Drag Me to Hell!
That’s the title of the first horror movie with a credit crunch theme. No kidding. We just read about it in the Financial Times.
The idea of the movie is simple enough. A young woman is a mortgage loan officer at an LA bank. She wants a promotion…but to get it she has to prove that she’s tough enough to say ‘no.’ So when a creepy customer comes in and asks for an extension of her mortgage, the woman rejects the proposal…perhaps a little too coldly.
Then begins the horror.
But just look around. There are plenty of frightening and unnatural scenes going on.
Broadly speaking, it’s a merciless war between inflation and deflation. But there are many different attacks, ambushes, counterattacks, feints, and massacres going on.
The Dow retreated 173 points yesterday. Typically, following a major fall in the stock market, there is a ‘reflex rally’ that lasts several months. Our rough guess was that it would carry on until summer. Most analysts thought it would exhaust itself sooner. Who knew? But yesterday, it looked as though the rally may be nearing an end.
The rally itself is a part of a larger battle between two contradictory body parts – the heart and the mind. The heart wants to believe that the worst is over. It reacts sentimentally, remembering the glory days of the great bubble era and wishing they were back. Higher consumer confidence readings sent the stock market higher on Tuesday – the heart ruled.
But on Wednesday, it was the head’s turn. The head looks at the facts: housing and employment are still going down. People will spend less money. Businesses will make less money. Ergo, no reason to expect stocks to go up. Instead, they’re more likely to go down. The Dow scurried back to the lines it occupied at the beginning of the week.
The head noticed, too, that the Treasury market is getting slammed by higher yields. The long bond yielded 4.56% yesterday – up from well below 3% at the end of last year.
“Treasury yields give cause for concern,” says this morning’s Financial Times.
“Rising Treasury yields threaten to stifle economic recovery,” continues another article in the same paper.
But has the top of the bond market really passed? Is the credit cycle now in full retreat? Will homeowners and businessmen be tortured with higher interest rates?
Those are the questions the head was asking yesterday. And it didn’t like the answers. If there were any green shoots, it reasoned, higher interest rates could crush them.
And then at least a few heads began thinking about what this meant to the big strategic issues…and how this flick will turn out.
At the end of last year, America’s great buddy, China, changed its policy. Instead of buying long-dated US debt, China began buying the short stuff. China’s top man openly wondered whether the US would be able to protect the value of the dollar and keep its promises to foreign lenders.
“We have a huge amount of money in the United States,” we quoted China’s premier just yesterday. He reminded the US that China had entrusted a lot of its wealth to US paper and went on to request that America respect its obligations to bond buyers. Obviously, the Chinese must wonder if the US is capable of protecting its currency while still funding its war against deflation.
Tim Geithner promptly responded. “Yes we can!” But the Chinese cogitated on the matter… “No they can’t,” they began to think. Then, they switched to buying short-term US debt, leaving the longer-term bonds to other buyers. Since the Chinese were the biggest buyers at US Treasury debt auctions, this switch in policy had a quick and noticeable effect. Bills rose. Bonds fell. The yield on bills fell to below zero, while the yield on the 30-year bond has gone steadily up.
If America’s supply lines to cheap credit have been cut, she is at a great strategic disadvantage. Or rather, her pre-existing strategic disadvantage is becoming more apparent: she depends on foreigners just to be able to continue living in the style to which she has become accustomed. As the president of the United States of America acknowledged this week:
“We’re out of money now.”
But how does this affect the war between inflation and deflation?
The US is on the side of inflation, of course. It put its whole economy on a war footing and has earmarked more resources (in real terms no less), to the fight than it spent on WWII.
In a larger sense, the US is at war with capitalism…and with nature herself. Markets have natural rhythms. They go from boom to bust…from inflation to deflation…from expansion to contraction naturally. Trying to stop the bust is futile. It is a fight against Fate…a losing proposition. And it is diabolically unnatural. You have to take the bad with the good in life. There’s no going to Heaven without dying. And you can’t rebuild a house without tearing down the old one. Mistakes must be corrected. Old, worn-out businesses have to go out of business so that new ones can take their places. Bad investments need to be deflated…liquidated. Failed managers and failed business models must be eliminated. Bubble delenda est.
The feds can’t beat nature. The bubble can’t be reflated. They can’t make the situation better than it would be if they left it alone. But they can make it a lot worse.
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