FSU Editorial: "Central Banks are the Primary Bubble-Creators" by Stephen Tetreault 04/17/2007

CENTRAL BANKS ARE THE PRIMARY BUBBLE-CREATORS AND EQUITY MARKET MANIPULATORS!!
by Stephen Tetreault
April 17, 2007

Manipulation of the global markets is directly tied to central banks around the globe and their wild levels of liquidity creation, as the overall global money supply is on a mega-hyper growth trend and there seems little anyone can/will do about it, until it’s to fricking late and the global economies crack! Remember the basic definition of inflation folks:

The modern definition of inflation is: A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money... The American Heritage® Dictionary of the English Language, 4th Edition, goes on to say: ...caused by an increase in available currency and credit beyond the proportion of available goods and services. I have often told my students that inflation is the consistent rise in the money supply followed by a rise in the cost of goods, commodities and services; as more dollars are chasing fewer goods�. However, it’s is also somewhat accurate to say that inflation is the weakening of the purchasing power of the dollar. As your dollars are worth less as more and more money hits the economy, you're hit with this hidden tax because your purchasing power is being eroded, and most folks do not even understand this principle.

We have seen lately folks that there appears to be a huge disconnect with the Asian markets these past weeks following the belt tightening measures by their central banks, though it will be very difficult for just a couple of central banks of a developing country to continue tightening while others stay on course with their easy and almost free easy money regime.

Currently according to my technical and fundamental analysis the Chinese Shanghai Composite and other emerging market indexes (Hang Seng, Taiwan Weighted, Bovespa, and M�xico to name a few) are displaying significant bubble like formations but it is difficult to guess when this bubble will be get pricked, and hopefully they deflate gradually, or we could see a global melt-down of the markets.

This wild global bull-run the world over is primarily driven by an enormous glut of excess LIQUIDITY. One is reminded that around mid-March this year the Australian money supply is 13% higher from a year ago, Brazil's M3 is up 18%, Canada's M3 is up 10.5%, China's M2 is up 17.8%, England's M3 is up 13%, the Euro Zone's M3 is up 9.8%, India's M3 is up nearly 22%, Korea's M3 is up 11%, Russia's M2 is up 49% and the US M3 as best as it can be calculated is up 11%. In the midst of such an enormous run-up in "global liquidity� this new-glut is responsible for most of the global bullish trying to keep markets down, for any extended period of time, is like pushing down a helium balloon under water. With most if not all of the major central banks having been "asset targeting" with their manipulated maneuvers until the fierce inflation monster rears its ugly head in a manor that will frighten the proverbial crap out of the global markets. Their ongoing manipulation could/might continue for some time, more until they press to hard on the accelerator and are unable to stay on course and they run off the cliff.

The global markets have been kept afloat by these huge inflows of liquidity folks and such is the overall power of easy and ever increasing monies chasing fewer goods, it’s this liquidity that has been propping up the asset markets. It would be a misnomer or being down right delusional to believe that asset markets all over the world are on a bull-run going longer than it should of, despite deteriorating fundamentals; earnings and consumer ballooning debt-loads and crumbling credit opportunities. Some investors are reluctant to consider the macro factors of the investing landscape and they consider only company specific fundamentals, momentum-players and general-market-hypsters. For the most part most of these factors do not really matter (as I have come to realize, many times) that in the near-term the macro factors don't significantly matter, price will follow money flows folks. However, when you see as I have that the equity markets all over the globe has risen and most of the major indexes and new host of ETF's have been behaving in the same manner having begun their run from early 2003 (when the liquidity streams turned into tsunami�s) then the overall market movements have as I have been pointing out for several years now not based only on economic or company specific fundamentals; there has to be the underlying insurgency of these huge streams of liquidity�.This is goldilocks scenario in progress when it will end only the central banks would know, but I can tell you this folks; if I'm only partly right this manipulation will create a mega negative economic tidal wave that will engulf most economies.

There is going to be a real-and increasing volatile component to the US and global markets that is just starting to raise its ugly head and be seen�.despite the recent bullishness there is in my opinion a looming and growing concern and wall-of worry that has been plaguing veteran and very seasoned traders/investors like myself�yes its been almost 6+ weeks since the Shanghai stock market plunge sent shock waves vibrating throughout the global markets, like the waves of a first shock earthquake that triggered the first Tsunami in a pattern of larger ones. Although most of the indexes have since stabilized and as of Friday�s close have regained most of their losses albeit on significantly less volume than the selling waves we witnessed. It's this type of volatility that I have been writing about, which could/should increase is frequency and probably in the days and weeks that lay ahead. Stock markets now are very prone to synchronized global down-turns or should I saw plunges when new and most often under-reported and ignored external shocks appear. But it is my opinion that the greatest factor behind the markets' recent problems on a global basis is the huge excess liquidity being pumped in by the central banks around the globe.

Even in a global chain reaction, different issues particular to each country work to drop share prices, and the size of the decline varies. This liquidity is normally controlled by the large hot-money players like (BS, LEH, GS, MER to name a few) and the huge amounts of excess liquidity being pumped in to the money-flow-system and which cannot be absorbed by real economic activities especially in a retraction period, which we are currently embroiled in, tends to move very rapidly across national borders in search of better and most often riskier returns, (the players first start in the easier to manipulate less-liquid markets such as the emerging markets, commodities such as unleaded gasoline, crude, corn etc.) thereby injecting volatility into share prices and currency exchange rates as a primary basis for their rampant and euphoric search for gains at any expense. In countries with higher interest rates, excess liquidity causes exchange rates, share prices and the prices of such commodities as oil to rise faster than they would normally based on pure economic fundamentals. And then when a negative contagion emerges, this hot money quickly evaporates and triggers sharp falls in the equity, financial and commodities markets.

There are three major factors behind this excess liquidity. One of the major contagions is the current account deficit of our spending-frenzy country, which is bloated to the tune of more than $ 840 billion a year, meaning that we must attract $2.3 billion excessive inflows just to offset the current account deficit. This is a vicious circle as our deficit is recycled into the country as deposits and investments by foreign investors because the U.S. dollar is used as a currency for international settlements of most commodities. Hence to put it in basic terms China and the vast number of other export-surplus countries like Japan along with crude exporting/producing countries are meanwhile reporting growing current account surpluses, and it is forecasted that the movement of this excess money may increasingly shift toward the euro this would be a huge negative for our greenback. If the contagions that I have repeatedly mentioned in my writings about our economy prompt the fed-heads to start lowering interest rates, sharp declines in the dollar and equity/stock prices would likely follow.

How was the market stimulated? It surely was the immediate-drop in the fed-funds rate�.back in 1999 (fed-funds rate) came in between the range of 5.00-5.50%, and it steadily climber to 6.50% till May of 2000 right after the markets topped�.it wasn�t until January 2001 when the Fed-cut-rates for the first time 50-basis-points as a result of a crumbling stock market; and in January they dropped rates a full 1%�.Remember folks the markets peaked in March 2000, and by January 2001 they were dropping hard�and they didn't start to rebound till after 911(2003) by then the fed-funds rate was 1.00%....so why now would a path of rate cuts be so darn great for the markets?....Just go back and look at the market's direction, and it didn't trough till way after the rates hit rock bottom�not-with standing 9/11 and the bush wars.

The next factor is the liquidity in countries that, unlike the U.S., are reporting sharply increasing current account surpluses. The accumulation of foreign currency reserves in China and oil-producing nations boosts their domestic liquidity, and they in turn are looking for places to put these monies. Furthermore, China's massive dollar-buying intervention and/or manipulation (depending on your vantage point) in order to avoid the sharp appreciation of the yuan has sharply increased their yuan liquidity. Although the Chinese central bank has raised interest rates and the cash reserve ratio, this liquidity has created a ballooning bubble in Chinese stocks and real estate prices that could also start to crumble. The extreme lack of clear transparent nature of the ballooning bad-loans plaguing state-owned enterprises and state-run banks is another major source of uncertainty in the Chinese system and this is one reason I will not fully invest in new issues or firms without distinct clarity in their financial statements.

Another contagion is the extremely-low interest rates and abundant easy-money supply in Japan, which has been pursued as a measure against that nation's own bad-loan problems that have taken many years to work off. The Bank of Japan has raised its key policy rate twice, but the interest rate gap with other major economies remains very wide, and the yen-carry trades, in which investors borrow yen on the cheap and invest it in financial instruments with higher yields, has multiplied the excessiveness in the global liquidity streams/pools. The recent sharp increase in short-term borrowing by foreign-owned banks in Japan has helped to finance this practice. The problems of global imbalances and the low interest rate of the yen have already been discussed by the Group of Eight at a summit in Russia last year, but the situation remains unchanged on both issues, and liquidity continues to increase worldwide�as the greed-factor takes on a life of its own!

As usual excess money moves from one speculative market/instrument to another ranging from such commodities as gold, crude oil and corn to financial products like bonds, stocks and real estate investment trusts and we continue to see that the volatility in each segment/sector/market swells. Those markets, meanwhile, remain exposed at any time to geopolitical risks, given that the situation in Iraq and the nuclear problems with Iran and North Korea remain unsolved. Japanese savings are increasingly being managed abroad because the interest rate in Japan is still extremely low. People should realize that managing their assets overseas carries not only exchange-rate risks but market, credit and geopolitical risks that are of a different nature than in Japan.

At the same time we have seen that global growth has had a good run. Following the downturn of 2001, the world economy has averaged growth of more than 4.2% per year, and central banks have through their huge liquidity injections and relatively cheap monies have worked feverously to countered the bursting of the "technology bubble" with was of course fueled from the easy-money policies and fear of Y2K; and subsequently the fallout from the 9/11 terrorist attack. How did they do this; once again by hyper-inflating the money supply while dropping rates to historically low levels; basically another period unlike any before it where liquidity was infused into various financial systems not only in the USA but on a concerted synchronized global-wide process; with a recognizable policy of cheap and easy money. To avert an abrupt deflationary scenario, the cash rate in our country was quickly reduced by Sir Alan-Greenspam to 1%, while the Europeans dropped their rates to 2% and the Bank of Japan lent vast hordes of money at rates just a tad above 0%. It is not surprising that these vast amounts of liquidity easily resulted in new-bubbles being created to an even greater extent than the dot-com bubbles. And the overall boost to the pools of global liquidity generated a worldwide property boom (asset-appreciation) that turned into an enormous housing bubble; which was a key factor in the underlying support of consumer confidence and their ravenous spending habits. The other significant driving force behind this huge run-up in global growth during the past 5-6 years has been the acceleration of India and especially China's economic development cycle; which was underpinned by expansionary government policies and a significantly undervalued currency exchange rate, the Chinese economy has seen and recorded annual growth of around 10-13% since 2001 (an unsustainable rate for much longer). This historically prolonged global growth has resulted in mounting pressures on resources and labor markets around the globe, leading to higher prices for crude oil and other commodities, as well as increasing labor costs have been feeding the big-bad core inflation monster and as a result central banks around the glove have been forced to responded by gradually withdrawing the interest rate stimulus (raising rates). Currently the overnight rate in the US stands at 5.25%, the European Central Bank has moved to rates back up to 3.75% (as they again they stood pat on Friday).

One of the largest contagions I see looming on the horizon (and has been ignored for the most part by the talking-butt-heads on the various bubblevision financial media channels) is US consumer spending which has significantly advanced way beyond its sustainable level during the technology boom of the 1990s; and the excesses were just starting to work out of the system after that bubble started to deflate, than the Fed-heads lead by mega bubble creator Greenspam enabled many households to delay the necessary adjustments to their bottom lines. Now with the housing sector crumbling resulting in falling house prices along with sub-prime borrowers are defaulting at record numbers on their loans. And even though crude prices are off their highs, unleaded gasoline has been rocketing and as a result their current levels remain a drag on the overall purchasing power of consumers, and we have been seeing negative tonality creep in. As a result we have already seen signs of moderating consumption growth and increased uncertainty has led to a significant reduction overall business investment; and historically what follows is a distinct slowdown in overall hiring activity; which would be a major negative for our economy. And this time folks with this relatively high rate of core inflation, the Fed-heads will not be able to act like mighty-dog and come to the rescue by switching on the massive liquidity faucet. And the effects of a weakening US economy will have a significant effect on Japan's, India�s and especially China's exports; and this overall multiplying effect will have far reaching ramifications around the globe. As I seriously doubt that Europe or Japan will be simulative enough to replace the loss associated with our consumption appetite.

Contact Information
Stephen Tetreault
T-Waves
Southern Maine, USA
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