The Treasury bubble is likely to be much less destructive than the Internet and Housing Bubbles.
The bubble in the US dollar, however, if one wishes to consider it as an adjunct or outcome of the bubble in Treasuries, has the potential to be disruptive and devastating
Reuters
Buffett says U.S. Treasury bubble one for the ages
By Jonathan Stempel
Sat Feb 28, 2009 9:31pm GMT
NEW YORK (Reuters) - Warren Buffett, whose Berkshire Hathaway Inc. sits on $25.54 billion (17.8 billion pounds) of cash, said worried investors are making a costly mistake by buying up U.S. Treasuries that yield almost nothing.
In his widely read annual letter to Berkshire shareholders, the man many consider the world's most revered investor said investors are engulfed by a "paralyzing fear" stemming from the credit crisis and falling housing and stock prices. Treasury prices have benefited as investors flocked to the perceived safety of the "triple-A" rated debt.
But Buffett said that with the U.S. Federal Reserve and Treasury Department going "all in" to jump-start an economy shrinking at the fastest pace since 1982, "once-unthinkable dosages" of stimulus will likely spur an "onslaught" of inflation, an enemy of fixed-income investors.
"The investment world has gone from underpricing risk to overpricing it," Buffett wrote. "Cash is earning close to nothing and will surely find its purchasing power eroded over time."
"When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s," he went on. "But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."
DISMAY OVER MORTGAGE PRACTICES
Investors' flight to quality followed years of excessive borrowing, especially in housing, and Buffett used his letter to make plain his dismay with a variety of mortgage lenders.
He said many ignored Lending 101 by not checking customers' ability to pay off home loans, or foisting "teaser" rates that reset to higher unaffordable levels.
In contrast, Buffett said, Berkshire's manufactured housing unit Clayton Homes had a 3.6 percent foreclosure rate at year end on loans it made, up from 2.9 percent in 2006, though more than one in three borrowers had "subprime" credit scores. The unit was profitable in 2008, earning $206 million before taxes, though earnings fell 61 percent, Berkshire said.
"The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability," Buffett wrote. "Home purchases should involve an honest-to-God down payment of at least 10 percent and monthly payments that can be comfortably handled by the borrower's income. That income should be carefully verified."
28 February 2009
The Bubble In US Treasuries and Its Implications
13 February 2009
31 December 2008
The Fuel for a Speculative Rally but Not a Recovery
At some point we may stop confusing asset bubbles with economic growth.
In the meantime, we might expect the shallow and immature stewardship of the economy to continue, unreformed and unconstrained. We may get quite a bear market rally in the first quarter of 2009. Whether it is the bottom or a bottom will remain to be seen.
Without a sustained increase in the median hourly wage and significant reform in the financial system and a sustainable construct for international currency exchange and trade there can be no sustained recovery in the real economy.
Excess liquidity and a corrupt financial system provides the fuel for a speculative rally, but it is also the fuel for a greater crisis to come, the longer we maintain this monetary charade. The Fed is pouring gasoline on damp wood.
Still, we ought not to underestimate the power of the Fed, having recently witnessed a counter trend reflationary rally after the Crash of 2000-2 that lasted three years and reached new stock market highs, and a housing bubble that almost crashed the world economy. They appear to have a lot of fuel, from a variety of unconventional sources, and Bernanke has the willingness to use it.
Cash at 18-Year High Makes Stocks a Buy at Leuthold
By Eric Martin and Michael Tsang
Dec. 29 (Bloomberg) -- There’s more cash available to buy shares than at any time in almost two decades, a sign to some of the most successful investors that equities will rebound after the worst year for U.S. stocks since the Great Depression.
The $8.85 trillion held in cash, bank deposits and money- market funds is equal to 74 percent of the market value of U.S. companies, the highest ratio since 1990, according to Federal Reserve data compiled by Leuthold Group and Bloomberg.
Leuthold, Invesco Aim Advisors Inc., Hennessy Advisors Inc. and BlackRock Inc., which together oversee almost $1.7 trillion, say that’s a sign the Standard & Poor’s 500 Index will rise after $1 trillion in credit losses sent the benchmark index for American equities to the biggest annual drop since 1931. The eight previous times that cash peaked compared with the market’s capitalization the S&P 500 rose an average 24 percent in six months, data compiled by Bloomberg show.
“There is a store of cash out there that is able to take the market higher,” said Eric Bjorgen, who helps oversee $3.4 billion at Leuthold in Minneapolis. “The same dollar you had last year buys you twice as much S&P 500 as it did a year ago.”
Leuthold Group, whose Grizzly Short Fund returned 83 percent in 2008 thanks to bets against equities, said in its December bulletin to investors that stocks offer “one of the great buying opportunities of your lifetime...”
The ratio of cash on hand to U.S. market capitalization jumped 86 percent in the first 11 months of the year, the biggest increase since the Fed began keeping records in 1959, as the U.S., Europe and Japan fell into the first simultaneous recessions since World War II.
So-called money of zero maturity, the central bank’s measure of U.S. assets available for immediate spending, is mostly held by households, according to Richard G. Anderson, an economist at the Federal Reserve Bank of St. Louis....
Any recovery will depend on a rebound in corporate profits and the economy after $30 trillion was wiped out from world equities this year, according to Frederic Dickson, chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. (At that's the rub, a speculative rally fueled by excess liquidity will fizzle and die if it is not accompanied by a recovery in real corporate profits, and that depends on an increase in consumption that is not dependent on additional consumer debt - Jesse)
Jobless claims reached a 26-year high this month, while economists surveyed by Bloomberg estimate household spending will fall 1 percent next year, the most since the aftermath of the attack on Pearl Harbor. A 13 percent slump in the median home resale price in November from a year earlier was likely the largest since the 1930s, the National Association of Realtors said last week, damping speculation the housing market is close to a bottom.
‘Biggest Cannon’
Analysts estimate profits at S&P 500 companies will shrink 10.3 percent in the first three months of 2009 and 5.8 percent in the second quarter, bringing the stretch of earnings declines to a record eight quarters, Bloomberg data show. Gross domestic product will contract in the first half of the year before growth resumes in the third quarter, according to a Bloomberg survey of economists.
“The fuel supply is there, but people have to have a reason to use it,” said Dickson, who helps oversee about $19 billion. “The Fed fired the shot out of the biggest cannon they know. Now the question is, will it hit the right mark?”
This year’s slump has left S&P 500 companies valued at an average of 12.6 times operating profit, the cheapest since at least 1998, monthly data compiled by Bloomberg show...
The last time cash accounted for a larger proportion of market value was 1990. The ratio peaked at 75 percent in October of that year, after the savings and loan industry collapsed, Drexel Burnham Lambert Inc. was forced into bankruptcy and the U.S. fell into a recession. The S&P 500 rallied 23 percent in six months and almost 30 percent in a year...
31 October 2008
Avoiding a Great Depression: Rescue, Rebalance, Reform
The 1920's were marked by a credit expansion, a significant growth in consumer debt, the creation of asset bubbles, and the proliferation of financial instruments and leveraged investments. The Federal Reserve expanded the money supply and the Republican government pursued a laissez-faire approach to business.
This helped to create a greater wealth disparity, and saddled a good part of the public with debts on consumables that were vulnerable to an economic contraction.
The bursting of the credit bubble triggered the stock market Crash of 1929. The Hoover administration's response was guided by Secretary of the Treasury Andrew Mellon. As noted by Herbert Hoover in his memoirs, "Mellon had only one formula: 'Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.'"
Indeed, the collapse of consumption and credit, and the ensuing 'do nothing' policy of liquidation by the government crippled the economy and drove unemployment up to the incredible 24% level at the climax of the liquidation and deleveraging.
Although some assets fared better than others, virtually everything was caught up in the cycle of liquidation and everything was sold: stocks, bonds, farms, even long dated US Treasuries, all of them collapsing into the bottom in late 1932.
The Federal Reserve made tragic policy errors most certainly with regard to interest rates. They were hampered by a lack of coordinated effort because of the official US policy focus on liquidation and non-interference, along with mass bank failures which rendered their attempts to reflate the money supply as largely futile.
Thrifty management of the credit and monetary levels when the economy is balanced in the manufacturing, service, export-import, and consumption distribution levels is a good policy to follow.
But good policies applied with vigor during a period of economic illness may be like forcing patients seriously ill with pneumonia to swim laps and run in marathons because you think such physical activity is inherently good and beneficial in itself at all times.
Additionally, monetary expansion alone also does not work, as can be seen in the early attempts by the Fed to expand the monetary base without policy initiatives to support expansion and consumption. Hoover's administration raised the income tax and cut spending for a balanced budget.
A combined monetary and government bias to stimulating consumption while restoring balance and correcting the errors that fostered the credit bubble is the more effective course of action.
Today it seems to us that the Fed and Treasury are trying to cure our current problems by filling the banks full of liquidity with the idea that it will eventually trickle down to the real economy through their toll gates.
We believe this will not work. The financial system is rotten, and not only in its toxic and fraudulent assets. It is a weakened, rotten timber that will provide scant leverage for the rescue attempts.
Better to cauterize the bleeds in the financial system and assume a 'trickle up' approach by reaching the econmy through the individual rather than the individual through the banks.
Provide secure FDIC insurance to everyone to a generous degree , and let those banks who must fail, fail. You will encourage reform and savings, we guarantee it. Stimulate work and wages, and then consumption, and the financial system will follow.
While the financial system as it is constituted today remains the centerpiece of our economy, we cannot sustainably recover since it is a source of recurring infection.
Globalists like to cite the introduction of the Smoot-Hawley tariffs as a major factor in the development of the Great Depression. This appears to be largely unsubstantiated, and attributable to a dogmatic bias to international trade as a panacea for failing domestic demand.
In fact, before Smoot-Hawley both exports and imports were in a steep decline as consumption collapsed around the world. If the US had declared itself open for free trade, to whom would they sell, and who in the US would buy? Consumption was in a general collapse around the world. Smoot Hawley did not help, but it also did not hurt because it was largely irrelevant.
It is a lesser discussed topic, but the US held the majority of the gold in the world in 1930 as the aftermath of their position as an industrial power in World War I and the expansion that followed. Since the majority of the countries were on some version of the gold standard, one could make a case that the US had an undue influence on the 'reserve currency of the world' at that time, and its mistaken policies were transmitted via the gold standard to the rest of the world.
The nations that exited the Great Depression the soonest, those who recovered more quickly and experienced a shallower economic downturn, were those who stimulated domestic consumption via public works and industrial policies: Japan, Germany, Italy, Sweden.
As a final point, we like to show this chart to draw a very strong line under the fact that the liquidationist policy of the Hoover Administration caused most assets to suffer precipitous declines. Certainly some fared better than others, such as gold which was pegged, and silver which declined but not nearly as much as industrial metals and certainly financial instruments like stocks which declined 89% from peak to trough.
FDR devalued the dollar by 40%, but he never followed Britain off the gold standard, maintaining fictitious support by outlawing domestic ownership. As the government stepped away from its liquidationist approach the economy gradually recovered and the money supply reinflated, despite the carnage delivered to the US economy and the world, provoking the rise of militarism and statist regimes in many of the developed nations.
There is a fiction that the economy never really recovered, and FDR's policies failed and only a World War caused the recovery. In fact, if one cares to look at the situation more closely, the recession of 1937 was a result of the aggressive military buildup for war in the world, the diversion of capital and resources to non-productive goods and services, and of course the general reversal of the New Deal by the US Supreme Court and the Republican minority in Congress.
As an aside, it is interesting to read about the efforts of some US industrialists to foster a fascist solution here in the US, as their counterparts and some of them had done in Europe.
What finally put the world on the permanent road to recovery was the savings forced by the lack of consumer goods during World War II and the rebuilding of Europe and Asia, devastated by war, significantly aided by the policies of the Allied powers.
A Depression following a Crash caused by an asset bubble collapse is a terrible thing indeed. But it does not have to be a prolonged ordeal.
Governments can and do make policy errors that prolong the period of adjustment, most notably instituting an industrial policy that discourages domestic consumption and money supply growth in a desire to obtain foreign reserves through exports.
From what we have seen thus far, we believe that the Russian experience in the 1990's is going to be closer to what lies ahead for the US. Unless the US adopts an export driven, low domestic consumption, high savings policy bias, non-productive military buildup and public works, and discourages population growth we don't believe the Japanese experience will be repeated.
Preventing the banking system from collapsing is a worthy objective. Perpetuating the symptom of fraud and abuse and 'overreach' that was becoming pervasive in the system before the collapse is not sustainable, instead leading to more frequent and larger collapses.
Balance will be restored, and a reversion to the means will occur, one way or the other. It would be most practical to accomplish this in a peaceful, sustainable manner, with justice and toleration.
