09/07/11 Laguna Beach, California – The financial markets seem to have caught a runny nose. But at this point, it’s hard to say if it’s the runny nose that follows a mild allergic reaction or the one that precedes a life-threatening pneumonia.
Despite a chronic case of the sniffles, the stock and bond markets of the world have performed reasonably well for most of the last of the two years. Even though the financial markets are acutely allergic to most strains of credit distress, Dr. Bernanke’s “Liquidity Elixir” has provided an effective antidote so far.
Even so, we suspect the elixir is treating symptoms, rather than the disease itself. Debt liquidation — either by repayment or default — continues to hobble economic growth worldwide, and also to terrify stock market investors.
Economies usually thrive when private-sector credit is expanding, and struggle when private-sector credit is contracting. The latter circumstance is the one that pertains today. To make matters worse, public-sector credit is expanding.
In effect, the US Postal Service and the IRS are increasing their indebtedness, while Apple Computer and ExxonMobil are reducing theirs. Unfortunately, “cost centers” like the IRS do not create employment growth; “profit centers” like Apple Computer do.
Therefore, when a country’s profit centers are retrenching, its job-creating engines will also be retrenching. And when a country’s job-creating engines are retrenching, nothing good can happen. Employment growth stagnates and credit distress accelerates throughout most parts of the economy.
Welcome to America, 2011.
Despite trillions of dollars of federal stimuli, the US economy can’t seem to shake off its hangover. Businesses are slow to invest and slow to hire. As a result, household finances continue to deteriorate…and defaults continue to mount.
Not surprisingly, many of the world’s largest financial institutions are just as sick as they were three years ago. And many of the world’s largest governments are even sicker. Dr. Bernanke’s elixir may be able to work wonders, but it can’t work miracles.
Bad loans go bad…eventually.
Bad loans go bad, no matter whether the borrower is a mortgage-holder who “bought” more house than he could afford or a government that promised more benefits than it could afford.
The only time a bad loan “goes good” is when a central bank or a national treasury or some other “angel investor” intercedes to rescue the lender from his own incompetence.
The problem with this selective intercession is that it alters the course of history for selected institutions or individuals, but not for the economy at large. Selective intercession is a sand castle. It might divert a wave or two. But after three waves, you would never know the thing was ever there.
Three years after the bailouts of 2008, the sand castles of government intervention are gone. Only the pounding surf of debt liquidation remains…and the surf is pounding away, both at European governments and at American households. As such, the signs of credit distress are increasing.
These signs take various forms. But one of the most telling forms is the direction of LIBOR interest rates. LIBOR stands for “London Interbank Offered Rate.” It is the rate at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank lending market).
In most circumstances, LIBOR rates track short-term Treasury rates. But in the midst of crisis conditions, LIBOR rates tend to spike, while Treasury rates fall. That’s exactly what happened during the credit crisis of 2008, as the chart below illustrates.
In the depths of the crisis, LIBOR rates soared, reflecting the reluctance of banks to lend money to other banks. The more worrisome the crisis seemed to be, the higher LIBOR rates climbed. As such, the LIBOR rate functioned as a kind of “fear gauge.”
And so it remains…
During the last few weeks, LIBOR rates have been on the rise once again. They have not risen high enough to sound a distress signal, but they have risen high enough to raise an eyebrow.
Let’s call it an early warning sign.
So whatever else you may be watching to guide your investment decisions, don’t forget to watch LIBOR.
Eric Fry
for The Daily Reckoning
Eric Fry
Eric J. Fry, Agora Financial’s Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research — institutional research products dedicated to international investment opportunities and short selling.
Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts. His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.
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Capitalism, in this context. Bonds may yield as high 20+ per annum. Place your bet, either it gives 20 over percent lucrativeness or capital total loss in the event of default.
Take supermart as a guideline. Suppliers unload their stuff for a credit period of 3 months which after accommodating delay or other valid reasons probably ends up 6 months for the acutal payment. Frequently, competition within the same peers enable them to hang placards demonstrating 20, 30 or even 50% discount ready. Extreme cool sales would be if no drastic actions taken. Rolling trade seems the way, where suppliers furnish the stuff and marts going on offer binge for cash to meet their ongoing massive outlays such as rentals, rates, electricity, wages and whatnots. Or, if the financial controller is able to draw out a mammoth sum for a purported ‘valid reason’ from a financial arm. On precision calculation that also may last for quite few couples of years. Till it no longer can roll. Maybe bailout invited. Capitalism has thus come to the crossroad.
I don’t think trillions of dollars in tax breaks for the wealthy should be called a “Stimulus”.
the frustrating thing for the ‘non-expert’ is the erratic unfolding of this mess. sometimes the greek disaster just treads water with no sign of the problem and then – bang – all heck breaks through for little apparent reason and it sems default is just around the corner. the bottom line is that the euro zone cannot expell them (no legal mechanisms) nor can they let them default without damaging themselves – so its ‘sturm und drang’ with little to show at the end of the day.
kind of the same with the us economy – QE3 will be issued in late spetember or so and we’ll stumble along another 6 months or a year.
so what is the ‘non-expert’ to do – abandon the market and miss the steroid QE3 rush (and get out before the sugar high wears off) or ride the tiger of the yellow metal (i’m in silver actually) and hope for the thing to blow itself up to make the metal woth even more?
i’m trying to do a bit of both but have little confidence in my strategy. maybe i just need to let my wife think i’m totally over the edge and fill the bunker with bottled water and canned food and stock up on ammunition.
Overall, no lack of professionals. Yet, the eventual episode is none other than dismal sketches. Insightful layman may sense a direction.