 Oops
. . .
Bill Bonner
The Daily Reckoning
[Oz]
Dec 30, 2006
Crash Warning still in effect
- even if people swear that the worst is behind us...
The Dow
hit a new record yesterday. With only two days left to go in
the year, traders and investors are getting in position...
adding the shares they want
to own for 2007... snorting
with confidence... chaffing
at the bit to begin another run around the track.
The IMF says investors are
'too complacent.' We agree. That's why we have issued our Crash
Warning. Not that we know something is going to go wrong
soon... it's just
that if something were to go wrong, a lot of people would be
greatly inconvenienced. There are so many optimists...
betting so heavily that things
will continue as they have been... that the odds favor the naysayer, the contrarian,
the pessismist, the crank doom and gloomer.
The typical investor owns stocks
that are too expensive... compared
to the dividend yield he receives. And the typical householder
owes too much money to too many people - especially the people
who've lent him money on his house. His house, too, is over-priced
for what it is; if he had to rent it out, he'd never get enough
money to cover his costs and give him a fair return on his capital.
But the news dribbles in day
by day... and so
far, the news is not bad. New house sales are greater than expected,
according to the most recent report. So, investors and economists
are beginning to think - as Alan Greenspan has proclaimed - that
the worst of the housing slump is behind us.
'The worst is behind us' is
a remarkably upbeat assessment. We turn our heads and we don't
see anything bad back there. Stocks have been hitting new highs...
consumers are still spending...
and even house prices are,
officially, holding at their highs or even creeping up a little.
If that's the worst there is - well, bring it on!
Oops... there, we've said it, haven't we? Like
George W. Bush, we've tempted the gods. Now, they will want to
teach us a lesson; that there are some times when you don't 'muddle
through.' Most of the time, trends in motion tend to stay in
motion. But not all the time. Sometimes, they stop and a new,
different trend begins. That is when the gods 'bring it on' and
give it to us good and hard. And that is when you discover that
all those things that you thought were so smart, were too clever
by half.
Who are the smartest people
around today? Derivatives
traders and hedge fund managers, of course. They're the ones
earning millions of dollars each year. They are building huge
houses in the Hamptons and bidding up prices of Picassos.What
do they do to earn so much money? What do they produce? What
do they make that so improves others' lives that they deserve
to get filthy rich? Don't bother to ask, dear reader. You won't
get a clear answer. Instead, you will be told that they 'allocate
capital' or 'arbitrage discrepancies' in the modern capitalist
system. What they are really doing, of course, is the same thing
that people do in Las Vegas - they are gambling.
And as long as the pot is getting
bigger... they
will probably do all right.
John Succo, a hedge fund manager,
addressed a letter to the New York Times, explaining:
"The Federal Reserve creates
credit through its open market operations like REPOS and coupon
passes. If the Fed wants to inject liquidity (credit) into the
system, they simply call up large broker dealers and buy some
of their bonds with credit they create out of thin air (this
expands their balance sheet). The dealer then passes this credit
on to "the market" by making loans to mortgage companies
or margin accounts or whatever. Because each layer of lender
is only required to keep marginal capital on hand, a $1 billion
REPO done by the Fed eventually creates as much as $100 billion
in new credit to the consumer.
"That credit creates the
liquidity for additional consumption in the U.S., but these days
we are buying our stuff from China (other countries too but we
will just say China to make it easy). When a Chinese company
receives dollars in trade, this normally would drive up U.S.
interest rates: the company goes to the central bank of China
to exchange Yuan for dollars; the central bank of China would
normally sell those dollars into the currency market for Yuan
thus driving up U.S. interest rates. But in our world of today
these dollars are being sterilized: the central bank of China
prints the Yuan to give to the company and takes the dollars
and buys U.S. securities.
"It is not the excess
savings of Chinese investors that are buying U.S. securities.
It is central banks creating credit themselves to buy those securities.
The tick data that measure foreign inflows of money does not
distinguish between private investors and central banks going
through brokers to buy U.S. securities. We believe that as much
as 90% of foreign money buying U.S. securities (not just Treasury
bonds, but corporate bonds, mortgages, and yes, stocks) is not
private investment, but central banks.
"In order for other central
banks like China's to print the Yuan necessary, they too must
create credit. Public debt in Asian countries is expanding as
a result and creating worries: this is why Thailand came out
essentially raising margin requirements to reduce speculation
that is occurring as a result. Notice how they were quickly slapped
down by their trading partners who do not want to rock the boat
at this time.
"This situation is very
unstable in the long run. The Federal Reserves' balance sheet
this year alone has expanded by $30 billion in this way and created
$3.5 trillion of new credit in the U.S. Public debt around the
world is growing exponentially and total debt in the U.S. now
stands at nearly 3.6 times GDP (1929 was 2.8 times).
"My hedge fund's position
is the opposite of the carry trade you mention. There is coming
(timing is unclear where it may be tomorrow or may be years away)
a massive correction in debt and derivatives whose magnitude
is only growing with time."
It could be tomorrow. It could
be years away. But it will be eventually. And the more complacent
people are, the more they will suffer when it does come. But
we will have more specific guesses for the New Year soon...
Permy: http://www.dailyreckoning.com.au/investing-2007/2006/12/29/
Dec 29, 2006
  Bill
Bonner
The Daily Reckoning
[Oz]
A freewheeling website for libertarians, gold bugs and doom enthusiasts
of every stripe.
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