I read one last night that builds their case from the ground up. It was 56 pages long, and for good reason. It began by showing some good stuff, how there is leverage in the system indicated by the increase in central bank reserves around the world (it missed one of the largest places where leverage resides: in the balance sheets of commercial banks/dealers/hedge funds from the incredible growth of derivatives, especially in the CDS market). This leverage, it correctly stated, was due to artificially low interest rates (which I have talked about ad nauseum) created by the Federal Reserve. The authors met with a Fed official and asked the following question and got the following response:
"Everyone knows that the level of short rates in the U.S. should be somewhere between 3.5% to 4.5%; so why are you taking so much time in getting them there?" His answer was: "we have no examples in the History of central banking of a central bank giving money away for a long time at very low cost without someone doing something really stupid with it. So we know that the seeds of the next LTCM have most likely been planted; we need to squeeze out the excesses without giving the financial markets a systemic shock".
So this excess liquidity has already set the stage for a big mistake to come by someone, so why not just keep going? Well, one answer is that we may be creating more and bigger mistakes to come by not stopping. But still the report seemed to be on track, setting the stage for what I thought would be a rational conclusion.
After continuing with showing how this excess liquidity has resulted in huge account imbalances between the U.S., which is running a huge (by any measure) trade deficit and borrowing the savings of other countries to do it, the paper made a remarkable conclusion: the trade deficit is a good thing, and the larger it gets the better. And the final recommendation is to buy stocks.
So there is most likely a systematic problem out there, one that the Fed may not be able to control as rates are still lower than inflation, there are unprecedented imbalances in the world, and the recommendation is to move cash into riskier assets? This is like sending a three-year old across a busy street because she probably won't get hit.
I won't bore you with the all the faulty logic that it took the authors to come to this conclusion. Some bad information about job growth and disposable income helped. One particularly bad assumption that lower worldwide prices caused by over-capacity would set off a consumer boom (versus my take where lower prices are a function of over-capacity, which we are creating more of through high liquidity and artificially low interest rates, in an attempt to drive up prices) stands out in my mind, but many of these assumptions were "buried" in complex analysis and circular arguments. I had to make myself read each point, something that was very difficult to do. It was a labor of hate.
Their conclusion is the same as the rationale put out by our own Federal Reserve, and in particular Mr. Bernanke, who said the rest of the world is lucky we are there to use their savings. A more accurate statement was made many years ago by Nixon's Treasury Secretary John Connolly who said, "The U.S. dollar is our currency and your problem."
My conclusion is the opposite, and the same as Morgan Stanley's Stephen Roach: these historically high trade and financing imbalances between the U.S. and the rest of the world are a de-stabilizing force, not a stabilizing one; that more of a bad thing does not make it good. That an economy whose consumption is driven not by income generation, but by borrowing against ever higher asset prices will eventually fail, especially when we are borrowing from nations that ultimately have different objectives.
When I read the report I was reminded of the media scandal where the administration was found to have distributed "canned" reports that furthered their agenda, but that looked like normal news reports. I suppose an ultra-Keynesian could reach the same conclusions as that of the report and Mr. Bernanke. Or maybe they are one in the same.
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