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Minyan Mailbag: Rosy Times


Just remember, if you are going to participate; you need to understand the game you are playing.


Professor Succo,

I am getting bombarded with MV caution. Please give me the other side; the Realm Of Possibity Examples (R.O.P.E.) that this just keeps going. There are many loud, well known market pundits that maintain "do not miss this move." There is money everywhere, why not? How does "the goal to orchestrate a gradual transition that allows for stable and sustainable coexistence" come to be? That is merely the China catalyst. Give me ROPE. I promise, there are no trees with sturdy branches nearby. Just asking for the other point of view.

-Minyan Skins

Minyan Skins,

A Financial Times article points out:

"The buoyant credit market creates an "incredibly attractive" logic for buying shares. In the US, he says, the high yield that risky companies pay to raise money using "junk" bonds is more than 2 percentage points lower than the equivalent yield produced by companies' cash flows. So a private equity buyer can take over a company and comfortably cover the cost of borrowing without doing anything to improve the company's profitability. This is pure financial arbitrage."

In the normal universe, this situation is an anomaly. The market willingness to lend money to companies 200 basis points lower than companies' returns on equity is strange indeed. It truly reflects the market's certainty that cash flows will grow rapidly. As you said, there is so much money searching for return that one must accept higher and higher risk trying to find it.

In the U.S., M3 has grown to about 15%. That percentage is the money (means) part. But as previously explained, this money is really increased debt. This debt, created in droves by central banks, is driving nominal asset prices higher.

As an experiment, consider if the US doubled the amount of credit outstanding overnight. If it fit evenly, there would be no actual economic impact (no increased wealth). However, the price of everything would double (nominal assets prices would double) as would GDP. Importantly, that credit creation process goes into the economy and markets unevenly and unfairly, therefore some people actually DO get rich at the expense of the others not exposed to asset prices (the poor and middle class). Some industries would show "boom" while others lag, and so on. Investment capital flows ever more aggressively in pursuit of these out-performers. Eventually 'booming' all sorts of industries into one large, virtually coordinated, credit driven boom.

Money being 'everywhere' and liquidity being 'ample' are functions of both means (credit as supplied by central banks creating it out of thin air) and motive (the psychology of investors to take risk). Due to over-capacity and high debt levels, more and more of this credit is going towards speculative ends and debt service instead of towards real production. This is why one says risk is increasing; the production of income is falling relative to debt levels.

The rosy scenario is simply that means and motive will both continue at their present rate. In such a case, we get what we have, only more of it. Nominal asset prices will increase while 'real' asset prices (wealth) in the aggregate will go virtually nowhere. Shorting stocks into this is dangerous, though things are getting much riskier.

That is as best we can hope for towards the rosy side of things. The pressure to participate by increasing risk is high indeed, it is one of the reasons that things continue. Just remember, if you are going to participate; you need to understand the game you are playing.

-Mr. Practical

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