by David Calderwood
by David Calderwood
So here we are, bouncing off a ten percent decline in the Dow 30 Industrial Average, and the clear-eyed among us are scratching our heads.
Nothing has changed, the real estate market is a submarine with its dive claxon sounding, the dislocations of surging gold and oil have everyone jittery, and just when it seems the bottom is about to drop out, we see Wall Street ignite the booster rockets and head for the sky.
How can it be? Rear-end deep in alligators, the folks who are active in the stock market strap on their party hats and announce a bottom by issuing Buy Orders?
There can only be one explanation: It's a conspiracy!
The truth is probably more pedestrian. No market-driven phenomenon moves in one direction forever. Each trend has a lifespan, and when it is reached the trend reverses, usually when continuing the trend seems most sure. As Lew suggested in his recent column, even the trend toward credit creation must someday reverse, otherwise we would be forced to conclude that the alchemists running the Fed, Treasury, and Wall Street had actually invented their long-desired perpetual motion machine.
Our challenge has always been to assess whether it is This Time that the reversal is the Big One. People who spend a lot of time analyzing these things could easily have concluded that any of the market tops of the past 20 years was the zenith of credit creation silliness. Those who acted on those assumptions were mercilessly punished by reality, however. It's truly painful to arrange ones finances to weather a storm that never arrives, watching the least informed around you reap fantastic rewards as the surreal party of credit expansion gets even more raucous.
Been there, did that, bought the t-shirt (you wouldn't believe the price).
The stock market decline during 2000 and 2001 panicked the moneyed elite and they responded like so many of Pavlov's dogs. To a Fed with only one tool, the hammer of credit creation, every problem looks like a nail. To carry the analogy, it doesn't matter that the problem they faced was the result of using the hammer in the first place.
My unusual view is that the trend toward declining stock prices would have ended about where it did regardless of what the Fed did, but like most things in history that's an untestable hypothesis.
Either way, what I think was the final, manic creation of credit ran its course until lenders were pushing newly created credit at any body that was still warmer than room temperature. I'm surprised that the recent crop of zombie movies didn't include a scene where the walking dead qualified for a home loan…everyone else did. Credit was created until the gluttony almost ruptured the stomachs of lender and borrower alike.
Conditions that occurred the past five years were both unprecedented and extremely unlikely to repeat. The ability to repackage weak debt and get it rated AAA is gone, not to return until after those with burned fingers today are retired or dead.
With 13-week T-bill rates hovering around 3.25% this week and an effective Fed Funds rate at about 4.5%, it's a foregone conclusion that the Fed will continue its recent actions and lower its target interest rates. A chart of T-bill rates vs. Fed Funds rates shows that the Fed follows the market-driven rates of T-bills, not the other way around. A trend toward lower T-bill rates (and lower Fed rates) simply implies a desire for lower risk, hardly a boon for stocks. The pundits' obsession with the Fed Funds rate is simply another illustration of irrationality.
The world is awash in dollar credits. Either holders of dollar credits can sell them for other currency credits, a process that appears to have already occurred as the price for dollars on world markets collapsed all year long, buy commodities (hence the fantastic rallies in gold and oil in dollar terms) or they can bring all those dollar credits back here to the USA and use them to buy up all the things Americans have pawned in order to maintain their profligate spending. This latter is tantamount to a lender taking possession of depreciating assets of an insolvent borrower. At some point even a few cents on the dollar is better than nothing.
I think this is what we're seeing with the purchases of US corporate assets by foreign individuals and funds. It seems to me, however, that these Sovereign Wealth Funds that are awash in dollars are the last place to expect salvation.
These funds are government owned and managed. It's like giving some state bureaucracy a bunch of money and expecting them to wisely manage it. I think there's a good chance that these funds will be the last suckers to the party. If we have excess credit drowning the world, the solution is for that credit to drain away. Among many ways for this to occur, the use of that credit to purchase assets just in time for those assets to decline hard seems like a great way to retire the Fed's excesses. Another is default, and we're seeing that in spades among weak real estate borrowers.
None of us know for sure what exactly the future will bring. We can only make educated guesses, but the stars do seem poised to line up for an end to the long period of credit creation. Lots of nervous people are watching the recent stock market lows. If that floor is broken fear may finally overwhelm greed. Either way I doubt the market process, involving the greed and fear of billions of people, is susceptible to the petty manipulation of a few arrogant men.
In the meantime, don't bet what you can't afford to lose. Pull up a chair, pop some corn and get ready to watch the next phase in the Clowns' Parade that is human history.
December 1, 2007
Copyright © 2007 by David C. Calderwood