Doug Noland: Now the Downside

Excerpts from Doug Noland’s The Perils of Inflationism

Proponents proclaim a decade of central bank stimulus has proven a tremendous success. They would point first to stock, bond and asset markets more generally. I view the same markets and see acute instability and fragility. I believe a decade of monetary stimulus has exacerbated financial, economic, social, political and geopolitical instabilities. This will surely be debated for decades to come…

…The notion of inflating risk asset markets with central bank liquidity has to be the most dangerous policy prescription in the sordid history of central banking. And, importantly, the longer central bankers held to this policy course the deeper were market structural distortions. Rather than attempting to rectify crucial flaws in contemporary finance, central bankers chose inflationism and market backstops as stabilization expedients.

This was a monumental mistake.

The expansion of central bank balance sheets ensured a parallel expansion in global speculative leverage. Over time, there was an increasing multiplier effect on each new dollar/yen/euro/etc. of central bank “money.” The original Fed QE “money” program basically accommodated speculative deleveraging. In contrast, the past few years (in particular) incited an aggressive expansion of speculative leverage throughout global securities and asset markets…

…The problem with speculative blow-offs is that they inevitably reverse. Upon the reversal, the seriousness of the problem is proportional to the amount of underlying leverage, the degree of market misperceptions and the scope of associated market and economic structural maladjustment. The world now confronts one hell of a problem…

The unfolding de-risking/deleveraging dynamic is extraordinarily problematic from a liquidity standpoint. A powerful “risk off” dynamic – having unfolded following a global speculative blow-off instigated by massive central bank liquidity injections – leaves global “system” liquidity acutely vulnerable.

Faltering global liquidity will now expose the misperception of “moneyness” for ETF and passive index products. As such, global markets are now at high risk to global de-risking/deleveraging fomenting a transformative change in risk perceptions. Past risk reassessments (that seem minor compared to what is now unfolding) have led to panic and dislocation.

Flawed central bank policies are directly responsible for both a decade-long global Bubble and the more recent speculative blow-off. Markets, meanwhile, cling to the belief that central bankers remain fully committed to doing “whatever it takes” to hold bear markets, recessions and crises at bay. There’s a disconnect.

The harsh reality is that “whatever it takes” has failed. It was built on fallacious notions of inflationism, markets and finance, more generally. Most regrettably, a tremendous amount of market hopes, dreams and capitalization have been built on little more than fallacy.

Total global Credit growth has slowed dramatically. I would argue speculative (securities and derivative-related) Credit, having evolved into a key marginal source of total global Credit, is now in significant self-reinforcing contraction. This portends liquidity issues for markets, faltering asset values and trouble for economies. In the markets, Fear is supplanting greed. Risk aversion and waning liquidity now spawn powerful Contagion across markets.

The Bubble has burst – the global Bubble, the Bubble in leveraged lending, and Bubbles across asset classes around the globe. In the case of leveraged loans, I don’t expect another bout of QE to resuscitate Bubble Dynamics. Excess within this market, similar to so many, went to parabolic extremes. Risk misperceptions went to extremes; lending terms to extremes; and speculation to extremes. Now the downside.

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Categories: Doug Noland, Perspectives