Perversely, the current post Bretton Woods system also allows for huge operations/stimulus to overcome any crisis/shock. We also shouldn’t underestimate the positive impact that this can have on nominal asset prices. Cash is arguably a far more dangerous asset in a fiat currency but unstable regime than it is in a more stable less crisis prone one. However, by continually using stimulus to deal with crises and not letting creative destruction take over, you make a subsequent crisis more likely by passing the problem along to some other part of the global financial system, and usually in bigger size. In a fiat currency world, intervention and money creation is the path of least resistance. In a Gold standard world, mining new gold was the only stable way of increasing the money supply.
We think this leaves the current global economy particularly prone to a cycle of booms, busts, heavy intervention, recovery and the cycle starting again. There is no natural point where a purge of the excesses is forced by a restriction on credit creation.
So we’re quite confident that there will likely be another financial crisis/shock pretty soon with their frequency continuing to be high until we create a more stable global financial framework.
Here is a link to the full report.
When I read this report three of David’s Fullerisms came to mind. “Central banks are serial bubble blowers”. Another is “central banks have killed off more bull markets than all other factors combined”. To round out the triumvirate “Money policy beats most other factors most of the time”. Therefore, monetary policy is critical if we are to have any hope of identifying the difference between medium-term topping activity and a major top.
Central banks have bought an impressive bull market with trillions of Dollars, Euro, Yen, Renminbi and Pounds in monetary stimulus. Right now, the USA is tinkering with reducing the size of its balance sheet so it is an opportune time to think about what could cause the next crisis. After all, despite rafts of legislation and armies of compliance people there is little evidence that anything has really changed to make the financial system less susceptible to occasional episodes of panic.
Debt issuance has exploded in the last decade as both governments, corporations and property investors gorged on easy access to credit and low absolute rates. Financing coupon payments represents much less of a threat than refinancing and we know there is a great deal of debt that needs to be refinanced in the coming years. This only becomes an issue when the cost of refinancing is a problem for heavily leveraged borrowers. The explosion in covenant light issuance is then likely to play a role as investors begin to actually read prospectuses for the bonds they own.
With interest rates just starting to rise the potential they will be at levels which represent issues for borrowers when the wave of refinancing peaks in 2019 through 2021 is non-trivial. I was invited to Jeff Gundlach’s talk tomorrow and am interested to hear what he has to say about the condition of the bond markets.
Another potential area that could cause a problem is the evolution of next generation quantitative systems. The simple fact of the matter is that programmers are not altogether certain how the artificial intelligence platforms they have created make trading decisions. That represents an issue as these platforms proliferate. The latter half of this interview of Matthew Rothman from Credit Suisse’s quant department doesn’t tackle that question but it does a good job of eliciting where the sector is heading and may be of interest. Meanwhile volatility is unusually low. That is a not a situation which will persist indefinitely. In fact, anyone who has been to The Chart Seminar will recognize that an inert range is an explosion waiting to happen.
The big question investors have is whether any of the factors people are worried about are going to result in imminent problems for markets. Major indices like the S&P500 and Nasdaq-100 have been trading in the region of big psychological levels, namely 2500 and 6000 for the last few months. There are still overextensions relative to the trend mean evident for both these indices, so it is not beyond the bounds of possibility that a somewhat more volatile environment could evolve. That will make monitoring the consistency of medium-term trends even more important. As long as progressions of higher reaction lows are sustained we can consider these uptrends still consistent.
Quite whether the Republican controlled US government can pass an attractive tax plan for business and investors is a question likely to be answered this week and is another subject which will influence investor decisions.
Gold rallied today from the $1300 area to confirm support at the upper side of the underlying trading range.