An Unprecedented Speculative Spree

The Daily Reckoning PRESENTS: Last year set new records everywhere: records in stock prices, records in mergers and acquisitions, records in private equity deals, record-low spreads, record-low volatility. Manifestly, there is not the slightest check on borrowing for financial speculation. Dr. Richebächer wonders, what can stop this speculative binge? Read on…


A study recently published by the Bank for International Settlements (Monetary and Prudential Policies at a Crossroad?) says:

“Financial liberalization is undoubtedly critical for the better allocation of resources and long-term growth. The serious costs of financial repression around the world have been well documented. But financial liberalization has also greatly facilitated the access to credit… more than just metaphorically. We have shifted from a cash flow-constrained to an asset-backed economy.”

Though we basically agree with the analysis and the conclusions of the study, we radically disagree with the one sentence that “Financial liberalization is undoubtedly critical for the better allocation of resources and long-term growth.” The indispensable first condition for proper resource allocation at a national as well as global scale is avoidance of excessive money and credit creation. In many countries, and in particular in the United States, they are excessive as never before.

If Mr. Bernanke complains about irregularities of M2, this is nothing in comparison with the fact that credit and debt growth in the United States has exploded for more than two decades. When Mr. Greenspan took over at the helm of the Fed in 1987, outstanding debt in the United States totaled $10.5 billion. In less than 20 years, this sum has quadrupled to $41.9 billion. In reality, this significantly understates the rise in debts because, for example, highly leveraged hedge funds with trillions of outstanding debts are not captured. In 1987, indebtedness was equivalent to 223% of GDP, which was already pretty high. Lately, it is up to 317% of GDP.

In actual fact, there used to be a very stable relationship between money or credit growth and GDP or income growth until the early 1980s. Growth of aggregate outstanding indebtedness of all nonfinancial borrowers – private households, businesses and government – had narrowly hovered around $1.40 for each $1 of the economy’s gross national product. Debt growth of the financial sector was minimal.

The breakdown of this relationship started in the early 1980s. Financial liberalization and innovation certainly played a role. But the most important change definitely occurred in the link between money and credit growth to asset markets. Money and credit began to pour into asset markets, boosting their prices, while the traditional inflation rates of goods and services declined. The worst case of this kind at the time was, of course, Japan.

Do not be fooled by the sharp decline in consumer borrowing into the belief that money and credit has been tightened in the United States. Instead, borrowing for leveraged securities purchases (in particular, carry trade and merger and acquisition financings) has been outright rocketing, with security brokers and dealers playing a key role. Over the three quarters of 2006, their net acquisitions of financial assets have been running at an annual rate of more than $600 billion, more than double their expansion in the past.

Federal funds and repurchase agreements expanded in the third quarter at an annual rate of $606.3 billion, or an annual 26%. The main borrowers were brokers and dealers. During the first three quarters of the year, their assets increased $427 billion, or 27% annualized, to $2.57 billion. A large part of the money came from the highly liquid corporations. There is no reason to wonder about low and falling long-term interest rates.

All this confirms that financial conditions remain extraordinarily loose. Even that is a gross understatement. Credit for financial speculation is available at liberty. Expectations for weaker economic activity only foster greater financial sector leverage. Why such unusually aggressive speculative expansion in the face of a slowing economy?

The apparent explanation is that the financial sector intends to make the greatest possible profit from the coming decline of interest rates, promising further rises in asset prices against falling interest rates. While the real economy slows, the leveraged speculation by the financial fraternity goes into overdrive. Principally, there is nothing new about such speculation. New, however, is its exorbitant scale.

Before leading his jumbo-sized delegation to Beijing, Henry Paulson, U.S. Treasury secretary, cautioned against expecting any big breakthroughs from the visit. And so it has turned out. The meeting produced plenty of statements about the desirability of improving relations, but nothing concrete to do so.

Of course, the Chinese are in a very strong position with the central bank holding more than $1 trillion of bonds in its portfolio, mostly denominated in dollars. According to reports, the American visit was initiated by Mr. Paulson in an effort to contain rising Sinophobia in the U.S. Congress, which increasingly blames China for America’s economic problems, from its huge current account deficit to stagnating real incomes. In other words, those troublemakers, not the trade deficit, are the problem.

One cannot say that U.S. policymakers and economists have been preoccupied with worries about possible harmful effects of the exploding trade deficit. They appear obsessed with the conventional wisdom that free trade is good and must always be good under any and all circumstances, as postulated in the early 19th century by David Ricardo.

Ricardo exemplified this by comparing trade in wine and cloth between Portugal and England. Portugal was cheaper in both products, but its comparative advantage was greater in wine. As a result, according to Ricardo, Portugal boosted its production and exports of wine. In contrast, England gave up its wine production and could produce more sophisticated goods. In both countries, living standards rose.

For sure, it appears highly plausible that American policymakers feel they are following Ricardo’s logic. Only they are disregarding some caveats of Ricardo’s. For equal benefit, first of all, balanced foreign trade is required. “Exports pay for imports” was a dogma of classical economic theory. Ricardo, furthermore, disapproved of foreign investment, with the argument that it slows down the home economy.

With an annual current account deficit of more than $800 billion, the U.S. economy is definitely a big loser in foreign trade. To offset this loss of domestic spending and income, alternative additional demand creation is needed. Essentially, all job losses are in high-wage manufacturing, and most gains are in low-wage services. In essence, the U.S. economy is restructuring downward, while the Chinese economy is restructuring upward.

Considering that Chinese wages are just a fraction of U.S. or European wages, it appears absurd that the Chinese authorities deem it necessary to additionally subsidize their booming exports by a grossly undervalued currency, held down by pegging the yuan to the dollar.

In the U.S. financial sphere, the year 2006 has set new records everywhere: records in stock prices, records in mergers and acquisitions, records in private equity deals, record-low spreads, record-low volatility. Manifestly, there is not the slightest check on borrowing for financial speculation. There is epic inflation in Wall Street profits.

One wonders what can stop this unprecedented speculative binge. Pondering this question, we note in the first place that the gains in asset prices – look at equities, commodities and bonds – have been rather moderate. To make super-sized profits, immense leverage is needed. We think the speculation is unmatched for its scope, intensity and peril. Plainly, it assumes absence of any serious risk in the financial system and the economy. The surest thing to predict is that the next interest move by the Fed will be downward.

In our view, the obvious major risk for speculation is in the economy – that is, in the impending bust of the gigantic housing bubble. Homeownership is broadly spread among the population, in contrast to owning stocks. So the breaking of the housing bubble will hurt the American people far more than did the collapse in stock prices in 2000-02. For sure, the U.S. economy is incomparably more vulnerable than in 2001. Another big risk is in the dollar.


Dr. Kurt Richebächer
for The Daily Reckoning
March 20, 2007

Editor’s Note: Dr. Richbächer has found the best investments to protect your portfolio, no matter what lies ahead for us in 2007.

Dr. Kurt Richebächer is the editor of The Richbächer Letter. Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

Yesterday, the markets seemed to return to ‘normal’ – or, at least to what is taken for normal by today’s investors. That is to say, things that were already over-priced became more overpriced. And investors who were already over-stretched, reached a little further.

Time heals all wounds…and wounds all heels. Got a problem? One way or another, time will solve it. Something not right? Someone getting away with something? Don’t worry…time will take care of it.

And if we can’t sort out what is going on in the financial markets, time will have to do it.

The Dow rose 115 points. “Investors regain risk appetite and put subprime fears on back-burner,” says the Financial Times.

And regaining an appetite is a good thing when you are sick. But we are not so sure it is a good thing when you are about to explode from overeating.

And if time can heal things…it can rot them too.

“Oh time…won’t you spare me over another year? I’ll give you my gold coins. I’ll give you my stocks. How ’bout my beach house?

“I’m not asking much. Just make my face look like it did in ’68…just let me buy a gallon of gas for 25 cents, like I did in ’72…just let us stay up all night and howl at the moon like we did in ’82…just make my dotcom stocks worth what they were in ’99…

“That’s not asking too much is it?”

Yes, you can ignore time, but it won’t ignore you.

Time sorts out everything and everybody. Nothing and nobody is missed. You can’t hide from it. You can’t escape it. You can’t outrun it. You can’t make a deal with it.

If only we could arrange time…chivvy it into place where we want it, we could have ourselves a bit of fun.

We would set the highway traffic back to the levels of ’50s. And our automobiles back to the ’50s too…but then, let’s put 21st century technology under the hood. We don’t want to have to fool with carburetors like we did back then.

And consumer prices; let’s put them back into the early ’60s too…before the first big wave of inflation hit. We recall buying a hamburger at The Little Tavern in Annapolis for 25 cents. Another quarter got us a Coke.

And what did it cost to go to the movies? We can’t remember, but we think it was about 60 cents a ticket. Everything was cheap. Of course, it didn’t seem cheap back then. So, since we’re rearranging the sequence of things, let’s set incomes at 2007 levels.

And let’s go back to the Eisenhower era to find a political system we can live with. There were real conservatives back then – people who were reluctant to spend the public’s money…and reluctant to meddle in the public’s affairs. Now, we have only phony conservatives – people who preach ‘conservatism’ while pushing the most activist agendas since FDR.

“Turn the desert tribes of Mesopotamia in to Dixie Democrats?” the old timers would have joked. “Why not turn them into Baptists too? Ha ha…”

Meanwhile, the front page of the USA Today tells us that this latest attempt to remake the world in our own image is running into problems. A few months ago, Iraqis held up their purple fingers and proudly supported democracy. But now that they’ve had some experience with it, a new poll shows that the majority of them are against it. Only 43% think democracy would be good for Iraq. The rest have other ideas.

By contrast, a majority of Iraqis think it is ‘acceptable’ to kill U.S. soldiers. These are the same people – at least, according to the fiction of it – that U.S. soldiers are trying to protect. Take them out of the picture, said America’s president last night, and the Iraqis might start killing each other.

Oh, if only we could rewind the tape. If only we could go back to the Eisenhower era when U.S. presidents still had wit and charm! Yes, those were the good old days – at least they seem pretty good looking now, from a half a century later. America was still a free country, as near as we can recall. No phony wars against terror…no Sarbanes…no Oxley…no Hillary…no George.

And who was chairman of the Federal Reserve in 1956? Who knew? Who cared? The dollar was still linked to gold. You could trust it. America was the world’s biggest factory…the world’s biggest creditor…the world’s biggest exporter…the world’s fastest growing economy. All people cared about was that ‘Ike & Dick’ were ‘Sure to Click’ – no kidding, we have an old campaign button.

Of course, public life was as full of humbug as it is now…but the humbug seemed more innocent, less intrusive…and ultimately, more humane.

But enough of this reminiscing…no point to it. Time cuts deals for no one. Not even for the New York Stock Exchange.

More news:


Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“I’ve long said that Aussie was an 80-cent currency, and I noted to the people on the desk yesterday that it was oh-so-close to that level, and I hoped it didn’t disappoint us like sterling did when it got oh-so-close to the 2.00 level.”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig


And more thoughts, views, ideas…

*** Let’s see. According to the press reports, three things helped investors chow down again.

First, Chinese stocks took off. After a brief and feeble panic-attack a couple of weeks ago, the Shanghai stock exchange is as fat and happy as ever. The index is nearly in record territory again.

Second, a whole new selection of merger and acquisition targets was added to the menu. How could investors resist? All that delicious, syrupy, rich sauce floating around! There is even talk of a major acquisition in the gold mining sector. Barrick is said to have its eye on Newmont whose shares are expected to bring in the mid-50s.

And third, investors are coming to terms with the whole subprime issue. Tim Harris, a strategist at JP Morgan, put the matter in perspective:

“It is estimated that the U.S. mortgage market is worth some $10,000 billion, approximately 10 percent of which is cumulatively classified as subprime; 12-15% of which may be in or approaching distress/default.”

No biggie, in other words. But wait! Ten trillion dollars is still a lot of money. And 10% of it is still $1 trillion…and 15% of $1 trillion is still $150 billion. Who’s got $150 billion to lose?

And the problem – again, according to the press – is the risks now overflowing into other segments of the mortgage market – notably into Alt-A and Jumbo loans. The same stretch for profit that led lenders to make loans to people who couldn’t pay them back…led investors to buy the loans packaged as debt-back securities…along with high priced stocks in a communist country…and a great deal more. They will keep stretching until something snaps, we figure. Maybe it already has.

Time will tell.

*** The shift to the Asian economy is happening faster than anyone predicted – yes, even you humble editors at The Daily Reckoning.

Take for instance, a friend of ours who provided research for the best-performing hedge fund (between 2000 – 2005) in New York. 18 months ago, he pulled most of his money out and invested – guess where? – in Shanghai.

Barely two years later, he has made seven times his money with his Far East investments…and the hedge fund in New York is just breaking even.

This kind of story is popping up more and more – clearly, China has widespread opportunities for investment right now…the question is: where, exactly, do you put your money? And how do you sift through the global market concerns to find good, solid investments?

Well, this year, at our annual Agora Financial Wealth Symposium, we are going to try and help answer any questions or concerns you may have about investing in the Far East. This year’s topic is “Rim of Fire: Crisis & Opportunity in the New Asian Era.” You can think of it as Basic Training for global investing. You’ll get a complete perspective on how a rare confluence of politics, business, globalization, and the age-old forces of supply and demand could make Asia the profit opportunity of a lifetime. And by the time you leave, you’ll be equipped with an array of strategies and specific actions you can take to start grabbing some of those profits for yourself.

[Ed. Note: The Symposium will be taking place at the beautiful Fairmont Hotel in Vancouver, British Columbia, July 24 – 27. And if you sign up now, you’ll receive the early bird special – $200 off the regular cost of admission.

Call Agora Travel at 800-926-6575 to be added to the list right away.]

*** And the opportunities for major gains don’t stop with just China – India is another influential player in the global economy right now. Again, the question remains – how do you profit?

Why not put everything you learned at this year’s Agora Financial Wealth Symposium to the test? Join Addison and Mt. Vernon Research Investment Director, Karim Rahemtulla on The Asian Tiger Investment Tour of India.

This tour, which will take place October 25 – 27, will take you through the major business hubs in India – Mumbai, Hyderabad, Bangalore…and more. You’ll travel with your experienced hosts in first-class style, staying at the finest hotels and enjoying some of the best food India has to offer – all the while learning how to position yourself to profit in Asia.

Secure your seat now – call Agora Travel at 800-926-6575, or email at

*** The dollar! Is anyone paying attention? The greenback is slipping. But in all the commotion hardly anyone seems to notice. We checked this morning and found the euro priced at nearly $1.33.

What could go wrong? Well, the dollar could continue slipping.

Now, let us imagine that you have the world’s biggest stash of money, which today is more than $1 trillion. No one ever had such a big pile. But let us imagine that the money isn’t really yours. You have been put in to manage it on behalf of the People’s Republic of China. And if you lose it, the people aren’t going to be very happy.

Now, about 70% of that money – $700 billion or so – are in dollars.

You have already gone on record as saying you intended to diversify out of dollars. You expect to do it in an orderly way. But with the dollar going down, you realize that when you finally do diversify you’re going to get less for your dollars than you could get now. In fact, if the dollar falls 5 cents against the euro, you have effectively lost 5% of your dollar holdings – or $35 billion. Hmmmm…what will the people say?

What if the dollar goes down 10%? Hmmm…now you’re talking serious money.

Of course, this is not the first time we have posed this question: Why don’t the people with serious money at stake move to protect themselves? And how come the dollar has, so far, resisted our predictions. With a current account deficit at 6% of GDP, it seems obvious that the dollar must fall. So must it fall when the carry traders unwind their trades. Many borrowed yen to buy dollars. When they get out of their positions they will have to sell dollars and buy yen. The dollar should fall. But it doesn’t. Or it hasn’t. Yet.

There is always tomorrow. Time will sort it out.

The Daily Reckoning