Asset Inflation - Central Banking Folly

The Central Bank
1

The 1970s taught the world the evils of uncontrolled “price” inflation. They irony of “price” inflation, is that while it is brutal to experience (havoc with capital allocation etc.), when it is gone, the economy is usually materially underleveraged and ripe for growth. The pain of the 1970s when rates topped out at +18%, set the foundations for a multi-decade bull run.

Since the early 1990s, Alan Greenspan (and his disciples Bernanke and Yellen), have been vigilant on '“price” inflation, but have done everything in their power to generate “asset” inflation. To generate “asset” inflation, you need to increase the indebtedness of the system (bank loans, student loans, credit cards, margin debt etc.). Note, that the pace of growth in the indebtedness must remain positive - if the level of indebtedness even flattens, prices will fall (as the FED has learnt in QE1 & QE2). Unlike “price” inflation, “asset” inflation feels great when it is happening (house prices rising, stock portfolios rising etc. etc.), however when it peaks, the debt that creates the “asset” inflation stays within the system (see graph below).

You can see below end of QE1 and QE2 when indebtedness flattened and markets collapsed. QE3 has continued to re-levering
https://research.stlouisfed.org/fred2/data/TCMDO_Max_630_378.png

Only “price” inflation or actual debt write down can reduce the debt. The latter is not palatable as it will further depress “assets” while the former has never happened in modern times (although Central Banks still dream of it - especially Japan). The irony of “asset” inflation however, is that by drowning the system in excess debt, so much new money is created that there are not enough productive activities to pay interest on everything, and therefore interest rates fall, which is deflationary (this sentence is not an accepted fact and could be debated ad-infinitum however I believe the facts support it - ultra low rates equal ultra low inflation). We therefore get the inverse of the above indebtedness chart when it comes to interest rates.
static2.businessinsider.com/image/4fc78f816bb3f72a26000016/image.jpg

All this is a long-winded intro to what I believe is the great folly of our lifetimes. Our Central Banks are well down the path to re-ignite the asset price bubble, but this time at ultra low rates. In the US for instance:

  1. US Stock Mark Trailing PE and Forward PE exceeds 2007 peak (and matches all other peaks bar 2000)
    https://www.cyniconomics.com/wp-content/uploads/2014/01/pricetopeakearnings2_thumb.png
    thepropertypin.com/viewtopic.php?p=752283#p752283
    thepropertypin.com/viewtopic.php?p=752373#p752373
  2. US Bond Yields are at a 100 year low (a true bubble)
    https://static6.businessinsider.com/image/4fc7964feab8ea060d000003/long-term-interest-rates-us.png
  3. US House prices are above their 2007 peak (now over 6.7 x income)
    https://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2013/12/20131224_homeprice_0.jpg
    zerohedge.com/news/2013-12-24/spot-paradox

The folly is that stuffing more debt into the system at ultra low rates, just to maintain “asset” inflation? Leaving aside the issue of the instability this will cause in the system (again!), it creates LARGE inter-generational wealth transfers. We are now at the point where our kids will be the first generation that WILL be poorer than we are?! We will look back at this era of ‘rock star’ Central Bankers with great regret in future years to come. We are looking at the last great asset bubble of our lifetimes (i.e. done a ultra low rates)
https://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2014/01/20140102_wealth8_0.jpg

zerohedge.com/news/2014-01-02/biggest-redistribution-wealth-middle-class-and-poor-rich-ever-explained

2

Interesting stuff.

3

Bernanke has set the stage for the Fed’s collapse -Jim Rogers
mineweb.com/mineweb/content/en/mineweb-political-economy?oid=222934&sn=Detail

4

All this warped revisionism, fanaticism and outright lies seems completely mental to me.

Why don’t punters ask what is the reason for this “extreme interference” 2007 to present?

Is it because they’d have to answer that pre-2007, free market forces were allowed to run fucking riot! Is it that they’d be faced with the fact the fed chairman of the time (Greenspan) was himself a free market ideologue, whose stated policy was to facilitate these markets to the end! Is it they’d have to admit that the politicians of the time were the exact same, ‘facilitating’ the markets; handing out tax breaks and tax reductions; and generally “getting out of the way” of business etc. (All under the influence of the same pervasive ideology…)

If the brains of these punters/commentators actually worked, they’d have to admit it was *shareholder owned *banks who made it a key part of their business (and the primary route to increasing their profits) to ensure that governments allowed them regulate themselves.

Let alone face the fact that it was these self same shareholder owned private sector banks that ‘printed’ new money (through loan issuance) that brought the monetary/asset equilibrium to what we are faced with today. And THAT is what necessitates the intervention… Asset prices HAVE to be maintained at a certain level relative to previous level.

  • Because otherwise the balance sheets of (a) private individuals (b) companies (c) governments and (d) the private sector banks themselves, get fucked (which causes serious adverse economic effects, anyone of reasonable mind must admit.).

But the really interesting aspect of all of this, imho, is this new social phenomenon of ignorant blogs and their acolytes, that try to turn the truthful perception and rationale upside down on its head. It is in effect a kind of ‘ponzi’ or ‘pyramid’ scheme (where the more successfully that each participant can foment a certain political intent in those in the level below them, for example, an acolyte of Jim Rodgers builds a following on a forum like the propertypin - the more gains accrue to all participants, to the extent that each has made economic and investment and lifestyle decisions based on the rationales they are helping to proclaim…).

Certainly the motivation is that you have significant parts of the population who see the asset devaluation as bringing previously unattainable assets within their reach. And they also see that deflation might further enhance their lifestyle. These new ponzi punters see that they can get rich by doing nothing, by sitting on their backside and adding their clicks and affirmations to the internet blogs (while continuing to be mediocre and risk adverse in their workday contributions no doubt).

No reasonable person is in any doubt that there exists a spectrum along which there is a moderate position regarding the extent that democratically elected governments should involve themselves in markets, to help ensure said markets fulfill their remit of serving the public good.

But the continual trying to paint things in black/white, either/or, and formulaic drum-beating and distortion of logic and rationale is truly mental.

NEWSFLASH: FREE MARKET FORCES PUMPED UP ASSET VALUES DURING THE BOOM. THE LOBBYING OF 2000-2007 PROCEEDED FROM THESE SELF-SAME FREE MARKET FORCES. IF CENTRAL BANKS HAD CONTINUED TO LISTEN TO THESE UNFETTERED FREE MARKET IDEOLOGUES/LOBBYISTS THROUGH THIS CRISIS SO THAT THESE SELF SAME PEOPLE COULD PICK UP SAID ASSETS FOR A SONG, AND SEEN THEIR SAVINGS AND MEANS QUADRUPLE IN BUYING POWER, THE FALL-OUT WOULD HAVE BEEN CONSIDERABLY WORSE THAN IT HAS ACTUALLY TRANSPIRED FOR THE MAJORITY. CENTRAL BANKS ARE JUST FILLING IN EXTREMELY DANGEROUS “HOLES” AS LIGHTLY AS THEY CAN. THE FOLLY IS NOT THEIRS, OR OF THEIR MAKING.

5

Not fully sure I understand you roc … however, the graph below is ‘black & white’ (imho)
https://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2013/12/20131210_GW.jpg
thepropertypin.com/viewtopic.php?p=752534#p752534
The great ‘con’ of asset price inflation (central bank driven via increasing leverage), will be the folly of our times.
They are all at it - US, Japan, China (even Draghi gets to do it now and again).
(and the cost our children will have to bear trying to sustain prices that should not be sustained).

6

Now try and contemplate the real world economic scenarios that would have unfolded if the market capitalisations of companies HAD actually permanently fallen by the level indicated by your graph. (Yes, yes, post-collapse, resources would have been re-allocated more ‘efficiently’, yadda, yadda). Point is once free market forces were allowed to inflate asset values, the equilibrium thus created has very real world implications. You can’t just have it collapse. Or at least I disagree with you about the degree of real-world social-economic fall-out that is acceptable.

7

Ah, I get your point now ‘roc’.

I do agree that Central Banks / Asset Reflation has a role to play in the teeth of the crisis (i.e. H1 2009). QE2 however was not needed on any ‘crisis’ grounds and was a very a very fine call. QE3 is was pure asset reflation - pumping 85bn into the market (similar to the ‘cash’ earnings of the S&P500) when it was at 14x trailing PE?!? There was no crises here.

We have not had ‘free market’ forces for decades now.

All through the 1990s, Greenspan (the father of QE who used the US banking system instead of the FEDs balance sheet, until he broke them), pumped massive amounts of leverage into the system, allowing the US banks to go from 10x to almost 30x leverage.

In the naughties, to replace the lost leverage in the stock market collapse, he let the US banks go from 30x leverage to 50-60x (and 100x between year ends), and pumped even more leverage into the system.

There is no ‘free market’ here, just a machine pumping an increasing level of debt (note - whenever the level of debt flattens prices fall), into the system to drive asset prices ever higher. It is under the false (or yet to be proved theory), that too high asset prices will eventually produce ordinary ‘price’ inflation that will reduce the debt. A virtuous ‘asset’ price to ordinary ‘price’ inflation cycle which unfortunately (as posted earlier), has not happened.

That is my issue.

8

bloomberg.com/apps/news?pid= … 5qh9Up4rlg

9

Link not working. It’s here bloomberg.com/apps/news?pid= … 5qh9Up4rIg

10

Thanks. Here it is again. So ask, (a) was the central bank fulfilling its remit as a central bank with Greenspan, Ayn Rand’s pal, at the helm, or did it in fact have its remit corrupted under the influence of his held ideology as below (b) did the asset inflation of the boom stem from private sector forces run riot or not, and, once a certain equilibrium in terms of money in the system and asset values had come about, what choices were really available to more responsible and intelligent forces impelled to intervene, in terms of actions to take, having account of likely repercussions stemming from the choices available.

11

There is a myth (perputated even by Greenspan) that his failing was to have been a ‘nutty professor’ who trusted in the purist free market ideology (Ayan Rand etc.). The reality (as per my first graph on this post), is that Greenspan pro-actively injected as much credit as he could into the system. US banks could not expand their balance sheets in the way they did from 1990 to 2007 without the explicit support and back-stop of the FED (in the same way as the US banks have been given enough lee-way to invest excess QE reserves into the S&P500 without violating Volker Rules).

The ‘free market’ was left to decide whether the PE of Coke was a better deal than the PE of Pepsi - relative pricing.

The absolute level of prices, was driven by Greenspan (as it was done by Bernanke, and will be done by Yellen).

gmo.com/websitecontent/GMO_QtlyLetter_ALL_3Q2013.pdf

12

Does your first graph not show total US debt as % of GDP? Is that not primarily a function of the vast sums splurged by enterprising Republican industrialists when in power on large tax-breaks for the well off and war-mongering etc?

Yes. By taking a step back (as I described above) and allowing private ‘enterprise’ to make their own rules, no?

Pleaae stop conflating the free market ideologue Greenspan with Bernanke and Yellen. That is completely and utterly fallacious. They consist a completely different paradigm.

13

In response, and to avoid over-lengthening the post with re-quotes

  1. No, it is solely correlated to the increase in leverage of the US banking system (US Gov net debt rose more modestly). Note by banking system, we need to includes the FEDs greatest invention (which Greenspan personally took to the ‘next level’ which is Fannie Mae / Freddie Mac (or Noonan’s wet-dream for the ECB).

  2. No, banking leverage (and their interaction with Fannie Mac / Freddie Mac) is highly regulated. The FED just took away all the rules limiting it (culminating in the Glass-Stegal repeal because it makes perfect sense to have Mrs. Murphy’s life savings on deposit reinvested into Japanese derivatives by Citibank to the good of society (or asset price inflation).

  3. I don’t make any distinction between them. The are all politicans (and highly skilled ones) and therefore whatever ‘idelogy’ they might profess to have is window dressing in their desire to support / do the bidding of whoever is the most powerful group in the room.

14

There are any number of observable (and documented) economic phenomena that act over time. They include credit cycles (one manifestation of which is increased leverage of individuals, companies, and private sector banks etc), new innovation and over investment, overproduction, inherent failure to see cycles as inherent in the capitalist process, large amplitudes in constructional industries, and more.

Central banks were set up to mitigate the effects of these economic phenomena which come about as a natural consequence of the capitalist process. (“La cause unique de la depression, c’est la prosperite”)

The fact that Greenspan didn’t effectively do this is clear. The reason WHY he didn’t do it is also clear, as per Bloomberg article above.

The attempt to try and state that it was actually central banks that “caused” the above phenomena, when actually it was their failure to fulfill their remit of reigning in the natural economic phenomena related to economic cycles (well documented and analysed by economists over two hundred years or so), and to conflate present central bank actions with the preceeding ones, is the stuff of Orwellian dystopias. Bellyfeel duckspeak.

15

If Greenspan let it “collapse” initially without intervening to accommodate government/banks, the system would have been purged nicely and have been ripe for sustainable growth. The following “collapses” would have been mild and would have been allowed to play out.

Instead, Greenspan continuously kicked the can don the road to the point where we have record low interest rates & QE. You may not want to divert your point from Greenspan but his predecessors have followed his actions, perhaps forced into a policy/course of no return.

16

The Fed was setup to create a one currency for all in the US (similar to the euro I guess)… Not to mitigate the effects the business cycle. And when it was set up it was set up with a gold backed currency, which, would have prevented the current asset inflation.

17

Exhibit A, M’Lud.

18

Are you trying to tell me that it was the free market that pumped up the property sector in the US and the government backed Fanny Mae and Freddie Mac had absolutely nothing to do with it?

You cannot not be a free market ideologue/lobbyist if you are lobbying the government to bring in rules and regulations that allows you to game the system to your advantage.

19

roc

your passion for financial services means that you must have a connection to it.
your naivety on the basic actions of central banks in capital markets means that you cannot be a trader / investor.
(lets not even get into the NY FED and its 10.30am POMO actions).
your confidence in your views and colourful dismissal of (basic) capital markets understanding means you must be…
… and economist or academic in financial services?

20

“The S&P500 Is Now Overvalued By Almost Any Measure”
David Kostin, Goldman Sachs, 11th January 2014

Yes the Squid calls it - the FED is close to achieving the hat trick of ‘all-time’ bubbles with QE (bond, real estate and stock market).
(a very rare moment for the Squid to be calling the top in any market - so beware - however their analysis is the point of this post).

By ‘all-time’, I mean that the asset is in a once in a hundred year high (all due to $75bn in monthly injections). As posted earlier, the US bond market meets this criteria while the Real Estate market has passed its 2007 high (previous generational high). The equity market however is still humbled by the 2000 ‘dot.com’ bubble.

Not any more. What makes Goldman Sachs analysis interesting is that they use a measure only found on niche blogs - Median Stock Valuation. (See John Hussman’s Open Letter to the FED where he quotes the famous Value Line Median hussmanfunds.com/wmc/wmc131125.htm)

The reason when the Median is so important is because in 1998-2000, about 20 mega cap stocks (AOL, World Com, Cisco etc.) became the focus all outperformance vs. index. If you did not own these ‘visionary’ stocks (the Twitter, Facebook and Amazon etc. of their day), you materially underperformed the index. They were heaven for i-bank prop traders as they were liquid (traders needed a fast exit in a hot market), permanently under-owned by institutions (which meant they were always being forced to buy them at higher prices) and impossible to value (no real profits meant anybody could have a view and the price could go anywhere). The P/Es on these stocks were crazy (+100 in cases), and drove the overall P/E of the indices into the mid 20s.

When you took out these stocks, the median P/E was more like 18x - which is very close to where the market is now. In a few more months of $75bn purchases, the S&P500 could surpass its all-time dot.com valuation on a median stock basis. Mission accomplished by the FED to create simultaneous 100 year bubbles in the 3 major asset classes. Now, how about Europe …

The Goldman Report can be read here.

zerohedge.com/news/2014-01-11/did-goldman-just-kill-music-sp500-now-overvalued-almost-any-measure

https://www.zerohedge.com/sites/default/files/images/user5/imageroot/2014/01/GS%20chart%201.jpg
https://www.zerohedge.com/sites/default/files/images/user5/imageroot/2014/01/GS%20chart%202.jpg