Wednesday, October 17, 2012


A new round of worldwide stimulus measures have been enacted over recent weeks. China announced gigantic infrastructure projects. EU announced an unlimited bond buying program to "repair monetary policy transmission channels" (and you thought quantitative easing was a creative term) and finally Mr. Ben Bernanke revved up his helicopter to the tune of $40B a month in MBS purchases. The party is on. Of course, all this stimulating seems more like a 'hair of the dog' variety and will not produce the euphoria that sir Alan Greenspan was able to conjure up in the 2000's.
European lawmakers, having been dragged into the festivities kicking and screaming, finally sees what we meant when we wrote (if they read our blog, that is) the following on July 1, 2010 about its attempts at being a Gloomy monetarist Gus at a 'neo-classical' synthesis party:
"Europe's attempts at fiscal austerity surely go against the grain, but I think that they will see the futility of fighting this trend (otherwise they will have to endure a useless bone-crushing recession only to finally succumb to inflation after their exports dry up). The US dollar is going to be the last to fall and is in fact likely to remain strong (relative to other currencies of course, it has been falling with respect to gold quite dramatically) for a while, because it appears as the less dangerous of the crazy bunch."
Alas, EU has taken too long to see that its choice has already been made by the previous events and that the pain of slow economic growth and high unemployment will not lead to any benefit. The best scenario is not to reach a Minsky moment, but once it is reached, the consequences are strictly enforced: inflation or deflation (and at high levels of debt, a depression). That still is the only long term choice for Europe as it is for US. Ben Bernanke realizes this better than anyone else, hence his willingness to take all kinds of criticism and mockery in starting the QE3.
As we wrote repeatedly starting in 2009, we have entered a true 'decade of crashes'. The worldwide QE4VR is not going to ensue until more pain has been inflicted. These new mini-crises (flareup of debt issues with Portugal/Spain, Emerging Markets Hard Landing...) will each ensue that Treasuries rally and a mini-deflationary event will ensue, but each of those events will serve as additional motivation for more and more stimulus and an eventual stagflationary period. As we wrote in early April 2010, :
"as the current slump continues we are likely to see other sovereign debt crises a la Greece .... These sovereign crises will produce a temporary strength in the dollar. This will likely happen before we get to the point of high interest rates in the US and a partial default by inflation. In the era of sovereign default, countries in the Eurozone are the only ones (among the countries whos debt is denominated in their own currency) likely to experience anything remotely resembling a real default (as opposed to default by inflation, which we believe will be endemic)."
Any risk manager must consider this long term need to reduce the real value of debts, as well as the global financial system setup, under which the crisis is relatively benign at the center (Treasuries as a safe haven) and vicious at the periphery. Appropriate stress tests would be:
- a stagflationary period (though the timing is unknown) 
- transient spikes in volatility (specifically originating at the periphery i.e. Emerging Markets).  
It is also worth seeing the target that Mr. Bernanke is trying to hit again and again and that is the housing market. Consumption in the US in large part depends on that market and it is likely going to be acting as a quasi safe haven for the medium term.

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