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Monetary Madness: Global Margin Call Underway

by: The Prudent Investor October 06, 2008 | about stocks: ACWI / DBV / EFA / FXE / UDN / UUP    
The Prudent Investor

The Prudent Investor

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Financial news has been coming fast and furious in the past four weeks, taking the nationalization of Frannie as a starting point for the worst turmoil any living market participant has experienced in his/her life. What we have seen since can only be called monetary madness, where central banks and governments ultimately saddle more than one generation of citizens with debts for the rescue of a financial system that ultimately cannot be successful by generating still more debt.

It has become almost impossible to follow all the inflationary measures disguised as "liquefying operations" by monetary authorities. At the same time, governments begin to blow up future inflation expectations with their unlimited guarantees of savings deposits that have a good possibility of blowing up in their face.

Socialism for the haves has become commonplace almost overnight in Europe. After Ireland and Greece, governments in Germany, Austria, Denmark, Sweden and the UK followed suit in a move to reassure savers that their money is safe in the bank. We can be confident we will hear similar announcements from more countries in the near future.

Not even bankers agree in private that this is the case, being grateful that the non-financial world is still not aware of the debt Himalaya that starts crashing upon the world and has not yet led to a massive run on continental European banks which are bleeding on all ends.

Central banks meanwhile keep trumping themselves over who will create more money without a correspondent value. But the pinstriped inflationistas have only a single strong card left in their hands. It is the card of public ignorance and the blessing that nobody can remember the last period of hyper-inflation.

Crisis Engulfing the Broader Economy

This will change as soon as the public will see that the next bank run will not be the last one. At this point in time, the banking crisis will have become toxic for the broad economy.

Anything real estate related, insurance companies and the leisure sector will feel the pinch next, either from hard to get credit, or falling bond prices, or the disappearance of disposable income due to rising prices. Do not mistake the current correction in commodities as a bear market. It is simply another result of the global margin call taking place right now.

Climbing spreads in the fixed income markets show the dichotomy between market reality and the wishful thinking of central bankers who increasingly lose power over their only tool, establishing leading interest rates for the short end of the market. The game can go on as bankers and investors are so foolish to accept negative real rates. This behavior will stop soon, once the tightening continues. And I see no step so far that is designed to restore confidence in a market where participants would like to adapt accounting rules to converge with their wishful thinking.

Sorry, the signs have been on the wall for at least four years. Money supply and debts first grew in the USA and the EU and this dangerous policy was followed by countries at such diverse stages of development as China, India and Russia, which are all fighting the same inflation problem by now.

The avalanche of cheap credit pumped out by central banks does not reach the broad economy and consumers in Europe anymore as banks scramble to improve their balance sheets. This may become a roadblock for the ailing economy, already limping ahead at growth rates that fall within the statistical margins of error.

As all measures since August 2007 have not helped to alleviate the crisis, we probably have to get ready for a very brute and nasty crash that will do what a crisis is here for: to cleanse out the weak part of the economy and start again with a clean plate. I know this euphemism does no justice to the economic contraction which will cost many their lifestyles, as they have come to know them.

But no authority in the world has ever been able to prevent a depression by decree or by printing money in limitless amounts. It only fueled inflation further, without any historical exception. Don't think it will be different this time. All economic and financial indicators have long surpassed the toxic levels that led to the 1930s depression. Oh yes, one thing will be different: This time it will be global.

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This article has 11 comments:

  •  
    Oct 06 05:18 PM
    "This time it will be global" ??? As if the first Great Depression wasn't?

    Stock market crashes are not inflationary events.
    Bank failures are not inflationary events.
    Property foreclosures are not inflationary events.
    Reply
  •  
    Oct 06 05:26 PM
    Governments and central banks are creating money and this will create huge inflationary pressure. But at the same time, we have this huge forced deleveraging which has to be deflationary to asset prices. How will this play-out in the coming weeks? In the coming months?
    Reply
  •  
    Oct 06 05:40 PM
    How will this play out? The way I answer it is that the U.S. currently has the dominant currency. With the U.S. owing trillions of dollars to other countries, would the U.S. prefer inflation or deflation? There's your answer.
    Reply
  •  
    Oct 06 06:08 PM
    bin Laden's money flow is drying up as the oil and stock markets collapse is at least one positive. Now if the idiots out there would quit buying their drugs.

    As one who believes that we will have no free markets without a strong defense, this is more important than few believe. Proof is that the media doesn't get it.
    Reply
  •  
    Oct 06 06:34 PM
    In a prolonged period of asset deflation, the only thing that can cause inflation is spiraling wages. Show me where this is going to happen. I see a lot of posts here calling for inflation, but no real thesis to back up the claims, besides the usual fiat currency, blah blah blah arguements.

    The Great Depression caused deflation, not inflation.
    Reply
  •  
    Oct 06 07:54 PM
    Worrying about inflation when the T-bill is overbid at zero yield and the dollar's chart looks like a lunar shot going up is utterly ridiculous. When will the monetarist numbskulls admit that *demand for money is not a constant*! Geez oh flip, buy a freaking clue already!
    Reply
  •  
    Oct 06 07:55 PM
    Toni and Alex_G has contributed valuable insights into the current state of affairs. How true the Great Depression caused deflation not inflation. Since as Toni says all financial and economic indicators [care to list them?] have exceeded the Great Depression toxic levels, the government will not be able to alter the outcome of at least a deep recession.

    Dow 8k is likely but Dow 5k is not impossible before things settle down.
    Reply
  •  
    Oct 06 09:56 PM
    Depression II is trying to happen; many of the elements are in place. In the 1930's Depression I, home prices were dropping, there was too much debt, commoditiy prices were dropping, profits disappeared because people didn't have the money to buy products, the stock market was imploding, farmers couldn't sell their products at a profit because market prices were too low, unemployment was soaring, banks were failing, and the government didn't know what to do. This time around (as Toni suggests toxic levels are even worse) the situation is potentially worse. Can massive amounts of increased borrowed government money thrown at massive amounts of already shaky borrowed money fix the problem, which was caused by too much borrowed money and leverage in the first place? We are entering a new dimension.
    Reply
  •  
    Oct 07 07:22 AM
    Mike Shedlock's recent article leaded me to ready his February 2, 2006 Article: Inflation: What the heck is it? It changed me prespective. I was crying what US Dollar was up and why Gold and Oil was down so much. After reading of his Article, I now understand that inflation is best defined as money supply + credit. It is true that government actions is inflationary, but the other part of the equation is credit goes extreme the other way to the downside. Adding the two together, you can see that inflation will not an immediate problem. How soon will inflation be a problem? I guess when the government is successful in restoring confidence and does not quickly remove the excess money that is now being pumped in.
    Reply
  •  
    Oct 07 11:09 AM
    We are in deflation. Period. The excess liquidity that drove consumer staples such as food and energy is gone (for now).

    Printing would certainly have an inflationary effect on imports such as oil and other common staples, but we shall see how much of that $700 B of liquidity winds up in the hands of a few consolidated players and if the energy/food bubble gets reinflated.

    What currency oil is pegged to in the future is an important question for our nation.

    A better alternative to this mess would have been to create an excellent energy policy, put the $700 B into regional banks that demonstrated fiscal responsibility these last three years and accelerate the energy market creating millions of jobs. When energy begins shooting back up through the roof, it will be the final coffin of our current economy and the dollar will crash and burn. Russia survived it, Weirmark Germany survived, etc. It is a dreadful yet necessary painful process that cannot be avoided but will be a clearing house of the corrupt in Washington and our financial system.

    Reply
  •  
    Oct 07 12:54 PM
    Some good comments today:
    1. User 257960: Inflation is driven by money supply plus credit. If credit is way down, money supply can be way up. Lets just hope that Bernanke knows when to reverse course.
    2. Alex S: We are a huge debtor, and we control the world currency. We will prefer inflation. A key insight.
    3. All indicators like the Great Depression? Very bad history. Farm incomes are great; unemployment is modest by historical standards; there have been few bank failures. We have been fixing the bubble in housing prices and the effects of lousy discipline in the financial system; the stock market is down - painfully, but not extraordinarily. It will be painful, but it is just demagogery to say it is the Great Depression.

    It would seem from the strength of the dollar and low long term interest rates that the markets believe that Bernanke will get it right. If you believe otherwise, short the dollar and long term bonds.
    Reply
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