The Credit Creation Strategy

DR Weekend Edition – The Credit Creation Strategy
The Daily Reckoning Weekend Edition
April 24-25, 2004
Paris, France
By Addison Wiggin and Tom Dyson

“It’s fairly apparent that pricing power is gradually being restored and threats of deflation, which were a significant concern last year, by all indications are no longer an issue before us,” Alan Greenspan declared triumphantly.

Of course, the markets have known that for a long time… the stock market first figured it out just before bombs started dropping on Baghdad, gold worked it out over two years ago, as did the dollar… in fact the only dollar-denominated price that hasn’t been rising is the price of money. Put differently, interest rates are still very low and the bond market is, historically speaking, trading near all-time highs.

Greenspan, as part of his strategy for revitalizing the economy, needed to stimulate inflation. He needed to flood the market with dollars, getting companies to invest, consumers to spend, factories to produce. This strategy has a name – it’s called credit creation.

Although the origins of this ‘credit bubble’ can be traced back a decade or more, the real expansion kicked off just prior to the new Millennium. The first concern was Y2K, then the tech bubble burst. 9/11 followed a year later. Stocks kept falling through 2002, and driven by corporate scandals, the threat of further terrorism and war, things were getting pretty dark by January 2003. Greenspan fought these concerns with credit. Greenspan was inflating… as fast as he could.

Only, he couldn’t publicly admit it – that would have completely undermined the strategy, causing the dollar to drop like a stone and interest rates to rise in a similar vein. The precarious stability would have been undermined.

Instead, Greenspan erected a smokescreen. With help from the Japanese (who bought ¥20 trillion worth of U.S. Treasurys), and the currency interventions of other Asian countries, Greenspan was able to suggest ‘deflation’ as a legitimate threat, and pointed at the bond market for justification.

To continue talking about deflation, at this time, would be simply ludicrous. And this week, he finally admitted the truth: there in no deflationary threat. Markets thought about little else. All they wanted to know was: “When will interest rates rise?”

Stocks fell in a straight line the moment Greenspan made the declaration, despite the procession of ‘Street-pleasing’ earnings, but managed to pull themselves together by the weekend… the Dow limping to a 21 point gain for the week, up 0.2% and closing at 10,473. The S&P also managed to land in positive territory, up 6 points to 1,141, but as always, it was the Nasdaq that stole the show, adding 2.7%, or 54 points, to settle at 2,050.

The metals also took a bashing, but unlike stocks, they weren’t able to bounce back… silver broke down below $6 having opened the week above $7. The metal closed the week at $6.15, down nearly 14%. Gold’s decline was more sedate… the barbarous relic shed $5 to $395.5.

Elsewhere, the yield curve steepened, 10-year yields adding 10.2 basis points – predictably bond traders weren’t particularly enamored by some of Greenspan’s recent insights. Oil mounted a brief challenge of the $40 mark, but quickly receded, closing the week down a dollar to $36.4 per barrel.

Addison Wiggin,
The Daily Reckoning
April 25, 2004

P.S. As we laboriously outline in our book, one of the “great lies” of our time is that stocks always go up. Steve Sjuggerud, writing from Argentina, offers definitive proof to the contrary…

His essay: “A river of losses” is a must read… see below…

THIS WEEK in THE DAILY RECKONING

EMPIRE OF DIRT (4/23/04)
By Bill Bonner

“… In ancient Rome, as in modern Washington, people chose their ideas like they chose their clothes – they wanted something that not only did the job, but also something that was fashionable. And at the time, it was à la mode for emperors and individuals alike to pretend that they lived in a free republic, which honored citizens’ rights, but in practice… the government, and its leader, could do what they liked. And what they seemed to like doing was going out and making war against everyone they thought they could beat… ”

THE RIVER OF LOSSES (4/22/04)
By Steve Sjuggerud

“… I now see the stock market (and most investable assets) like a river, working its way from the mountain peak to the sea. There are occasional ‘flat’ sections of the river, where things appear calm and the current isn’t very strong. And then there are some wild rapids heading down. There are even the occasional eddies along the river banks that flow against the grain. And while the river has all three of these states (flats, rapids, and eddies), the inexorable flow is
down… ”

BACK UP THE TRUCK ON GOLD (4/21/04)
By Doug Casey

“… I don’t have a crystal ball, but I do have a sense of market history. Most of the people that were active players in the last real gold bull market, from August 1971 to January 1980 (which took gold from $35 to over $800) are now either dead or retired. Most of the players in today’s markets only know of gold as a dog… but I believe we’re looking at a gold bull market of historic proportions in the years to come… ”

INDIA – THE NEXT CHINA? (4/20/04)
By Lynn Carpenter

“… India’s not the next China. Not yet. Both countries have many risks, but China’s emergence has a momentum and key support that India’s does not. Quite simply… India has been on the brink of ’emerging’ and becoming a world force about 40 times in the last 20 years. But it never quite sticks. It’s not trustworthy yet. India hasn’t reached the tipping point… ”

DRESSING UP INFLATION (4/19/04)
By The Mogambo Guru

“… Reflation is merely putting a New Age prefix on inflation – but one which results in an added piquancy of a delightful hint of benefit to it, like a refreshing hint of Spring or something, as it makes the price of assets rise. But reflation is just inflation dressed in a frilly hat. So why would any government that had an IQ above that of a slug do such a thing as try to reflate/inflate the economy?… ”

———————————————————————————————————————-

HEADLINE, NEWS And INSIGHT:

Nothing In Life Is Free
by John Myers

“…  Politicians [are]… creating ‘free’ money at a faster rate than the economy is growing. But there’s an old saying, ‘Nothing in life is free.’ Only when [inflation] becomes extreme do you realize that your purchasing power has gone to hell…  and that even if you are making more money than you were before, you are actually able to afford fewer things. And in the end, that is bad for all businesses… ”

Real Estate Danger Signs
by Dr. Steve Sjuggerud

“… Long-time readers of mine know that I don’t think U.S. real estate is wildly overpriced…  yet. But I think it’s about to be. Everybody sees real estate as a ‘sure thing.’ I’m concerned that people now think real estate is even more of a sure path to wealth than the Internet stocks of the late 1990s. And we all know what happened to that ‘sure thing.’… ”

Out of Gas in Iraq
by Mr. X

“… The Army is just making things worse for the coalition. The Army is intent on having its presence seen and felt in Iraq because they think that will make everyone think they are in charge. What they don’t seem to realize is that a large military presence is the one thing, pretty much the only thing, the Iraqis can’t tolerate. Until the Army realizes all of this – which it seems like it never will – things will only get worse. And in response, the Army will just increase its presence… ”