INFLATING A NEW BUBBLE?
20 February 2008
BIG PICTURE - I have a suspicion that the recent insane
market volatility would have caused some sleepless nights
throughout the investment world. There can be no doubt
that the current year did not commence well with widespread
declines in the capital markets, resulting in the selling
nadir which forced the Federal Reserve to cut rates aggressively.
A few days later, in an effort to boost the ailing American
economy, the extremely intelligent US establishment announced
its own bailout package worth roughly US$150billion. These
measures helped to stabilise the situation and the markets
have been consolidating over the past few days.
Now, I am aware that there are many skeptics who are
not impressed by the monetary easing. These folks believe
that the central banks are only compounding the current
problems by adding more fuel to the already raging inflationary
fire. According to them, the ongoing monetary and fiscal
stimulus will not work as the US consumer is already stretched
to the limit and cannot possibly spend any more. For sure,
the skeptics have a point. It is worth noting that since
the beginning of this decade, Americans financed their
consumption binge by using their homes (which were appreciating
in value) as ATMs. In other words, home equity extraction
became a major source of financing for households in the
US. Unfortunately, the housing boom ended abruptly in
2006. Consequently, home equity extraction has contracted
ever since whilst the personal savings rate seems to have
bottomed out (Figure 1).
Figure 1: A problem for the US economy?
Surely, the above development is not a healthy sign for
the US economy given the fact that consumer spending accounts
for roughly 70% of GDP. In my view, the ongoing housing
recession will continue for several months and this should
act as a headwind for economic growth in the US. However,
where I differ in my assessment from the dire forecasts
of the bears is that I expect the latest bout of monetary
and fiscal easing to work (like it always has), thereby
inflating stock-markets worldwide. Over the past several
months, central banks and various Sovereign Wealth Funds
have pumped billions of Dollars into the financial system
and I expect this infusion of money to ultimately
support the stock market in the US and elsewhere. Remember,
this is an election year in the US and the American establishment
will tolerate either a deflating housing market or a declining
stock market but not both. So, you can bet your farm that
everything will be done to inflate the stock-market so
that Americans are feeling happy and wealthy
before they go and vote!
It is interesting to note that ever since gold was removed
from the monetary system in the early 1970s, regular
financial crises have been the norm rather than the exception.
And the response of the central banks following each crisis
has always entailed creating additional inflation via
lower interest-rates (Figure 2). Let it be known that
it is these bouts of monetary easing which have provided
the fuel necessary for the next bubble or mania in the
Figure 2: Financial Crisis = Monetary easing
You may remember that 1987 brought with it the infamous
Black Monday when the Dow plummeted in a single
day. Back then, the Federal Reserve responded to the crash
by pumping liquidity into the system, thus setting the
stage for a massive bubble in Japanese assets. Unfortunately
for investors, the Japanese mania ended in tears in 1990,
resulting in widespread wealth destruction. A few years
later, the financial world got jolted again by the Asian
Crisis (1997) and Long-Term Capital Management Crisis
(1998) and again the Federal Reserve responded by slashing
interest-rates and injecting more liquidity into the system.
Over the next couple of years, this particular round of
monetary easing spawned and fueled the biggest asset-bubble
of all-time - the technology bubble which popped in early
2000. The bursting of the NASDAQ bubble at the beginning
of this century caused serious pain to the business world
(with the exception of the CEOs at Silicon Valley
who made fortunes at the expense of the investing public)
and threw the economy into a recession. Once again, the
Federal Reserve (under the glorious leadership of Mr.
Greenspan) decided to tackle the bear by dropping interest-rates
to a miniscule 1% - a multi-decade low. Even though the
US recession was relatively mild at that time and ended
in November 2001, the Federal Reserve left interest-rates
unchanged for several months, thereby creating a massive
housing bubble in the US. Like all previous credit-induced
booms however, the housing bubble burst in 2006; creating
the ongoing sub-prime and credit crises. Now, if history
is any guide, over the months ahead, I suspect the Federal
Reserve will wage an all-out inflationary war which will
create a massive bubble in the emerging-markets of Asia
and Latin America. At this stage, it is impossible to
forecast when the emerging-markets bubble will end but
if I had to guess, I would say that the day of reckoning
will probably arrive in 2010.
Turning back to the current situation in the US, opinion
is divided as to whether the US will slip into recession,
thereby triggering a global bear-market. It is my view
that when adjusted for true inflation, the worlds
largest economy is already in recession. However, I doubt
very much if the official statisticians working in Washington
will ever admit to a recession in this election year.
So, I would have to conclude that at least in the eyes
of the mainstream media, the US will avoid a recession
not least due to all the help being provided by the officials.
Given the crazy monetary inflation and subsequent debasement
of currencies taking place today, I suspect commodities
(metals, food and energy) will continue to power ahead.
Puru Saxena publishes Money Matters, a monthly economic
report, which highlights extraordinary investment opportunities
in all major markets. In addition to the monthly report,
subscribers also receive Weekly Updates covering
the recent market action. Money Matters is available by
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Website - www.purusaxena.com
Puru Saxena is the founder of Puru Saxena Limited, his
Hong Kong based firm which manages investment portfolios
for individuals and corporate clients. He is a highly
showcased investment manager and a regular guest on CNN,
BBC World, CNBC, Bloomberg, NDTV and various radio programs.
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