The important news:
Yesterday, both the Bank of England and the European Central Bank announced moves to boost the economy. They’re both falling in line behind Mr. Bernanke, who is “pulling out all the stops” in order to avoid a deep depression. Both the BoE and the ECB are going to take up forms of QE – quantitative easing – in which the banks buy government debt directly.
Don’t try QE at home, dear reader; you’ll be arrested for counterfeiting. QE so closely resembles old-fashioned printing press money that you couldn’t tell them apart in a police line up. Both are ways to increase the supply of money…which, according to theory, leads to consumer price inflation.
The Dow fell 102 points yesterday too. The bear market rally has gone on for nearly 9 weeks. It’s probably ready for a rest…and maybe a pullback. We doubt it’s over though. There is still far too much money and far too many suckers who have not been pulled back into the stock market. The next leg down of this bear market will have to wait – most likely.
Another ominous thing that happened yesterday was that bond yields increased. The yield on the 10-year Treasury note – at 3.3% – is more than a full percent above its low. The yield on the 30-year bond is at 4.26%.
These yields are still very low. But they seem to be moving higher. They are ominous because at some point in the future we expect all Hell to break loose in the bond market. The slippage we’re seeing now in bond prices (when prices go down, yields go up) may or may not be an early warning.
But we probably have a few new readers of Markets and Money…let us backtrack in order to bring them into the picture.
We begin by going back half a century. America emerged the world’s biggest, strongest, most innovative and dynamic economy after WWII. Then, it went from strength to strength…to weakness. Gradually, Americans turned their attention away from production and towards consumption. And gradually, America’s most profitable businesses shifted from making things to financing them. That’s why GM created GMAC…and why GE staked its future on GE Finance. And it’s why the center of American economic power moved from the manufacturing hinterlands of Detroit and Cleveland…to the financial centers on the coast…notably the big one in Lower Manhattan.
The financial sector boomed by supplying credit. Americans borrowed. And so, their debt increased. From being the world’s leading creditors in the ’50s and ’60s…they became the world’s leading debtors in the ’80s and ’90s. Gradually, the consumer economy required more and more debt to produce an extra unit of output. Debtors had to borrow not only to buy…but also to pay back, or pay the interest on, previous borrowings.
In the Eisenhower years, it took only an extra $1.50 or so of debt to spur an extra dollar’s worth of GDP. By the end of the century, the cost had risen to over $4…and then to $6 a few years later. Total debt, which had been about 150% of GDP before Ronald Reagan took office, shot up to 370% in the final years of G.W. Bush.
By the late ’90s and early 21st century, the American economy had entered the Bubble Epoque. The financial industry – aided and abetted by the Fed – was providing so much ‘liquidity’ it was causing asset prices to bubble up everywhere. Of course, bubbles always blow up – without exception. And when the dot.com bubble exploded in 2000, at first, we thought that was the end of the Bubble Era. Little did we realize, the biggest bubbles were still to come. Then came the bubbles in housing, art, emerging markets, oil, and commodities. All blew up. But the biggest bubble of all – the bubble in credit – blew up too, bringing the Bubble Epoque to a close. Capitalism giveth. Capitalism taketh away. The process of what Schumpeter called “creative destruction” continues.
We are now in the post-bubble era. The financial industry has been bombed out. It can no longer create bubbles. Governments all over the world are propping up the walls…and shoring up the foundations. But the Bubble Epoque can’t be revived.
Is that the end of the story? Not at all. The feds’ efforts to stop the progress of capitalism will have some spectacular consequences. The fireworks will start when the bond market cracks…sending yields through the roof. And that’s all we have to say about it today…stay tuned.
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