Doug Noland: Arms Race in Bubbles

This is a syndicated repost courtesy of Credit Bubble Bulletin . To view original, click here. Reposted with permission.

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The week left me with an uneasy feeling. There were a number of articles noting the 30-year anniversary of the 1987 stock market crash. I spent “Black Monday” staring at a Telerate monitor as a treasury analyst at Toyota’s US headquarters in Southern California. If I wasn’t completely in love with the markets and macro analysis by that morning, there was no doubt about it by bedtime. Enthralling.

As writers noted this week, there were post-’87 crash economic depression worries. In hindsight, those fears were misplaced. Excesses had not progressed over years to the point of causing deep financial and economic structural maladjustment. Looking back today, 1987 was much more the beginning of a secular financial boom rather than the end. The crash offered a signal – a warning that went unheeded. Disregarding warnings has been in a stable trend now for three decades.

Alan Greenspan’s assurances of ample liquidity – and the Fed and global central bankers’ crisis-prevention efforts for some time following the crash – ensured fledgling financial excesses bounced right back and various Bubbles hardly missed a beat. Importantly, financial innovation and speculation accelerated momentously. Wall Street had been emboldened – and would be repeatedly.

The crash also marked the genesis of government intervention in the markets that would evolve into the previously unimaginable: negative short-term rates, manipulated bond yields, central bank support throughout the securities markets, Trillions upon Trillions of central bank monetization and the perception of open-ended securities market liquidity backstops around the globe. Greenspan was the forefather of the powerful trifecta: Team Bernanke, Kuroda and Draghi. Ask the bond market back in 1987 to contemplate massive government deficit spending concurrent with near zero global sovereign yields – the response would have been “inconceivable.”

Articles this week posed the question, “Could an ’87 Crash Happen Again.” There should be no doubt – that is unless the nature of markets has been thoroughly transformed. Yes, there are now circuit breakers and other mechanisms meant to arrest panic selling. At the same time, there are so many more sources of potential self-reinforcing selling these days compared to portfolio insurance back in 1987. Today’s derivatives markets – where various strains of writing market insurance (“flood insurance during a drought”) have become a consistent and popular money maker – make 1987’s look itsy bitsy.

The record $3.15 TN hedge fund industry barely existed in 1987. The $4.1 TN ETF complex didn’t exist at all. The amount of trend-following finance dominating present-day global markets is unprecedented. Moreover, the structure of contemporary finance has already (repeatedly) proven itself conducive to financial dislocation. Over the years – and especially post-2008 reflation – boom and bust dynamics have turned only more forceful. Central bank fixation on countering the bust has precariously propelled the latest boom.

The ’87 crisis response fatefully unleashed the “Terminal Phase” of Japanese Bubble excess – the consequences of which persist to this day. Decades of exceptional development flushed away with a few years of recklessness. Chinese officials over the years claimed to have learned from the dismal Japanese Bubble experience. Clearly, they did not. The 2008 crisis was multiples of 1987. The recent post-crisis reflation, as well, has been at an incredibly grander and prolonged scale. This has ensured that China’s Bubble and “Terminal Phase” have inflated so far beyond Japan’s eighties fiasco.

Bubble mirage had Japan’s economy and banking system poised to lead the world. Now it’s China. In contrast to Japan’s beleaguered post-Bubble political class, China’s communist party won’t have to agonize over elections.

China faces extremely serious issues – and I’ll assume enlightened Chinese communist party officials are not oblivious. Beijing was the leading culprit behind my disquiet this week. Most focused elsewhere. The Trump administration’s tax package made initial headway in the Senate. There was also market-friendly reporting that Federal Reserve governor “Jay” Powell may be Trump’s leading candidate for Fed chairman. With securities markets rising ever higher into record territory, who cares about some communist party gathering? Heck, is communism even pertinent in today’s tantalizing New Age? Did you see the cryptocurrencies this week?

Chinese President Xi Jinping has a plan. China will be the world’s super power. The great communist party, with its progressive system of meritocracy, is the only mechanism to adroitly guide Chinese “new era” development. And President Xi is the master – the modern-day Emperor – with the depth of experience, the vision, the charisma, the power to ensure China’s rightful place on the world stage. He embodies the benevolent dictator for the masses; the resolute commander for an increasingly hostile world; the deity to guide and protect an insecure society. Spooky stuff.

October 20 – Financial Times (Tom Mitchel): “‘Government, military, society and schools — north, south, east and west — the party is leader of all,’ Mr Xi proclaimed in a three-and-a-half hour speech… to the party congress. Next week the congress will appoint a new Politburo Standing Committee stacked with Xi loyalists. One person who advises senior officials attributes Mr Xi’s now seemingly unassailable dominance of Chinese politics to a Machiavellian insight. ‘Because of the economic prosperity of the reform era, almost everyone in officialdom was corrupted,’ he says. ‘Xi used this fact as leverage to scare everyone. They have to follow him because everyone is vulnerable. All you have to do is investigate them.’ In his marathon address to the congress this week, Mr Xi positioned himself not just as modern China’s third great leader after Mao and Deng, but also the heir to a glorious Communist tradition stretching back to Russia’s Bolsheviks. ‘A hundred years ago, the salvos of the October Revolution brought Marxism-Leninism to China,’ Mr Xi said, noting that the Chinese Communist party was founded just four years later. ‘From that moment on, the Chinese people have had in the party a backbone for their pursuit of national independence and liberation, prosperity and happiness.’ According to Mr Xi’s arc of history, China is only three decades away from resuming its traditional and rightful place as the world’s dominant economic and cultural power, with the US caught in a downward spiral accelerated by Mr Trump’s election.”

Xi’s speech was said to have left young devotees sobbing (and previous leadership yawning and checking their watches). Xi is moving aggressively forward with a consolidation of power – assiduously crafting a cult of leadership. He has shrewdly perched his government’s skill and competence up on a high pedestal, with its leader the unassailable “man now regarded as China’s great centraliser and most powerful ruler since Mao Zedong, the party’s revolutionary hero.”

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