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Flooding the Market Only Drowns It

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And conditions it to drink longer from government spigots.

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Photosynthesis is the process plants and algae use to make their food. Plants need 3 things to make photosynthesis work; water, sunlight, and carbon dioxide. In this analogy, the markets are the plant.

The Fed, Treasury, and other like-minded central banks have been providing the water of life by injecting copious amounts of monetary stimulus into their respective systems -- especially the US and China (FXI).

These injections have provided short-term psychological sunlight by relieving fear of a total systemic collapse of the financial system. This has allowed the sun to peek through some seriously large cumulonimbus clouds and has given way to an aggressive move higher in equity prices.

Carbon dioxide is the by-product of many things -- mostly resulting from mankind. In its solid state, it's also known to us as dry ice; but for this analogy, let's call it debt. Carbon dioxide is extremely toxic in amounts exceeding 10% of air volume. Interestingly enough, about 12% of all homes in the US are either in default or foreclosure. The Fed, Treasury, and several other central banks have been consuming large amounts of carbon-dioxide debt by buying, swapping, or guaranteeing it. However, much like the earth's atmosphere, there's still too much of it in the system.

Now, if you were a farmer (read: investor) and you were being told how much water you may or may not be allowed to use on your crops depending on weather conditions (read: how much risk you have to take for a projected but unguaranteed investment return), how confident would you feel about planting crops that require large amounts of water with an unknown crop yield?

World governments are trying to irrigate using the flooding technique as opposed to a center pivot irrigation technique. Like it or not, by doing so, they've conditioned the markets to drink from their spigot for much longer than they realize.

If the G8 -- and more importantly the US -- start to turn off the spigot, whatever fragile photosynthesis we currently have will be severely constrained, and it would reaccelerate what we all know is a serious debt-driven liquidity problem.

Yesterday's violent global-market reaction to the G8 talking about planning exit strategies is saying this loud and clear.

Side note: Center pivot irrigation provides proportionately calculated and efficient amounts of water to crops in the field.

The credit markets aren't close to being in a position to survive on their own. It's like planting an oak tree in the Sahara, pouring a thousand gallons of water on it, and expecting it to survive thereafter. In order to avoid another liquidity drought, the markets need -- and will continue to need for quite some time -- world governments to keep providing water to the roots in order to muster whatever green shoots they can, or risk a visit from the lawnmower.

Have the liquidity injections caused credit market spreads to tighten? Yes, almost every day since the end of March (see below). But it's at the cost of a lower dollar and yields ramping higher -- which is resulting in substantially higher interest rates to businesses and homeowners who are trying to roll or refinance their carbon-dioxide debt.

For now, the credit markets are merely an aqueduct to the central-bank aquifer, and the market knows it.



No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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