Financial Bubbles | - Part 3

The IMF’s latest report on slowing growth in the global economy makes it easy for a skeptical reader to connect a few dots regarding the latest round of central bank sponsored malinvestment in general (a word that clearly doesn’t exist in the modern economists’ lexicon) and the shale oil boom/bust cycle in particular.

From this Reuters story we get the following summary about what’s ailing the world::

“New factors supporting growth, lower oil prices, but also depreciation of euro and yen, are more than offset by persistent negative forces, including the lingering legacies of the crisis and lower potential growth in many countries,” Olivier Blanchard, the IMF’s chief economist, said in a statement.

The IMF advised advanced economies to maintain accommodative monetary policies to avoid increasing real interest rates as cheaper oil heightens the risk of deflation.

If policy rates could not be reduced further, the IMF recommended pursuing an accommodative policy “through other means”.

Left unsaid was that cheap money gushing from the Federal Reserve in Washington and big banks on Wall Street was a major factor driving the shale oil boom that played a key role in recently plunging energy prices that, now, are raising the specter of world wide deflation that – you guessed it – should be countered by even more cheap money.

Vicious cycle anyone?

It seems former Bank of England governor Mervyn King is on to something in this report at the Telegraph when he notes the following:

We have had the biggest monetary stimulus that the world has ever seen … The idea that monetary stimulus after six years is the answer doesn’t seem (right) to me.

Why is it that central bankers suddenly seem to make much more sense when they are no longer central bankers? King joins suddenly lucid former Fed Chief Alan Greenspan who has recently been famously fond of a barbarous relic and makes you wonder where the heck central bankers still employed by central banks are steering the ship.

Jim Grant of Grant’s Interest Rate Observer opines on the “noisy and sudden” impact of artificial interest rates and exchange rates engineered by the world’s central bankers, concluding “It is a day to take measure of our infatuation with central banking”.

Grant reportedly called this move a few months back and recommended cheap (at the time) call options on the CHF/EUR exchange rate that are, today, doing quite well.

Not surprisingly, the key takeaway here for Grant is that, as it relates to influencing prices, Mr. Market is much more powerful than any or all of the world’s central bankers, recent developments demonstrating the temporary nature of the latter.

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Back to the Past

The Detroit Auto Show has focused even more attention on tumbling energy prices that, suddenly, have American car buyers thinking more about how much horsepower they can get instead of how much gas mileage they’ll need to help make ends meet.

This item at the The Atlantic had a series of pretty interesting photos from the area’s heyday many decades ago that included the photo below. Give the aforementioned energy price slide, we might see something similar to this at gas stations in the not-too-distant future.

These photos from the early-1940s include both race riots and war preparations, a timely reminder that, despite the current problems the world faces, things could be worse.

Easy Money and Asset Bubbles

You’d think that, at some point, central bankers around the the world will collectively wake up and smell the coffee vis-a-vis monetary policy and asset bubbles. A few encouraging signs were seen just today, first from an NBER working paper titled Betting the House in which, despite assurances to the contrary from former Fed Chief Ben Bernanke, there might indeed be a strong link between easy money and asset bubbles:

We use novel instrumental variable local projection methods to demonstrate that loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era.

The other quasi-revelation comes from the St. Louis Fed where researchers stumbled across the first housing boom that didn’t require broad participation from homeowners:

They fail to make a connection between easy money and soaring prices, simply noting:

The data suggest that this is the first national housing boom in the postwar era that has not been supported by an increased demand for owner-occupied housing. This current episode could solidify the idea that it is possible to have housing booms driven entirely by investors. Therefore, it is no longer clear going forward that the homeownership rate provides a good predictor of future house prices.

Clearly, easy money from the Fed fueling demand from said “investors” was a step too far…

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