Archive for May, 2010
Recently I have become increasingly concerned about the stability of the markets,
because US Federal reserve ended their temporary liquidity measures (the “soup”
of emergency lending facilities that emerged during the financial crisis of 2008) in
late January, while the Quantitative Easing policy (lately mostly Fed purchases of
tainted MBS securities from banks using money created out of thin air, or “digitally
printed”) ended in late March 2010.
I believe the derivative Ponzi scheme grew so large, it is now entirely dependent
on newly printed money to feed it, otherwise it will collapse under it’s own huge
weight like all Ponzi schemes do. I think this is exactly what happened 2 weeks
ago, when the DOW plunged more than 1000 points intraday. News sources claimed
it was “fat finger” effect, or someone made a few orders of magnitude mistake while
placing a sell order.
Rather, I think computers that now dominate the trading volume, engaged in
indiscriminate selling and there were no bids under the market simply because
the new Fed liquidity, or printing, evaporated as of mid-April, when the last contracts
settled. Thus, the derivative bubble, which has already popped in 2008, ran completely
out of oxygen.
If this hypothesis is right and while the SEC and others try to figure out the reason
behind Thursday stock market meltdown, we may see more crashes shortly unless
Quantitative easing (money printing) resumes. Sovereign issues in Southern
Europe were blamed for the mess, and the market bounced on Monday following
the a huge European bailout. However, the bailout is a loan, not a printing effort.
Moreover, the loan money will not be injected overnight. Therefore, the danger of
more market mini-crashes or a big one due to derivatives and computers
malfunctioning from the lack of oxygen was not removed.
Stay tuned for May options expiration week, we may see a market meltdown!
See this earlier post for an explanation.
Deterioration of sovereign debt in Southern Europe has recently become
the key concern of financial markets.
Dr. Doom Nouriel Roubini predicted that this will become a concern in 2010.
He explains the problem in this Forbes article:
Nouriel Roubini and Arpitha Bykere
In 2009, downgrades and debt auction failures in countries like the UK, Greece, Ireland and Spain were a stark reminder that
unless advanced economies begin to put their fiscal houses in order, investors and rating agencies will likely turn from friends to
foes. The severe recession, combined with a financial crisis during 2008-09, worsened the fiscal positions of developed
countries due to stimulus spending, lower tax revenues and support to the financial sector. The impact was greater in countries
that had a history of structural fiscal problems, maintained loose fiscal policies and ignored fiscal reforms during the boom
years. Going forward, a weak economic recovery and an aging population is likely to increase the debt burden of many
advanced economies, including the U.S., Britain, Japan and several eurozone countries.
In 2008 and 2009, the decisions by these governments to do “whatever it takes” to backstop their financial systems and keep
their economies afloat soothed investor concerns. But if countries remain biased toward continuing with loose fiscal and
monetary policies to support growth, rather than focusing on fiscal consolidation, investors will become increasingly concerned
about fiscal sustainability and gradually move out of debt markets they have long considered “safe havens.”
Most central banks will withdraw liquidity starting in 2010, but government financing needs will remain high thereafter.
Monetization and increased debt issuances by governments in the developed world will raise inflation expectations. These
governments will have to offer higher real yields or investors will move to more attractive emerging markets. Some countries will
continue to witness increased credit default swaps. Higher yields and interest cost on debt will also hurt economic growth—by
crowding out private consumption and investment, and reducing government’s productive spending. Several factors will likely
influence investors’ perception about sovereign risk—a country’s debt financing ability, its status as a “safe haven” relative to
other developed economies, politicians’ commitment to undertake fiscal reforms, exchange rate movements, and the debt
The UK, Spain, Greece and Ireland will face sovereign risk pressures, especially if their fiscal imbalances are not addressed
immediately. Some eurozone members are quickly approaching their debt sustainability limits as deleveraging through
devaluation is not an option for these countries. Countries like Germany—whose fiscal imbalances have deteriorated largely due
to the economic and financial downturn—might have a greater capacity to stabilize their debt ratio. The U.S. and Japan might
be among the last to face investor aversion—the dollar is the global reserve currency and the U.S. has the deepest and most
liquid debt markets, while Japan is a net creditor and largely finances its debt domestically. But investors will turn increasingly
cautious even about these countries if the necessary fiscal reforms are delayed. The U.S. is a net debtor with an aging
population, weaker economic growth and risks of continued monetization of the fiscal deficit. Japan’s aging population and
economic stagnation will reduce domestic savings.
Developed economies will therefore need to begin fiscal consolidation as soon as 2011-12 by generating primary surpluses,
which can be accomplished through a combination of gradual tax hikes and spending cuts. However, an aging population, a
sluggish economic recovery and higher unemployment will keep governments’ entitlement spending high and revenues subdued.
These factors might also make tax hikes politically challenging. Fiscal consolidation efforts might not be strong until the bond
vigilantes signal shifting to safer assets. To achieve credibility, governments will need to pass binding legislation enforcing
tighter fiscal belts when their economies begin to recover on a sustained basis.
Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics
(RGE), is a weekly columnist for Forbes. (Read all of his columns here.) Arpitha Bykere is a Senior Research Analyst at RGE.
Sovereign defaults present serious risk for the stock market. Overall, stocks in
affected countries decline considerably, and the desease infects the rest of the
Globe. Here is a recent example, the currency crash in Iceland. While US is
much bigger, the problems in the US, the UK, and Southern Europe are all similar.
2008 proved that TBTF (too big to fail) do fail!
Be careful and prepared