? The Dow is mere days away from 24,000, and Bitcoin is surely poised to make a run to $10,000!

 


For the Week:

The S&P500 gained 0.9% (up 15.0% y-t-d), and the Dow jumped 2.0% (up 18.0%). The Utilities rose 1.6% (up 12.8%). The Banks rallied 2.3% (up 10.2%), while the Broker/Dealers were little changed (up 20.0%). The Transports added 0.4% (up 10.3%). The S&P 400 Midcaps gained 0.9% (up 10.5%), and the small cap Russell 2000 added 0.4% (up 11.2%). The Nasdaq100 increased 0.3% (up 25.6%). The Semiconductors rose 1.0% (up 35.8%). The Biotechs slipped 0.4% (up 38.0%). With bullion sinking $24, the HUI gold index fell 2.6% (up 8.3%).

Three-month Treasury bill rates ended the week at 109 bps. Two-year government yields rose eight bps to 1.58% (up 39bps y-t-d). Five-year T-note yields jumped 12 bps to 2.02% (up 9bps). Ten-year Treasury yields gained 11 bps to 2.39% (down 6bps). Long bond yields rose nine bps to 2.90% (down 17bps).

Greek 10-year yields were little changed at 5.51% (down 152bps y-t-d). Ten-year Portuguese yields declined three bps to 2.31% (down 144bps). Italian 10-year yields fell four bps to 2.04% (up 23bps). Spain's 10-year yields gained five bps to 1.66% (up 28bps). German bund yields rose five bps to 0.45% (up 25bps). French yields gained five bps to 0.86% (up 18bps). The French to German 10-year bond spread was little changed at 41 bps. U.K. 10-year gilt yields slipped four bps to 1.33% (up 10bps). U.K.'s FTSE equities slipped 0.2% (up 5.3%).

Japan's Nikkei 225 equities index jumped 1.4% (up 12.3% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.075% (up 4bps). France's CAC40 added 0.4% (up 10.5%). The German DAX equities index was about unchanged (up 13.2%). Spain's IBEX 35 equities index slipped 0.3% (up 9.3%). Italy's FTSE MIB index dipped 0.3% (up 16.2%). EM equities were mostly lower. Brazil's Bovespa index declined 0.8% (up 26.8%), while Mexico's Bolsa was little changed (up 9.5%). India's Sensex equities index slipped 0.1% (up 21.6%). China's Shanghai Exchange declined 0.4% (up 8.9%). Turkey's Borsa Istanbul National 100 index jumped 2.1% (up 38.8%). Russia's MICEX equities index dropped 1.3% (down 7.2%).

Junk bond mutual funds saw outflows of $450 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined three bps to 3.88% (up 36bps y-o-y). Fifteen-year rates dipped two bps to 3.19% (up 40bps). Five-year hybrid ARM rates added a basis point to 3.17% (up 32bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down seven bps to a five-week low 4.11% (up 48bps).

Federal Reserve Credit last week jumped $13.6bn to $4.433 TN. Over the past year, Fed Credit slipped $2.1bn. Fed Credit inflated $1.622 TN, or 58%, over the past 258 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $4.6bn last week to $3.365 TN. "Custody holdings" were up $243bn y-o-y, or 7.8%.

M2 (narrow) "money" supply last week jumped $27.6bn to a record $13.748 TN. "Narrow money" expanded $677bn, or 5.2%, over the past year. For the week, Currency was little changed. Total Checkable Deposits jumped $49.3bn, while Savings Deposits declined $21.8bn. Small Time Deposits were about unchanged. Retail Money Funds were unchanged.

Total money market fund assets added $2.9bn to $2.744 TN. Money Funds rose $109bn y-o-y, or 4.1%.

Total Commercial Paper declined $2.0bn to $1.062 TN. CP gained $157bn y-o-y, or 17.3%.

Currency Watch:

The U.S. dollar index gained 0.7% to 93.701 (down 8.5% y-t-d). For the week on the downside, the New Zealand dollar declined 3.0%, the South African rand 2.8%, the Brazilian real 1.5%, the Japanese yen 1.5%, the Canadian dollar 1.3%, the Norwegian krone 1.2%, the Swiss franc 1.0%, the Singapore dollar 0.9%, the Australian dollar 0.9%, the British pound 0.7%, the Swedish krona 0.7%, the Mexican peso 0.5%, the euro 0.3% and the South Korean won 0.2%. The Chinese renminbi declined 0.62% versus the dollar this week (up 4.90% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index was little changed (up 1.0% y-t-d). Spot Gold fell 1.8% to $1,281 (up 11.1%). Silver dropped 1.9% to $17.078 (up 6.9%). Crude added 39 cents to $51.84 (down 4%). Gasoline rose another 3.4% (unchanged), while Natural Gas fell 2.8% (down 22%). Copper gained 1.0% (up 26%). Wheat sank 3.1% (up 4%). Corn fell 2.0% (down 2%).

Trump Administration Watch:

October 20 - Bloomberg (Erik Wasson and Saleha Mohsin): "The U.S. posted its largest budget deficit since 2013 in the fiscal year that just ended, as a pickup in spending exceeded revenue gains. The federal government's gap grew to $665.7 billion in the 12 months through Sept. 30, compared with a $585.6 billion shortfall in fiscal 2016... Treasury Secretary Steven Mnuchin and Budget Director Mick Mulvaney, in a statement accompanying the report, blamed weaker-than-expected tax receipts on historically 'sub-par' economic growth."

October 19 - Wall Street Journal (Demetri Sevastopulo): "CIA director Mike Pompeo on Thursday warned that North Korea could be just 'months away' from developing the ability to strike America with a nuclear-armed ballistic missile. Speaking at the Foundation for Defense of Democracies, Mr Pompeo said the US had to deal with North Korea under the assumption that Kim Jong Un was 'on the cusp' of being able to hit the US after a spate of missile tests that have helped his scientists improve their expertise. 'We ought to behave as if we are on the cusp of them achieving that objective,' he said when asked if Pyongyang was "perilously close" to developing that capability."

October 19 - Wall Street Journal (Michael C. Bender and Felicia Schwartz): "Secretary of State Rex Tillerson warned China on Thursday that the U.S. has an arsenal of economic weapons to force Beijing to address trade imbalances and a continuing territorial dispute in the South China Sea. 'We can do this one of two ways,' Mr. Tillerson said during a 35-minute interview in his State Department office, seeming at times to speak directly to his Chinese counterparts. 'We can do it cooperatively and collaboratively, or we can do it by taking actions and letting you react to that.'"

October 19 - Politico (Ben White, Victoria Guida and Josh Dawsey): "Federal Reserve Governor Jerome Powell is the leading candidate to become the chair of the U.S. central bank after President Donald Trump concluded a series of meetings with five finalists Thursday, three administration officials said. The officials cautioned that Trump, who met with current Chair Janet Yellen for about half an hour on Thursday, has not made a final decision."

October 16 - Bloomberg (Jennifer Jacobs, Saleha Mohsin, and Craig Torres): "Stanford University economist John Taylor, a candidate for Federal Reserve chairman, made a favorable impression on President Donald Trump after an hour-long interview at the White House last week, several people familiar with the matter said. Former Fed board governor Kevin Warsh has meanwhile seen his star fade within the White House, three of the people said. They would not say why but Warsh's academic credentials are not as strong as other candidates, and his tenure on the Fed board has been criticized by a diverse group of economists ranging from Scott Sumner to Nobel laureate Paul Krugman. Trump gushed about Taylor after his interview, one of the people said."

October 17 - Bloomberg (Garfield Clinton Reynolds): "Investors are still betting a Federal Reserve run by economist John Taylor would mean higher U.S. interest rates despite his signaling he would be more flexible in setting monetary policy than his academic work suggests. Reflecting such suspicion, the dollar rose and the 10-year U.S. Treasury note fell on Monday after Bloomberg News reported Taylor... impressed President Donald Trump in a recent White House interview. Driving those trades was speculation that the 70 year-old Taylor would push rates up to higher levels than a Fed helmed by its current chair, Janet Yellen. That's because he is the architect of the Taylor Rule, a tool widely used among policy makers as a guide for setting rates since he developed it in the early 1990s."

October 19 - Bloomberg (Laura Litvan and Erik Wasson): "The year's most divisive fights in Congress are set to converge in a bitter partisan clash in December that could result in a U.S. government shutdown. The unresolved battles -- over a wall on the U.S.-Mexico border, immigration, health-care subsidies, Planned Parenthood and storm relief -- are hanging over talks on must-pass spending legislation to keep the government open after Dec. 8. The spending measure is at risk of becoming so weighted with controversial items that it collapses. 'The laundry list of things they want to put on it grows every day,' said Jim Dyer, a former House Appropriations Committee Republican staff director. Even without contentious issues, completing a trillion-dollar spending bill in time would be a tall order."

October 15 - Politico (Rachael Bade and Burgess Everett): "Republicans' unified control of Washington is triggering an identity crisis within the party over what it means to be a fiscal conservative in the age of Donald Trump: Do deficits even matter, or do tax cuts trump all? If the White House and GOP lawmakers can't come to terms on the matter soon, it could very well doom Trump's cherished tax reform initiative. Conservatives have long railed against the nation's now-$20 trillion debt. But now that they're desperate to pass a tax bill, many Republicans' repulsion to red ink is fading fast. Yet some deficit hard-liners are holding the line, insisting that tax cuts be paid for, either by axing deductions or with stiff spending cuts. The debate is causing some hard feelings within the GOP."

October 18 - Financial Times (Shawn Donnan): "Republicans in Congress are examining how to block a potential move by Donald Trump to pull the US out of the North American Free Trade Agreement as members of the president's own party also warn him that any such move could put a joint push for tax cuts at risk. The preparations come amid rising concerns on Capitol Hill and among US businesses about changes to the 23-year-old trade pact with Canada and Mexico that the Trump administration is pursuing and what they fear are 'poison pill' proposals intended to force a collapse of increasingly bitter negotiations. They also illustrate how the Trump administration is becoming isolated in Washington on trade and other issues and how pro-trade Republicans are gearing up for another fight with the president to protect a Nafta they see as vital to the US economy."

October 16 - Reuters (David Lawder and Dave Graham): "The top U.S. and Canadian and trade officials... accused each other of sabotaging efforts to renegotiate the North American Free Trade Agreement, even as they and Mexico agreed to extend talks into the first quarter of 2018. A seven-day round of talks... ended in acrimony over aggressive U.S. demands on autos, a five-year sunset clause on the pact itself and Canada's dairy regulations, among other key issues. Canada's foreign minister, Chrystia Freeland, accused Washington of pursuing a 'winner take all' approach."

Federal Reserve Watch:

October 19 - Wall Street Journal (Kate Davidson): "After criticizing the Federal Reserve for the past eight years, Republicans have a chance to change the course of the central bank when President Donald Trump nominates someone to take the helm in early 2018. But they are divided over which direction monetary policy should take. GOP efforts to subject the Fed to more scrutiny and limit its discretion gained traction in the wake of the financial crisis, especially in the House, and Republicans hammered Fed officials over why they continued to keep interest rates so low, saying the policy hurt savers and distorted markets. Now, with the prospect of a Republican-led tax cut and faster economic growth on the horizon, some in the party are wary of a choice that could disrupt markets or cut off growth by lifting rates higher to keep inflation under control. 'I'm not sure there's a clear way that Republicans think about the Fed,' said Tony Fratto, who worked on economic issues in the George W. Bush administration. 'When you ask, 'What would you want from a new Fed chair,' I think it's a little bit all over the place.'"

October 18 - Reuters (Lindsay Dunsmuir): "The U.S. economy expanded at a modest to moderate pace in September through early October despite the impact of hurricanes on some regions, the Federal Reserve said in its latest snapshot of the U.S. economy..., but there were still few signs of an acceleration in inflation. 'Despite widespread labor tightness, the majority of districts reported only modest to moderate wage pressures,' the U.S. central bank said in its Beige Book report of the economy, derived from talking to business contacts across the country."

U.S. Bubble Watch:

October 16 - Financial Times (Nicole Bullock, Robin Wigglesworth, John Authers and Christian Pfrang): "Art Cashin recalls the heady atmosphere that dominated the New York Stock Exchange for much of 1987. After five or six straight days of the market rallying, senior partners at brokerage trading desks would instruct the junior partners [traders] to 'lighten up a little bit', Mr Cashin says. 'When they did, the market just went higher.' 'The market in 1987 was relentless,' says Mr Cashin, director of floor operations for UBS Financial Services at NYSE, who began working on 'the floor' as an assistant clerk in 1959... 'Unfortunately there are some similarities [to today]. It reminds me a bit of what we have seen this year.'"

October 18 - CNBC (Michael Santoli): "The 30th anniversary of the 1987 crash is a perfect occasion to take in the vivid accounts of a headlong bull market skidding violently off course. 'The bull is dead,' a senior trader at the old Shearson Lehman told a reporter. 'I've been in the business 33 years and it's one of the worst corrections I have ever seen.' His counterpart at the former Donaldson Lufkin & Jenrette added, 'We have young traders out here with their eyes popping out of their heads.' An analyst at Josephthal & Co. reported, 'My guts are numb. It's unreal; it's just unreal.' But here's the thing: All of those accounts of market carnage were made the Friday before the crash on Monday, Oct. 19, 1987, when the Dow Jones industrial average plunged 22.6% in the worst single session in Wall Street history."

October 16 - Bloomberg (Cecile Vannucci): "The number of speculators' bets against CBOE Volatility Index futures just hit a fresh record, but so did the number of VIX contracts outstanding. Wagering on equity swings has become increasingly popular this year as the gauge of stock swings heads for its lowest ever annual average. While the VIX is up this month, history shows that it tends to fall in the fourth quarter."

October 19 - Wall Street Journal (Riva Gold): "Stocks continue to hit record highs, yet those pushing them there are trading less and less. The number of stocks and exchange-traded products changing hands in the U.S. and Europe has fallen steadily in recent months as ultralow volatility, a lack of market-moving news and the rising popularity of passive investment funds have kept many investors on the sidelines. Some investors are mulling what the drop-off says about a global equity rally that has lifted many markets, including in the U.S., to new highs."

October 18 - CNBC (John W. Schoen): "Voters worried that Congress and the White House can't tame federal borrowing may be overlooking another big debt bomb closer to home. States are falling further behind in the money they owe public employee pension funds, leaving taxpayers on the hook, according to... S&P Global Ratings... Despite recent stock market gains, state governments are not setting aside enough money to keep up with the rising liability of paying public worker pensions and other retirement benefits... In all but two states (Michigan and Alabama), the money set aside as a share of what's needed fell last year to an average ratio of 68%. That means states have funded just 68 cents for every dollar they owe in future payments."

October 19 - Bloomberg (Yuji Nakamura and Lulu Yilun Chen): "Tezos, the startup which raised $232 million in a July initial coin offering, plunged on derivative exchanges after revealing a management spat and little progress in developing its product. Derivatives on Tezos tokens fell as much as 31%... On BitMEX, December futures on the tokens plunged 58% as traders unwound bets the project would be launched before the end of the year. The actual tokens have yet to be created. Founders Arthur and Kathleen Breitman said in a blog post... that recruitment had come to a standstill and little work has been done on their product: a better blockchain for digital currencies."

China Bubble Watch:

October 18 - Wall Street Journal (Nathaniel Taplin): "Politicians are widely distrusted by citizens in most societies, but surprisingly often they say what they actually mean. On Wednesday, Chinese President Xi Jinping opened the nation's twice-a-decade congress--where the leadership for the coming five years will be selected--with a robust and lengthy defense of the Communist Party's role as captain of the economy, and a series of rote gestures toward further market-based economic reforms. Investors should take him at his word."

October 16 - Wall Street Journal (Lingling Wei): "As a new president, Xi Jinping promised to give markets more room in China's economy. He even considered scrapping a hulking ministry supervising state-owned companies. Today, Mr. Xi has set aside such notions. In today's China, state intervention attempts to engineer economic outcomes, ranging from raw-materials prices to the value of stocks and the currency. State-owned corporate giants are bulking up, with private capital funneled into them for support. The agency Mr. Xi toyed with dismantling is back in the driver's seat. Going into his second term, Mr. Xi finds relying on markets too risky and state capitalism a better model. When the Chinese leadership talks of reform today it doesn't mean economic liberalization as it did in, say, the era of Deng Xiaoping. It means fine-tuning a government-led model."

October 17 - CNBC (Everett Rosenfeld): "Chinese President Xi Jinping... stressed the benefits of 'socialism with Chinese characteristics' at the beginning of the Communist Party's once-every-five-year Party Congress. The president told the assembled members of the party that his nation's prospects are bright, but it faces severe challenges. He proceeded to lay out his vision for a socialist future. 'We will unite the Chinese people of all ethnic groups and lead them to a decisive victory in building a moderately prosperous society in all respects and in the drive to secure the success of socialism with Chinese characteristics for a new era,' he said..."

October 15 - Reuters (Lusha Zhang and Kevin Yao): "Chinese banks extended more loans than expected in September, buoyed by demand from home buyers and companies, even as the government tightened the screws to wean the economy off its years-long addiction to cheap debt... Both bank lending and total social financing, a broad measure of credit and liquidity, look set to hit another record high this year... In September, banks extended 1.27 trillion yuan ($193.05bn) in net new yuan loans... Analysts polled by Reuters had predicted 1.1 trillion yuan, compared with August's 1.09 trillion yuan... Total social financing (TSF), a broad measure of credit and liquidity in the economy, rose to 1.82 trillion yuan in September from 1.48 trillion yuan in August."

October 18 - New York Times (Keith Bradsher): "China turned to a tried-and-true recipe to cook up another three months of respectable growth. Heavy lending by state-owned banks, brisk government spending and strong exports helped keep China's economy growing briskly and steadily. China's statistical agency said... that the economy had grown 6.8% in the July-to-September period, compared with the same quarter a year ago. President Xi Jinping had put heavy pressure on practically every government ministry to make sure that the economy put in a solid performance. The Chinese Communist Party's twice-a-decade congress began this week, and it's a time when the country's leaders want predictability and an image of strength... Chinese officials say they are working hard to control China's ballooning debt. The third quarter may not be a good example of that. Measures of credit and money supply grew faster than the economy itself in August and September..."

October 17 - Bloomberg (Nisha Gopalan and Andy Mukherjee): "So what if there's a lot of China debt out there, and the pile just keeps getting bigger? Investors, at least, appear not to care. As President Xi Jinping prepares for a second five-year term, he's already managed to convince markets that China's deleveraging train has left the station -- never mind that there's no evidence state-owned enterprises have even begun to shed assets or debt, more than a year after the government rolled out steps to rein in borrowing. At the end of 2012, just before Xi took office, as many as 986 nonfinancial state-owned and state-linked enterprises had a little more than $2 trillion in assets supported by around $775 billion in shareholders' funds, an analysis by Gadfly shows. Assets have since swelled to $3.6 trillion, while the equity cushion has grown to only $1.25 trillion. Financial leverage... has thus risen to 286%, from less than 274%, on the eve of this week's twice-a-decade Communist Party congress."

October 16 - Bloomberg: "China's factory prices jumped more than estimated, as domestic demand remained resilient and the government continued to reduce excess industrial capacity. Consumer price gains matched projections. The producer price index rose 6.9% in September from a year earlier, versus an estimated 6.4%."

October 16 - Bloomberg: "They've made billions of dollars helping sell everything from iPhones to hairdryers on China's burgeoning online shopping platforms. Now, tech giants led by Alibaba Group Holding Ltd.'s finance affiliate are making money off the loans consumers use to buy those products. Amid surging demand from cash-strapped Chinese millennials, companies such as Ant Financial -- controlled by Alibaba's billionaire founder Jack Ma -- have been extending more consumer loans. The firms are then packaging the debt into complex financial products that they then sell on to investors, with Ant Financial selling at least 149 billion yuan ($23bn) of the so-called asset-backed securities this year... But the new practice is raising red flags for some analysts, who say there needs to be more transparency about how the securities, known as ABS, are created."

October 18 - Financial Times (Tom Hancock and Gabriel Wildau): "Ocean Flower Island is a vision of luxury, Chinese-style. A man-made archipelago off the coast of the tropical island of Hainan in the South China Sea, it will boast thousands of apartments, 28 museums and 58 hotels including one which is '7-star level' and another shaped like a European castle. Gold-painted Mercedes golf carts whisk potential customers to the sales centre for the project, where Chinese developer Evergrande Real Estate is leading construction. Inside the centre, Mr Yu, a 56-year-old owner of a building company who asked not to use his full name, wears a shirt emblazoned with the words 'Beverly Hills Polo' and sips green tea. He is keen to buy a 108 sq m apartment on one of the islands, adding to his eight properties elsewhere. 'The house will definitely increase in value,' he says."

October 16 - Reuters: "China's official Xinhua news agency attacked Western democracy as divisive and confrontational..., praising on the eve of a key Communist Party Congress the harmony and cooperative nature of the Chinese system. China's constitution enshrines the Communist Party's long-term 'leading' role in government, though it allows the existence of various other political parties under what is calls a 'multi-party cooperation system'. But all are subservient to the Communist Party. Activists who call for pluralism are regularly jailed and criticism of China's authoritarian system silenced."

Central Banker Watch:

October 14 - Wall Street Journal (Tom Fairless): "The European Central Bank should be patient and persistent in the face of weak eurozone inflation, ECB President Mario Draghi argued..., as the bank prepares to decide on the future of its giant bond-buying program. Speaking on the sidelines of the meetings here of the International Monetary Fund and World Bank, Mr. Draghi gave an upbeat assessment of the economic outlook for the 19-nation eurozone. But he argued that underlying inflation remains too weak, perhaps due to weak wage growth. That means the ECB should be patient as it considers its future policies, he said. 'It's going to take time,' he said. 'We have got to be persistent with our monetary policy.' The ECB's €60 billion-a-month bond-buying program, known as quantitative easing or QE, is due to expire in December."

October 17 - Financial Times (Claire Jones): "The European Central Bank looks set to remain active in the eurozone bond markets for most of 2018, confounding expectations that policymakers would end their landmark €60bn-a-month quantitative easing programme as early as June next year. ECB watchers now expect Mario Draghi... to say at the next governing council meeting on October 26 that the central bank will continue its asset purchases until next September -- or possibly even December 2018. 'It's the first time since QE began that the communication from the eurozone's monetary policymakers is clear: both the hawks and the doves seem in agreement that it will be a slow taper,' said Frederik Ducrozet, economist at Pictet Wealth Management."

October 17 - Bloomberg (Lucy Meakin): "Mark Carney reaffirmed that the Bank of England is close to its first interest-rate increase in over a decade, as inflation hit 3% and one of his colleagues said the economy is approaching a 'tipping point.' In a series of testimonies to lawmakers, the BOE governor and the two newest members of the rate-setting Monetary Policy Committee signaled that the erosion of economic slack is dominating their thinking as they prepare for a Nov. 2 decision. The appearances coincided with a report showing consumer prices rising at the fastest pace since April 2012."

Global Bubble Watch:

October 18 - Reuters (Kevin Yao and Elias Glenn): "China's central bank chief... issued a stark warning about asset bubbles in the world's second-largest economy, which looks set to clock its first acceleration in annual growth since 2010, driven by public spending and record bank lending. Speaking on the sidelines of the closely-watched, twice-a-decade Communist Party Congress, People's Bank of China Governor Zhou Xiaochuan spoke of the risks of a 'Minsky moment' in the economy, referring to a sudden collapse in asset prices after long periods of growth, sparked by debt or currency pressures."

October 15 - Wall Street Journal (David Harrison and Harriet Torry): "Leaders of the world's largest central banks indicated that weak inflation in advanced economies could prolong the postcrisis era of easy-money policies. Despite a broad-based improvement in the global economy, wages and consumer prices remain stubbornly low, making central bankers wary of removing their stimulus measures too quickly, they told a Group of 30 banking conference... Their concerns contrasted with the generally upbeat tone that prevailed during last week's fall meetings of the International Monetary Fund and World Bank..."

October 15 - Reuters (Howard Schneider and Leika Kihara): "The leaders of the world's top central banks who risked trillions of dollars and their reputations to rescue the global economy are now set to walk off stage at a time when the lingering effects of the crisis, evolving technology and a combustible political landscape will challenge their successors. The Federal Reserve, the Bank of Japan and the People's Bank of China may all have new bosses in early 2018 and there will be a new head of the European Central Bank the following year... Some $10 trillion in assets bought by the Fed, the ECB and the BOJ to prop up their economies remains on the books and will have to be pared back. Stubbornly low global inflation and weak growth complicate the return to more conventional policies. There are unfinished reforms in China and Europe, while the rise of nationalism could erode central bank independence."

October 17 - Bloomberg (Theophilos Argitis and Greg Quinn): "Canada's banking regulator released final rules that will make it tougher for borrowers to take on uninsured mortgages, adding to a growing list of measures to rein in the nation's housing markets. The Office of the Superintendent of Financial Institutions announced measures targeting borrowers in the uninsured segment of the mortgage market that has been responsible for the bulk of growth recently. A mortgage doesn't need to be insured against default if the borrower makes a down payment of at least 20%."

October 17 - Bloomberg (Ranjeetha Pakiam): "Gold wins out over cryptocurrencies when assessed on the majority of the key characteristics of money, according to Goldman Sachs..., which adds that fear and wealth are the core drivers of bullion. 'Precious metals remain a relevant asset class in modern portfolios, despite their lack of yield,' analysts including Jeffrey Currie and Michael Hinds wrote. 'They are neither a historic accident or a relic.' Looking at properties such as durability and intrinsic value, they are still relevant even with new materials discovered and new assets emerging, such as cryptocurrencies, they said."

Fixed-Income Bubble Watch:

October 18 - CNBC (Patti Domm): "The bond market is warning that trouble could be on the horizon, either from an economic slowdown or an eventual recession. The yield curve, a set of interest rates watched closely by bond market pros, has gotten to its flattest level since before the financial crisis. The spread between 2-year note yields and 10-year yields this week reached near the lows, at about 0.75, it has been since before the financial crisis."

Europe Watch:

October 19 - Bloomberg (Charles Penty, Todd White, and Esteban Duarte): "Prime Minister Mariano Rajoy will deploy the Spanish government's most wide-ranging constitutional powers for the first time in the country's history as he seeks to land a decisive blow on the Catalan separatist movement. Spanish stocks and bonds dropped as Rajoy's government said it will move forward with the process of suspending the powers of the Catalan administration after regional President Carles Puigdemont refused to shelve his claim to independence. Spain's government issued a statement on Thursday morning invoking Article 155 of the Constitution 'to restore the legality' of the semi-autonomous region."

October 19 - Bloomberg (Esteban Duarte): "Separatist campaign group the Catalan National Assembly is calling on its supporters to pull cash from lenders including CaixaBank SA and Banco Sabadell SA between 8 a.m. and 9 a.m. Friday. In a video posted on twitter Thursday night, the Assembly asked Catalans to withdraw money from the top five banks, highlighting CaixaBank and Sabadell to protest at their decision to move their legal domiciles out of the region."

October 14 - Reuters (Francois Murphy and Michael Shields): "Austria's shift to the right in a parliamentary election has paved the way for young conservative star Sebastian Kurz to become the next leader and opened a path for the resurgent far right to return to power. The People's Party, which named 31-year-old Foreign Minister Kurz its leader only in May, secured a clear victory on Sunday with a hard line on immigration that left little space between it and the anti-Islam Freedom Party (FPO)."

October 18 - Reuters (Mark Bendeich and Sara Rossi): "As nervous investors retreat from Catalonia, afraid the wealthy region may secede from Spain, another European region whose politicians once campaigned for independence is looking to attract some of them -- by talking of autonomy, not secession. The Italian region of Lombardy, the country's industrial engine and home to its financial capital Milan, is holding a referendum on Sunday for more autonomy, an outcome its once-proudly secessionist leader hopes will lure more investment."

Japan Watch:

October 17 - Bloomberg (Stephen Stapczynski, Ichiro Suzuki, and Masumi Suga): "Kobe Steel Ltd. said it will co-operate with the U.S. Department of Justice after the agency requested documents related to the fake data scandal that risks engulfing Japan's third-biggest steelmaker. Kobe has said some 500 companies worldwide are in a supply chain tainted by admissions that it falsified certifications on the strength and durability of metals going back to 2007, including automotive giants Ford Motor Co. and General Motors Co. and the U.S.'s biggest plane maker, Boeing Co."

Emerging Market Watch:

October 18 - CNBC (Gauri Bhatia): "If there's an idea, there will be funding. That's been the reality for India's start-up community for years -- but it might be ending. India's start-up dudes -- largely male, young engineering graduates or dropouts --are being jolted out of their fantasy world as investors tighten their purse strings and demand a greater bang for every buck they spend. India is the third-largest start-up hub in the world... It saw a peak in funding in 2015 when close to $6 billion was invested in new companies... Start-ups were originally seen as job creators and innovators who were solving India's problems. But that reputation has taken a hit and investor confidence in the sector is the lowest it has been in two years, industry insiders said."

Geopolitical Watch:

October 16 - Associated Press: "North Korea's deputy U.N. ambassador warned... that the situation on the Korean Peninsula 'has reached the touch-and-go point and a nuclear war may break out any moment.' Kim In Ryong told the U.N. General Assembly's disarmament committee that North Korea is the only country in the world that has been subjected to 'such an extreme and direct nuclear threat' from the United States since the 1970s -- and said the country has the right to possess nuclear weapons in self-defense. He pointed to large-scale military exercises every year using 'nuclear assets' and said what is more dangerous is what he called a U.S. plan to stage a 'secret operation aimed at the removal of our supreme leadership.'"

October 18 - Reuters: "U.S. Secretary of State Rex Tillerson said before a visit to India next week that the Trump administration wanted to 'dramatically deepen' cooperation with New Delhi, seeing it as a key partner in the face of negative Chinese influence in Asia. Speaking... less than a month before President Donald Trump is due to make his first state visit to China, Tillerson said the United States had begun to discuss creating alternatives to Chinese infrastructure financing in Asia. In another comment likely to upset Beijing, he said Washington saw room to invite others, including Australia, to join U.S.-India-Japan security cooperation..."

October 16 - BBC: "State department spokeswoman Heather Nauert urged all parties to 'avoid further clashes'. Iraqi soldiers moved into Kirkuk three weeks after the Kurdistan Region held a controversial independence referendum. They are aiming to retake areas under Kurdish control since Islamic State militants swept through the region. Residents of Kurdish-controlled areas, including Kirkuk, overwhelmingly backed secession from Iraq in a vote on 25 September."

October 18 - Bloomberg (Javier Blas): "The crisis unfolding around the Iraqi city of Kirkuk has left some of the world's largest commodity trading houses worried the country's autonomous Kurdish region will struggle to repay billions of dollars in cash-for-oil loans. The approximately $3.5 billion in debts were going to be met with the roughly 500,000 to 600,000 barrels a day of crude that the northern region of Iraq was pumping... But output has now collapsed to about half that level after the federal government in Baghdad recaptured some oilfields that the Kurds seized in 2014."

 

Author: Doug Noland

Doug Noland
Credit Bubble Bulletin

Doug Noland

I just wrapped up 25 years (persevering) as a "professional bear." My lucky break came in late-1989, when I was hired by Gordon Ringoen to be the trader for his short-biased hedge fund in San Francisco. Working as a short-side trader, analyst and portfolio manager during the great nineties bull market - for one of the most brilliant individuals I've met - was an exciting, demanding and, in the end, a grueling and absolutely invaluable learning experience. Later in the nineties, I had stints at Fleckenstein Capital and East Shore Partners. In January 1999, I began my 16 year run with PrudentBear, working as strategist and portfolio manager with David Tice in Dallas until the bear funds were sold in December 2008.

In the early-nineties, I became an impassioned reader of The Richebacher Letter. The great Dr. Richebacher opened my eyes to Austrian economics and solidified my lifetime passion for economics and macro analysis. I had the good fortune to assist Dr. Richebacher with his publication from 1996 through 2001.

Prior to my work in investments, I worked as a treasury analyst at Toyota's U.S. headquarters. It was working at Toyota during the Japanese Bubble period and the 1987 stock market crash where I first recognized my love for macro analysis. Fresh out of college I worked as a Price Waterhouse CPA. I graduated summa cum laude from the University of Oregon (Accounting and Finance majors, 1984) and later received an MBA from Indiana University (1989).

By late in the nineties, I was convinced that momentous developments were unfolding in finance, the markets and policymaking that were going unrecognized by conventional analysis and the media. I was inspired to start my blog, which became the Credit Bubble Bulletin, by the desire to shed light on these developments. I believe there is great value in contemporaneous analysis, and I'll point to Benjamin Anderson's brilliant writings in the "Chase Economic Bulletin" during the Roaring Twenties and Great Depression era. Ben Bernanke has referred to understanding the forces leading up to the Great Depression as the "Holy Grail of Economics." I believe "The Grail" will instead be discovered through knowledge and understanding of the current extraordinary global Bubble period.

Disclaimer: Doug Noland is not a financial advisor nor is he providing investment services. This blog does not provide investment advice and Doug Noland's comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. The Credit Bubble Bulletins are copyrighted. Doug's writings can be reproduced and retransmitted so long as a link to his blog is provided.

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