Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 27-Oct-2009
Nouriel Roubini apparently is predicting a global market crash

Web Log - October, 2009

Nouriel Roubini apparently is predicting a global market crash

Many others are experiencing a "sense of foreboding," according to Gillian Tett of the Financial Times. In a recent article, Tett quotes a banker correspondent:

"Forget about the events of the past 12 months. ... The punters are back punting as aggressively as ever. Highly leveraged short-term trades are back in vogue as players ... jostle to load up on everything from Reits [real estate investment trusts] and commercial property, commodities, emerging markets and regular stocks and bonds. ...

Any sense of control is being chucked out of the window. After the dotcom boom and bust it took a good few years for the market to get its collective mojo back [but] this time it has taken just a few months. ... Was October 2008 just a dress rehearsal for the crash when this latest bubble bursts?"

Tett concludes by saying, "It is crystal clear that the longer that money remains ultra cheap, the more traders will have an incentive to gamble (particularly if they privately suspect that today's boom will be short-lived and want to score big over the next year). Somehow all this feels horribly familiar; I just hope that my sense of foreboding turns out to be wrong."

The title of Tett's article is "Rally fuelled by cheap money brings a sense of foreboding." She refers to the same facts that I referenced a couple of weeks ago in the article "The current stock market bubble correlates with bailouts and stimulus," Since that time, it's been more and more widely recognized that the current stock market rally is being fueled by governments around the world pouring out free or low-cost money, via central banks and fiscal policy.

On CNBC on Monday morning, NYU professor Nouriel Roubini discussed explicitly how central banker policy was creating a "wall of liquidity" that was feeding a new worldwide asset bubble, growing larger than the last one. Along the way, he appears to be predicting a global market clash with near certainty.

The following is my transcription. The lines in brackets [] are paraphrases of interviewer questions.

"[Could we see the stock market run continue?]

Yes, in the short run what's happening is that there's a wall of liquidity, not just in the United States but around the world, that's chasing assets -- it's equities, it's commodities, it's gold, it's emerging market asset classes.

Nouriel Roubini <font face=Arial size=-2>(Source: CNBC)</font>
Nouriel Roubini (Source: CNBC)

And now we have even the mother of all carry trades. Everyone is borrowing short, shorting the dollar, borrowing and investing in assets all over the world. Global equities, comodities, credit, emerging market asset classes.

The risk is however, right now people are borrowing at zero percent interest rates in the United States. Effectively the rate of borrowing is negative, because with the dollar falling -- ?? in the capital gain, -- you're buying any asset around the world. All these assets are perfectly correlated.

Eventually, the dollar cannot keep on falling. Once the dollar stops falling, it reverses. You have a sudden reversal of the dollar, you have to close your shorts, you have to dump assets, and you could have a market crash all over the world. That's a risk.

[Is that anywhere near happening?]

No, it's not near happening because for the time being the Fed is keeping short rates at zero, expected to remain zero, and the Fed is becoming the biggest seller of volatility because it's buying $1.8 trillion of Treasuries, agency debt and RMBSs, so volatility on the long end is low, and on the short end is zero, so this game is played until ????.

[Question about central banks]

There's a gap between what you have to do for the real economy, and what you have to do for financial stability. The real economy is still weak. There's deflation actually in the economy. Look at the cycle 2001-2006. They kept the fund rates all the way down to 1% through 2004, three years after the recession was over. Then they did step by step [raises of] 25 basis points every six weeks.

This time it's the same, only worse. Output has fallen 4%, not 0.4%. Unemployment rate is going to peak at 10%, not at 6.5. We have actual deflation rather than risk of deflation.

So if the Fed wants to target the real economy and avoid deflation, it has to keep the Fed funds rate at 0 for longer. But if it does that, then you create another huge asset bubble.

With the carry trade, that asset bubble is now becoming global, and everyone has to follow U.S. monetary policy by intervening in a non-sterilized way. That eases money at reduced rates, and therefore we're exporting our monetary policy to the rest of the world.

And that's leading to a global asset bubble. And once there's the unraveling of that carry trade that eventually is going to occur, because the dollar cannot keep on falling, then you can have a market crash on a global basis.

[q: Is this current asset bubble worse than the one that preceded the fall of Lehman?]

It could become worse because if the Fed keeps the rates at zero, and if the Fed keeps controlling and reducing volatility on the long end, then everybody is playing the same game. Everybody is buying dollars and going long in risky assets all over the world.

[Have we put out one fire, only to create another one?]

I think we have two objectives here -- stabilize the real economy, and avoid financial instability. But we're using one target, the Fed funds rate, to target the real economy, but we're creating a new asset bubble, bigger than the previous one, and that's a mistake we're doing right now."

Roubini's reasoning can be summarized as follows:

I've read through this transcript several times, and I don't see that he's left much doubt that this is going to happen. The only point of ambiguity in what he's saying is the timing. He says that it won't happen soon because the Fed will keep interest rates low for a while, but surely he realizes that isn't the issue. The trigger will not be the Fed funds rate, which is set by policy; the trigger will be the ending of the fall of the dollar, and that's set by the market. And with deflation already occurring, the dollar could stop falling at any time, irrespective of the Fed funds rate.

As usual, you have to ask the question, "What would Nouriel Roubini say if he believed that a global market crash was imminent?"

And the answer is that he'd be saying what he said in the above transcript.

He wouldn't be talking about a global market crash at all if he thought it was a distant possibility; the fact that he seems to predict it indicates that he believes that it could happen in the near future.

I've always been puzzled by what people like Nouriel Roubini and Ben Bernanke really believe. As I've been saying for seven years, a market crash MUST occur with 100% probability by applying the Law of Mean Reversion. I don't expect the man on the street to understand the Law of Mean Reversion, but I DO expect professors of economics at NYU and Princeton to understand the Law of Mean Reversion.

This is the first time that I've heard Roubini, or indeed any major financial official in Washington or around the world, predict a market crash. This is a big change in opinion by Roubini, or at least a big change in what he's saying.

From the point of view of Generational Dynamics, the increasingly reckless behavior of financial institutions explains why there MUST be a major stock market crash, and that the worst, by far, is yet to come.

Citibank is an archetypal example of what's going on. The financial engineers and managers at Citibank were prime perpetrators in defrauding investors and the public in creating structured securities that are now called "toxic assets," and they did so in such a way that they could pay themselves billions of dollars irrespective of how many other people lost everything.

And now those same people at Citibank are charging millions of their own customers 30% interest, and using the money to pay themselves hundreds of millions of dollars in additional bonuses. This appears to me (as a non-lawyer) to be criminal extortion. Citibank appears to be turning into a criminal organization.

I've been talking for several years about the debauched and depraved abuse of credit that we've seen in financial institutions, and I've been increasingly sickened and disgusted as I've seen it get worse and worse, as long-time readers of this web site are well aware. But I just can't find the words to describe what I'm seeing today in Citibank and elsewhere. I've lived a long life in America, and I've seen individual examples of criminal behavior, including such people as Bernie Madoff. But I've never seen any behavior so nauseating and loathsome as I'm seeing in Citibank and other places. I truly believe that many of these people are going to go to jail, as their counterparts did in the 1930s, and no one will be happier to see that than I will.

But getting back to the generational point, you can see why there MUST be a major stock market crash. The portion of the crisis that's occurred so far has done nothing to curb the behavior of financial engineers and managers at Citibank in using fraud and extortion to pay themselves million dollar bonuses. The only thing that will stop them, and other bankers like them, is a financial crisis that will destroy Citibank itself. (This is why I often talk about the "The nihilism and self-destructiveness of Generation X.") Citibank gouging and screwing their own customers with 30% interest rates is so self-destructive that it almost appears to be a last act of desperation.

(Comments: For reader comments, questions and discussion, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (27-Oct-2009) Permanent Link
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