Animal spirits alright

Risk markets are all booming this morning with the next 600 billion instalment of the Bernanke put meeting its stated aim to “buoy animal spirits”.
It's every person for themselves. Whether and how much caution to throw to the wind here is a personal choice. Market prices were historically expensive and over bought leading into yesterday's fed magic, the higher prices go in the next little while, the higher the risk to capital; that's just the way it is. For some the thought of missing out on interim rallies is agony. I understand the temptation. In the end though, the test is not an interim ride, all's only well that end's well, and this latest government-goosed bubble is destined to end just as badly as the last several they have engineered. Extreme care is warranted.
The US is following the same path as Japan. The facts speak for themselves as pointed out by Japanese economist Richard Koo in this presentation he gave in April 2010. Here are the charts he references in this clip.

The bottom line is that debt-aversion today is a societal shift that will be with us for another 10 years at least. Asset bubbles driven by credit bubbles end in balance sheet recessions and massively deflated asset prices that grind down over a period of many years. This has been the aftermath of Japan since 1989. It was also the aftermath of the land and stock bubbles that burst in 1929. A similar cycle to these is playing out on a global basis today across all asset classes from stocks, real estate, commodities, gold and bonds.
A key difference for Japan was that Japanese people and institutions held the bulk of their debt coming into the bust domestically. Foreigners hold the bulk of US debt. This means that although the US would prefer to inflate their way out of debt and debase the dollar to do so, they actually cannot afford to heavily debase the dollar without prompting a rebellion in their foreign lenders that would force up US interest rates at a time when the government and economy have no ability to pay higher rates. This is why I think the US dollar may prove more resilient than many predict in the end.
As for all the China bulls drooling over insatiable demand stories there, see this excellent presentation by Vitaliy Katsenelson: China- the mother of all grey swans and Japan- past the point of no return.

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2 Responses to Animal spirits alright

  1. Anonymous says:

    According to ECRI, the business cycle is way bigger than the Fed.
    Ultimately the cycle will decide about the direction, like always.

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