Arms Race in Bubbles

By Doug Noland

Credit Bubble Bulletin: Arms Race in Bubbles

The week left me with an uneasy feeling. There were a number of articles noting the 30-year anniversary of the 1987 stock market crash. I spent “Black Monday” staring at a Telerate monitor as a treasury analyst at Toyota’s US headquarters in Southern California. If I wasn’t completely in love with the markets and macro analysis by that morning, there was no doubt about it by bedtime. Enthralling.

As writers noted this week, there were post-’87 crash economic depression worries. In hindsight, those fears were misplaced. Excesses had not progressed over years to the point of causing deep financial and economic structural maladjustment. Looking back today, 1987 was much more the beginning of a secular financial boom rather than the end. The crash offered a signal – a warning that went unheeded. Disregarding warnings has been in a stable trend now for three decades.

Alan Greenspan’s assurances of ample liquidity – and the Fed and global central bankers’ crisis-prevention efforts for some time following the crash – ensured fledgling financial excesses bounced right back and various Bubbles hardly missed a beat. Importantly, financial innovation and speculation accelerated momentously. Wall Street had been emboldened – and would be repeatedly.

The crash also marked the genesis of government intervention in the markets that would evolve into the previously unimaginable: negative short-term rates, manipulated bond yields, central bank support throughout the securities markets, Trillions upon Trillions of central bank monetization and the perception of open-ended securities market liquidity backstops around the globe. Greenspan was the forefather of the powerful trifecta: Team Bernanke, Kuroda and Draghi. Ask the bond market back in 1987 to contemplate massive government deficit spending concurrent with near zero global sovereign yields – the response would have been “inconceivable.”

Articles this week posed the question, “Could an ’87 Crash Happen Again.” There should be no doubt – that is unless the nature of markets has been thoroughly transformed. Yes, there are now circuit breakers and other mechanisms meant to arrest panic selling. At the same time, there are so many more sources of potential self-reinforcing selling these days compared to portfolio insurance back in 1987. Today’s derivatives markets – where various strains of writing market insurance (“flood insurance during a drought”) have become a consistent and popular money maker – make 1987’s look itsy bitsy.

The record $3.15 TN hedge fund industry barely existed in 1987. The $4.1 TN ETF complex didn’t exist at all. To be sure, the amount of trend-following finance dominating present-day global markets is unprecedented. Moreover, the structure of contemporary finance has already (repeatedly) proven itself conducive to financial dislocation. Over the years – and especially post-2008 reflation – boom and bust dynamics have turned only more forceful. Central bank fixation on countering the bust has precariously propelled the latest boom.

The ’87 crisis response fatefully unleashed the “Terminal Phase” of Japanese Bubble excess – the consequences of which persist to this day. Decades of exceptional development flushed away with a few years of recklessness. In China, officials over the years claimed to have learned from the dismal Japanese Bubble experience. Clearly, they did not. The 2008 crisis was multiples of 1987. The recent post-crisis reflation, as well, has been at an incredibly grander and prolonged scale. This has ensured that China’s Bubble and “Terminal Phase” have inflated so far beyond Japan’s eighties fiasco.

Bubble mirage had Japan’s economy and banking system poised to lead the world. Now it’s China. In contrast to Japan’s beleaguered post-Bubble political class, China’s communist party won’t have to agonize over elections.

China faces extremely serious issues – and I’ll assume enlightened Chinese communist party officials are not oblivious. Beijing was the leading culprit behind my disquiet this week. Most focused elsewhere. The Trump administration’s tax package made initial headway in the Senate. There was also market-friendly reporting that Federal Reserve governor “Jay” Powell may be Trump’s leading candidate for Fed chairman. With securities markets rising ever higher into record territory, who cares about some communist party gathering? Heck, is communism even pertinent in today’s tantalizing New Age? Did you see those cryptocurrencies this week?

Chinese President Xi Jinping has a plan. China will be the world’s super power. The great communist party, with its progressive system of meritocracy, is the only mechanism to adroitly guide Chinese “new era” development. And President Xi is the master – the modern-day Emperor – with the depth of experience, the vision, the charisma, the power to ensure China’s rightful place on the world stage. He embodies the benevolent dictator for the masses; the resolute commander for an increasingly hostile world; the deity to guide and protect an insecure society. Spooky stuff.

October 20 – Financial Times (Tom Mitchel): “‘Government, military, society and schools — north, south, east and west — the party is leader of all,’ Mr Xi proclaimed in a three-and-a-half hour speech… to the party congress. Next week the congress will appoint a new Politburo Standing Committee stacked with Xi loyalists. One person who advises senior officials attributes Mr Xi’s now seemingly unassailable dominance of Chinese politics to a Machiavellian insight. ‘Because of the economic prosperity of the reform era, almost everyone in officialdom was corrupted,’ he says. ‘Xi used this fact as leverage to scare everyone. They have to follow him because everyone is vulnerable. All you have to do is investigate them.’ In his marathon address to the congress this week, Mr Xi positioned himself not just as modern China’s third great leader after Mao and Deng, but also the heir to a glorious Communist tradition stretching back to Russia’s Bolsheviks. ‘A hundred years ago, the salvos of the October Revolution brought Marxism-Leninism to China,’ Mr Xi said, noting that the Chinese Communist party was founded just four years later. ‘From that moment on, the Chinese people have had in the party a backbone for their pursuit of national independence and liberation, prosperity and happiness.’ According to Mr Xi’s arc of history, China is only three decades away from resuming its traditional and rightful place as the world’s dominant economic and cultural power, with the US caught in a downward spiral accelerated by Mr Trump’s election.”

Xi’s speech was said to have left young devotees sobbing (and previous leadership yawning and checking their watches). Xi is moving aggressively forward with a consolidation of power – assiduously crafting a cult of leadership. He has shrewdly perched his government’s skill and competence up on a high pedestal, with its leader the unassailable “man now regarded as China’s great centraliser and most powerful ruler since Mao Zedong, the party’s revolutionary hero.”

October 17 – Bloomberg (Ting Shi): “President Xi Jinping warned of ‘severe’ challenges while laying out a road map to turn China into a leading global power by 2050, as he kicked off a twice-a-decade party gathering expected to cement his influence into the next decade. In a speech that ran for more than three hours on Wednesday, Xi declared victory over ‘many difficult, long overdue problems’ since he took power in 2012. He said China would continue opening its doors to foreign businesses, defend against systemic risks, deepen state-run enterprise reform, strengthen financial sector regulation and better coordinate fiscal and monetary policy. ‘Right now both China and the world are in the midst of profound and complex changes,’ Xi said. ‘China is still in an important period of strategic opportunity for development. The prospects are very bright, but the challenges are very severe.’”

Xi and Chinese leadership are battening down the hatches. Recall that less than two years ago the Chinese Bubble was at the brink. It was Xi and his “national team” that took incredible measures to reverse a dynamic of collapsing markets and exodus from the Chinese currency. In short, confronting an inconveniently timed bust, they resorted to stoking their historic Bubble. Why not – everyone else has gotten away with it.

The upshot has been two additional (fateful) years of rapidly inflating apartment prices and economic maladjustment. There has been as well a couple more years of historic compounding Credit growth. It was only fitting that Xi’s overstated exultation elicited a shot of sobriety from China’s respected central bank chief (from his catbird seat).

October 19 – Financial Times (Gabriel Wildau): “China’s central bank governor has warned in unusually stark language of the risks from excessive debt and speculative investment, as he used the Communist party congress to caution that the country’s fast-growing economy faced a possible ‘Minsky moment’. ‘When there are too many pro-cyclical factors in an economy, cyclical fluctuations will be amplified,’ Zhou Xiaochuan, governor of the People’s Bank of China, said at a meeting on the sidelines of the Communist party gathering in Beijing. ‘If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky Moment’. That’s what we should particularly defend against.’”

Credit growth accelerated into the communist party congress. Chinese Total Social Financing (total non-governmental Credit) expanded a stronger-than-expected $277 billion during September. Year-to-date Total Social Financing growth of $2.375 TN is running 16.3% above last year’s record pace. Lending was led by booming demand for household real estate purchases. Total Chinese Credit could surpass $4.0 TN in 2017, easily outdoing U.S. Credit growth at the height of our mortgage finance bubble. Despite all the talk about excessive debt levels and the need for deleveraging, Chinese officials have yet to get their arms around a historic credit bubble.

Xi spoke of a focus on financial stability. His comment, “Houses are built to be inhabited, not for speculation,” reiterates official concern for housing prices. Past efforts to counteract apartment inflation with added supply failed to dampen enthusiasm for speculating on ever higher prices. At this late stage of such a prolonged Bubble, only harsh medicine will suffice. Prices will need to fall and speculation punished for the spell to be broken.

Bubbles are always about a redistribution and destruction of wealth. Its unparalleled global scope makes the current Bubble is so concerning. Xi now owns the Chinese Bubble, and there would appear little prospect that he’ll ever be willing to take responsibility for the damage wrought. Fingers will be pointed directly at foreigners, foremost the U.S. and Japan.

I believe the global government finance Bubble – history’s greatest financial boom – will conclude this long Credit cycle going back to the conclusion of WWW II. As the “granddaddy of Bubbles,” it is fitting that things turn really crazy during an exceptionally prolonged “Terminal Phase.” We’re at the point where no one is willing to risk bursting the Bubble, certainly not timid central bankers.

There’s so much at stake. Importantly, from the global Bubble perspective, a faltering Bubble would risk surrendering power on the global stage. Xi certainly doesn’t seem willing to see a faltering China retreat from global ascendency. The same can be said for Shinzo Abe in Japan. Here at home, making America great again gets no easier with a bursting Bubble. And while there’s no President of Europe, Mario Draghi has assumed the role of defender of European resurgence with an interminable windfall of free “money.”

It’s all quite unsettling. Global finance has run completely amok. This has been unfolding for so long now that few are concerned. Most revel in asset inflation drunkenness. Instead of safeguarding sound finance and stable money – the bedrock of civil societies and peaceful global relationships – governments and central banks around the world are harboring Bubble excesses like never before. This ensures catastrophic consequences when Bubbles burst. It has reached the point where these Bubbles have become part and parcel to global power, with countries not willing to risk being left behind. It’s as if it has become An Arms Race in Bubbles.

Three decades of serial booms and busts begat An Age of Government Strongmen – and weak central bankers. It would only be fitting for President Trump to opt for the milquetoast Jerome Powell to shepherd Fed inflationist doctrine, perhaps even trying to placate his base with a slot on the FOMC for John Taylor. Apparently, there are more urgent fights these days than reform at the Federal Reserve. Everywhere, it seems, various fights are taking precedence over stable finance. It just makes one dread the kind of conflicts that could break out when this historic global financial boom buckles. But, then, who on earth cares? The Dow is mere days away from 24,000, and Bitcoin is surely poised to make a run to $10,000!

Subscribe to NFTRH Premium for your 50-70 page weekly report (don't worry, lots of graphical content!), interim updates and NFTRH+ chart and trade ideas or the free eLetter for an introduction to our work. Or simply keep up to date with plenty of public content at NFTRH.com and Biiwii.com. Also, you can follow via Twitter @BiiwiiNFTRH, StockTwits, RSS or sign up to receive posts directly by email (right sidebar).