“Credit crisis…foreclosures…market crash…recession…falling dollar…bankruptcy…inflation: Why the Smart Money is Buying,” says this week’s Forbes cover. Forbes thinks it is being bravely contrarian. “Buy when blood is running in the streets,” it quotes a Rothschild. After the traffic accidents of the last 9 months, it thinks it sees an opportunity – similar to the one in 2002. Of course, everyone wants to go against the crowd, provided everyone else is doing it too.
Today, the markets are as crowded with people who believe that central bankers will save the day. Blood may be running in the streets, they say. But the ambulances are on the way. The whole mess will be cleaned up quickly. And with dividend yields near 2% and earnings ratios near 20, a ‘contrarian’ might feel a little hemmed in, like a passenger on a cheap airline.
What follows is a truly contrarian look at our modern ambulance squads…and a modest prediction: there will be more blood on the streets when they get finished.
This week, the sirens squealed in London. The Bank of England announced a new bailout plan, known as the “Special Liquidity Scheme.” The figure of 50 billion pounds was thrown about in the press, but Mervyn King said it was only an estimate. Amid the confusion and complexity of the financial crisis, the BoE’s bailout scheme is as simple and naked as Eve…and as full of mischief. Troubled banks can go to the nation’s central bank and trade their dodgy credits for good ones – government bonds. The plan is very similar to the U.S. Fed’s bailout gesture, known as the Term Auction Facility. The U.S. central bank, also in rapid response mode, exchanges U.S. Treasury bonds, thought to be the world’s safest credits, for a hodge-podge of “alternative assets,” that is, alternative to good ones. Of course, the U.S. Fed didn’t begin or end there. It also cut its rates 300 basis points.
Even the European Central Bank, with its sniffy continental sangfroid is on the scene. While it maintains its key rate at pre-emergency levels to combat inflation, its assets have been growing at a breathtaking rate – nearly 20% per year. The BCE, it turns out, is eagerly providing billions of euros to slippery borrowers, based on collateral which it admits is “less liquid” than before. It has added $115 billion of this sausage stuffing to its balance sheet in the last 12 months.
The initial question a contrarian might ask is: what, exactly, is the emergency that caused these emergency responses? What accident is so bloody and so menacing, that it has the world’s three most powerful central banks racing across town, scattering crowds and ignoring traffic signals?
On the surface, there is none. What does it matter to us if a few over-stretched banks and bankers lose money? Last time we looked, there was still full employment in Britain and America. And in Europe, where full employment is less of an issue, those who put their shoulder to the wheel last year still do so. World GDP is still going up – though not quite as fast as before. Inflation is still almost under control. As near as we can tell, God is still in his heaven. The queen is still on her throne. In the United States, stock prices are moving up…and house prices are down only about 15% from their all-time high. And U.K. property prices had barely begun to decline at all. The emergency, as near as we can tell, is only that some people are getting what they’ve got coming; central banks – essentially, a bankers’ guild – are trying to prevent it.
Rescue missions used to be rare. Between the day BoE governor Lancelot Holland administered a 4 million pound transfusion to Overend, Gurney & Co. in 1866, and the day the medics appeared at Northern Rock, 141 years elapsed. But rescues are becoming much more common, largely – we contend – because central bankers are causing more accidents. Central bankers have allowed what business analysts call “mission creep.” They used to be concerned only with protecting the value of the currency itself. As for the rest, it was up to businessmen, investors and bankers to look after themselves. But now, there’s a central banker directing traffic on every street corner. Full employment, re-election, trade balances – soon, they will be helping kittens down from the trees…while the currency goes to hell.
The last big pile up came in 2001-2002. That was such an emergency that Alan Greenspan felt the need to cut the signal lending rate in the United States down to 1% – far below the level of consumer price inflation as well as the real cost of money. This ’emergency rate’ was left in place for far too long; it is what led to an explosion of borrowing and spending…the bubble in residential real estate…the subsequent blow-up in subprime…and today’s on-going emergency.
“Contrarian” investors, then as now, might have figured that the bottom was in by the autumn of 2002. They would have been right – to an extent. But the smartest move in 2002 was to buy neither stocks nor property. The smart money bet against central banking itself. The smart money bet that the Fed’s easy money policies would do more harm than good…and that the central bankers’ own paper currency would pay the price. The smart money bet on gold, which has more than doubled subsequently. Our guess is that gold will be the ultimate winner this time too.
for Markets and Money