Doug Noland: That’s on Them

GameStop collapsed 80% this week, with Express and AMC Entertainment down 48%, Vaxart 36%, and Siebert Financial 31%. Riches have been made and lost. Wealth was redistributed – and count me skeptical that the flow was from professional speculators to retail traders.

February 1 – Bloomberg (Matthew Boesler): “Federal Reserve Bank of Minneapolis President Neel Kashkari… became the latest central bank official to push back against the idea that the trading frenzy in GameStop Corp. and other hot stocks calls for a monetary policy response. ‘GameStop has gotten a lot of attention. If one group of speculators wants to have a battle of wills with another group of speculators over an individual stock, God bless them,’ Kashkari said… ‘That’s for them to do, and if they make money, fine. And if they lose money, that’s on them… I’m not at all thinking about modifying my views on monetary policy because of speculators in these individual stocks.’”

Mr. Kashkari is not some nerdy academic economist unschooled in the nuisances of contemporary securities markets. Prior to his stint at the Treasury Department (hired by former Goldman CEO Hank Paulson), he was a Goldman Sachs investment banker. Kashkari left government work in 2009 for greener pastures at Pimco, where he worked as a managing director for about three years (including head of global equities).

I ponder the degree Kashkari and other Fed officials are concerned by the millions now actively speculating in U.S. equities and options markets. “If they lose money, that’s on them.” Seems like a reasonable perspective. We all need to take personal responsibility for our actions. But it’s just not that simple.

Destructive forces are at work – forces that have worked long and hard. Is it okay that for years now incentives have promoted speculation? And, at this point, it has all become deeply structural. The Fed is there to safeguard against financial crisis. Stocks will always recover and go higher, while recession ensures Trillions of QE and fiscal stimulus (the elixir for booming liquidity and corporate profits!). The biggest worry is not being fully “invested.” The upshot: Tens of millions of Americans are now actively speculating on ever-rising stock prices. In a system skewed for the “haves” and against the “have-nots,” we’re forced to participate in a speculative Bubble for fear of being the chumps left behind.

A massive infrastructure has evolved to ensure it is both easy and perfectly rational to throw “money” at inflating markets. Most of all, the Fed continues to devalue savings while backstopping the securities and derivatives markets, creating a deleterious incentive structure promoting speculation and market Bubbles. Especially after last year’s unprecedented monetary inflation, this mechanism exacerbates inequality while placing tens of millions of unwitting market speculators at major risk.

“If they lose money, That’s on Them.” That may be okay for a group of market players. It’s fine for the professional speculator community. But it is definitely not okay when market speculation has grown to become a major societal issue, especially with our social fabric already frayed and frail. I believed at the time it was immoral for Bernanke to have slashed savings rates to zero and forced savers into the securities markets. More than a decade of inflationism – along with the Fed repeatedly monkeying with the markets – has so distorted incentives and risk perceptions that it is impossible for the public to accurately assess market risk. When they lose serious money, it will be on the Fed.

The thought of the anger, animosity and vengeance that will be unleashed when the Bubble bursts is deeply troubling. The backlash will be momentous. A sweeping regulatory crackdown is inevitable. It will take years – or, more likely, decades – for trust to return. Wall Street and the Fed will be the main villains, while already fragile confidence in our government will be badly shaken. Capitalism will be in jeopardy.

It remains a challenge to communicate the deleterious effects of inflationism and unsound money. We’re in a period of monetary hyperinflation, yet there are no wheelbarrows or spiraling prices for bread and foodstuffs. Savings of lifetimes have not been wiped out.

The contemporary system of digitalized “money” and Credit, where central banks inject monetary inflation directly into the securities markets, has unique inflationary manifestations. It’s virtually miraculous superficially, with surging prices for stocks, bonds, real estate, private businesses and asset prices more generally. Wealth seemingly expands by the week. Yet Monetary Disorder is taking an increasingly heavy toll on financial, economic, social and political stability. Insecurities, inequities, animosities, distrust and anger fester.

I began posting the CBB in 1999 after I had become convinced of fundamental and momentous changes in finance. “Money” and Credit were expanding unchecked outside the traditional mechanism of bank lending and deposit growth. The proliferation of aggressive non-bank financial operators – from the GSEs, to the Wall Street firms, securitizations, derivatives, the leveraged speculating community and the like – was creating a powerful mechanism for unprecedented Credit expansion outside traditional bank reserve and capital requirement constraints.

History informs us of the perils associated with unchecked monetary inflation. It was obvious during the nineties that this new financial structure and attendant unfettered Credit growth were highly unstable – fueling asset inflation, speculation and serial Bubbles. I waited anxiously for the Fed to recognize this new system’s instability and danger. It became increasingly worrying when the Fed used mortgage Credit for system reflation following the bursting of the “tech” Bubble.

The dimensions of the Bubble Problem became clear to me when the Bernanke Fed responded to the bursting mortgage finance Bubble with bailouts and $1.0 TN of QE. I warned of the unfolding global government finance Bubble in 2009. I essentially gave up hope when the Fed’s 2011 “exit strategy” was scrapped in favor of another doubling of the Fed’s balance sheet to $4.5 TN. I thought I had witnessed “crazy” – that is, until 2020.

Over time, the entire world joined in to forge a unique global dynamic: in a historic first, global “money” and Credit expanded without limits to either quantity or quality. And with the world awash in liquidity (much dollar-denominated), China accumulated an international reserve horde surpassing $4.0 TN. Mushrooming reserves and trade surpluses ensured China became the greatest enthusiast for unbridled finance.

Chinese and EM investment booms pulled manufacturing jobs away from the U.S., while booming financial markets financed the American economy’s transformation to services, finance and asset-based wealth creation. Unfettered finance also fueled the technology revolution, as global manufacturing coupled with endless tech products and services created a powerful check on consumer price inflation. Misreading the forces behind disinflationary consumer price pressures, monetary policies were kept loose. Asset inflation and Bubble Dynamics were perpetually accommodated.

In early CBBs, I found value in a “financial sphere” and “economic sphere” analytical framework. I was worried that unchecked finance was ensuring myriad distortions and inflation in the “financial sphere” were having increasingly detrimental effects on “economic sphere” structural development. The more prolonged the Bubble in the “financial sphere,” the deeper the structural impairment to the real economy and the greater the toll on society.

I’m a strong proponent of Capitalism. I believe in free markets. But Capitalism and markets will not function effectively in a period of unsound money. Indeed, unchecked “money” and Credit and an inflating “financial sphere” are anathema to Capitalistic systems. I have “Austrian” and “libertarian” leanings. But I’ve always viewed the Austrian School’s theory of laissez-faire “free banking” as so hopelessly detached from modern realities as to hinder the broader debate.

Similarly, I’ve long held that talk of adopting a gold standard was a waste of time. As beneficial as they were during previous periods, there was zero chance of a return. The pressing need was for recognition and rectification of the more dangerous shortcomings in the current system of unfettered “money” and Credit growth. Measures that would restrain monetary inflation and the “financial sphere” Bubble, more generally, were the only mechanism available to protect Capitalism, free markets, the soundness of the “economic sphere” and social stability.

It’s been one major disappointment after another. From my analytical framework, the precisely wrong measures were – are being – taken. Unchecked “money” and Credit has proliferated to the point where the Fed’s balance sheet doubled in 73 weeks to $7.4 TN, as M2 “money” supply expanded $4.6 TN, or 31% (to $19.5 TN). The Federal government ran a historic $3.1 TN deficit last year – and Washington is gearing up for a repeat. The now customary solution to predictable economic hardship and inequality is, of course, additional monetary inflation. And I am reminded of a recurring delusion from great inflations throughout history: the notion that “just one more year” – “one final bout” of money printing will get us over the hump before the return to restraint and moderation.

Not surprisingly, the damage wrought by monetary inflation also grows exponentially. Inequality, the securities market Bubble and stock market mania, social strife and political instability. At this point, the “economic sphere” is but a sideshow.

I am reminded of the sage words from the late German economist Dr. Kurt Richebacher: “The only cure for a Bubble is to not let it inflate.” Over the years, I’ve often fielded the question, “Doug, if you were a policymaker, what would you do?” There are today no easy answers – no solutions that come without tremendous hardship. I know the sooner Bubbles are addressed, the better. But policymakers long ago missed their timing. The first law of holes: If you find yourself in a hole, stop digging. Yet governments and central banks will not slow their feverish excavation efforts until market forces dictate a change of course.

The entire global system is in the throes of late-phase “Terminal Phase” excess for a multi-decade Bubble. There has been unprecedented structural impairment. And the risk of bursting Bubbles is at this point so extreme that officials see no alternative other than to stick with massive and unrelenting monetary inflation.

The S&P500 rallied 4.6% this week, the largest gain since November. The Russell 2000 surged 7.7%, increasing y-t-d gains to 13.1%. Most major U.S. equities indices traded to record highs. After spiking to 38 the previous week, the VIX (equities volatility) Index collapsed to end this week at 21. Why the bipolar market behavior?

U.S. and global stock markets came close to an accident – and this week they recoiled forcefully. The pattern is familiar. Those having purchased near-term put options and other derivatives watched the value of their hedges get absolutely crushed. Meanwhile, the sellers of call options – that had been reducing their hedges as the market declined – were again forced to aggressively buy underlying stocks and instruments to hedge against a rapidly rising market. Brave traders betting on a market top have, once again, been whipsawed out of their short positions. And there’s all the trend-following and performance-chasing activities. Fear of Missing Out (FOMO). It’s a potent late-cycle brew of speculative trading sure to stoke volatility.

The synchronized nature of global market speculation is extraordinary. Major equities indices were up 9.6% this week in India, 7.0% in Italy, 5.9% in Spain, 4.9% in South Korea, 4.8% in France, 4.6% in Germany, 4.5% in Brazil, 4.0% in Japan, 3.6% in Turkey, 3.5% in Russia and 2.7% in Mexico. Bank stock indices surged 13.1% in Italy, 7.8% in Europe, 6.5% in Japan, and 8.7% in the U.S.

Italian and European markets were bolstered by news of Mario Draghi’s appointment to cobble together a coalition government in Italy. U.S. sentiment was boosted by generally encouraging economic news, though Friday’s January payroll data were a mild disappointment. New Covid cases and hospitalizations have dropped, while the vaccination rollout has gathered steam. News that the Democrats have decided to move forward quickly with Biden’s $1.9 TN stimulus proposal through budget reconciliation supported the bullish narrative.

But perhaps the most impactful market development was out of China. Liquidity conditions eased significantly, with China’s overnight funding rate collapsing to 1.88% from the previous Friday’s 3.33%. Global anxiety that Beijing might finally be determined to rein in Bubble excess was quickly supplanted by exultation that Chinese officials wouldn’t dare risk removing the punchbowl. Curiously, the Shanghai Composite gained only 0.4%, recovering but a fraction of the previous week’s drop. Perhaps Chinese equities discern this week’s loosened liquidity conditions were only a temporary phenomenon – with further tightening measures to follow over the coming weeks and months.

I get the dynamics behind heightened global equities market volatility. I find the Treasury market more intriguing. Ten-year Treasury yields jumped 10 bps this week to 1.17% – the high since March. Long-bond yields surged 14 bps to 1.97%, with yields up a notable 33 bps y-t-d to pre-pandemic levels. Notably, the 10-year Treasury inflation “breakeven” rate jumped 10 bps to 2.20% – right at the highs going back to 2014. The Bloomberg Commodities Index rose 3% this week, increasing 2021 gains to 5.7% (up 40% from April lows to near two-year highs). WTI Crude surged 8.9% to a one-year high $56.85

Inflationary pressures are building, and a colossal supply of Treasuries is in the pipeline. Bond market nervousness is justified. But I also appreciate the Treasury market must see the fragile stock market Bubble as tranquilizing. All bets are off if equities go into melt-up mode.

It has the feel of global markets having entered a period of acute instability. Equities have turned wildly volatile, while bonds are increasingly vulnerable. Currencies are unstable as well, as traders try to discern if there’s more to go in the dollar squeeze or whether the bear market rally is about to give way. And how crazy could things get in the physical commodities if squeeze dynamics really take hold?

It’s also worth mentioning the semiconductor shortage that has begun to hamper manufacturing for autos and other products. It’s one more manifestation of destabilizing monetary inflation. There is now the clear prospect for massive near-term fiscal stimulus, while the Fed is determined to keep its foot pressed firmly on the accelerator. It’s a combustible mix. It’s not a market backdrop I would be comfortable trading, though millions clearly don’t share this view.

Original Post 5 February 2021

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