After a few weeks of rising prices, the bulls are getting excited. Some are even calling the bottom…again. Are they right? Are we in a new bull market? We have no idea of course. The honest answer is that it’s just too hard to tell. Sure, the market might continue to rally for a few months yet. Then it might bump its head hard on the ceiling and crash to the floor. From there, it could take a while to pick itself up again. Or not.
Big, brash, bottom calling comments remind us of an old Charles Bukowski quote:
‘The problem with the world is that the intelligent people are full of doubts, while the stupid ones are full of confidence.’
Just because we’re doubtful about the direction of the market doesn’t mean we put ourselves in the intelligent camp. After all, we’ve been confidently bearish on our China call for some time now. On the Bukowski spectrum, that puts us in the stupid camp with all the other idiots trying to predict the financial future.
And when you think about it, that’s all we’re doing here. The financial industry employs hundreds of thousands of people around the world to divine the financial future. That it’s impossible to do so is irrelevant. The truth is no one knows what’s going to happen in the future. But people don’t want the truth. As Bertrand Russell said, ‘Man wants certainty, not truth.’
So if you’re after certainty, you can stop reading now. But if you want to hear our ideas about how the market works and why another bull market is unlikely, read on…
Put simply, the whole financial system is based on debt, or credit. Banks create credit by making loans. This puts ‘purchasing power’ into the hands of the borrower. It creates demand for goods and services. As credit expands, economic growth increases. Expanding debt and economic growth (and rising asset prices) go hand in hand.
Every now and then a recession comes along. There are myriad reasons given for what causes recessions, but ultimately it’s about a slowdown in lending or an outright contraction in the amount of credit created. In other words, debt growth slows or contracts. That’s why the standard response to a recession or economic slowdown is a lowering of interest rates. If you cut the cost of acquiring debt and encourage its accumulation, the economy will start growing again.
This has been the post 1971 cycle. It’s happened all around the world. The advanced industrial economies have gone through the ‘wash, rinse, repeat’ process so many times that they are all dealing with near zero per cent interest rates. With the official cash rate of 3.5%, Australia is getting there too.
It used to be that high debt levels would scare investors off. At an international level, high and unsustainable debt levels meant a weak currency and high market interest rates.
Now, in the industrialised world at least, debt levels and interest rates act like a see-saw. The higher the debt, the lower the interest rate. In other words, the more financially fragile a country becomes, the more faith investors have in it repaying its debt.
The absolute absurdity of this statement demands an explanation. Why would a semi-sane person hand their savings over to a profligate spender whose economy is irrevocably geared towards consumption over production? In other words, why take the risk if the reward is so slender?
It comes back to what central banks do when their economies are under threat. When they can no longer lower interest rates to get credit flowing again, they simply begin monetising debt, which means buying the bonds of their sovereign governments. Big investors – those managing billions – front run the central banks and buy those bonds. They know there will always be a bid for them.
What seems like insanity to the individual is very easy money for the big player moving billions around the system. The real danger will come when the big players realise that game is over and head for the exits.
Constant central bank intervention distorts all the signals and incentives given off by a ‘freer’ market for money. As obvious as this is to us, the world still looks to this group for salvation when the economy goes pear shaped. It is a truly bizarre spectacle.
But our central banking friends are not the strangest part of the machine. Central banks are not really the problem. They exist because ‘the system’ allows them to play a major role in how capital flows around the world.
The problem is the system itself. The world’s financial system has evolved into an unbalanced mess. The credit crisis of 2008 gave us a chance to correct those imbalances but we choose to ignore it. In the one corner are the excess producers of the world (savers) and in the other you have the excess consumers of the world (the spenders).
There is no self-regulating mechanism to ensure the imbalances between these two groups don’t get out of hand. The US, controller of the world’s reserve currency, pumps out debt (and promptly spends the proceeds) while the savers buy that debt and proudly claim it to be a ‘reserve asset’.
The world’s savers are producing real goods and services for the world’s spenders, getting a paper promise in return. It’s an uneasy imbalance. Nature doesn’t deal with imbalances too well. In time, she finds a way to correct them. And in time she will find a way to correct this monstrous, 40 year imbalance too.
In the meantime, we might get another bull market. But it won’t be anything like the secular bull markets that occurred when the system was in its infancy. Because the system is now an old man, given to grouchiness, pain and reminiscence. Sure, it might still have some good times and cause for optimism, but in its twilight years reality has set in.
There is plenty about this market that we don’t know. But we do know that debt levels have grown so high that denial and distortion have pushed interest rates down all around the world. These low rates deny savers a market based reward for the risk they take on of keeping their capital ‘in the system’.
For 10 years now some investors have seen the writing on the wall. Bit by bit, they have taken their wealth out of the system and stored it in gold. This trickle of awareness has pushed the price of gold up from around US$250 to US$1,600 an ounce.
That may seem like a big move. To some, it is. The mainstream media has spent the past 12 months proclaiming that gold is in a bubble. Our guess is it’s not. As we said, only a yearly trickle of capital has managed to move gold to $1,600. When the trickle becomes a flood, that move will look very small indeed.
The real bull market has been with us all along.
for Markets and Money
From the Archives…
As Draghi Drags the European Crisis On
03-08-2012 – Nick Hubble
China’s Economy – How the Devil is in the Detail
02-08-2012 – Greg Canavan
The Greatest Interest Rate Fix featuring… Mario Draghi and Friends
01-08-2012 – Bill Bonner
What the Credit Boom Left Behind
31-07-2012 – Greg Canavan
The Australian Economy: A Case Study in Weirdness
30-07-2012 – Greg Canavan