Bubble, Bubble, Toil, and Trouble

The 'Helicopter Economics Guide Investing' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The Subprime Crisis that began causing turmoil in the U.S. markets in July 2007 was merely a small part of a massive and pervasive credit bubble that reached into every nook and cranny of the U.S. financial system. A huge excess in credit had been extended and utilized everywhere and to almost everyone. Government, consumers, market players, and businesses had borrowed beyond the hilt to maintain a system that required an ever-increasing amount of credit to sustain itself. Subprime debt was merely the weakest link in this credit chain, so it broke first.

The origins of the subprime bubble can be traced back to events in the 1980s, Early in the decade the idea that less regulation of financial institutions was a good idea took hold. The Savings and Loan industry was deregulated and it turned into a monumental failure that wound up costing the U.S. taxpayer $200 billion because of the out of control corruption, theft, and financial incompetence that deregulation allowed to occur. Nevertheless, deregulation of the financial industry continued and regulation of financial instruments such as derivatives or new industry players, such as hedge funds did not take place because 'regulation was too costly'. Federal Reserve chair Alan Greenspan was generally opposed to regulation and not only did everything possible to prevent new regulations, but didn't utilize the Fed's existing powers to regulate during the years he controlled the Fed from 1987 to 2006.

Decreasing regulation was then combined with a huge increase in liquidity provided by the Federal Reserve. This process began during the 1987 stock market crash, which Alan Greenspan handled successfully with a sharp drop in interest rates and by pumping money into the financial system. This set the tone for the next 19 years of the Greenspan Fed. In order to bailout the U.S. banking system from the Savings and Loan Crisis, interest rates were lowered
too much and for too long in the early 1990s. This excess in liquidity in turn led to the stock market bubble later in the decade. When the tech-stock bubble collapsed, interest rates were eventually lowered to one percent and this inflated a real estate bubble - something that Greenspan continually denied existed.

The conditions that led to these bubbles were no different than the ones the created all bubbles throughout history. Declining yields combined with an excess of capital (both are created simultaneously by the Fed), lack of regulation which allows for widespread fraud and corruption, and a technical or financial innovation. In the case of the tech stock bubble, the Internet was the technical innovation and for the real estate bubble, it was packaging subprime loans into bonds which could be sold, transferring the risk to other parties and providing capital to make more loans. As more and more loans were made, the quality of those loans by necessity deteriorated.

Bubbles always have feedback mechanisms as well and once started they become almost impossible to stop until they burst. Once they burst however, an anti-bubble forms with the original feedback mechanism operating in reverse. This anti-bubble in itself becomes almost impossible to stop until it exhausts itself. The feedback mechanism is what allows prices in bubbles to go way beyond anything reasonable or even imaginable when they start and then to the drop on the downside to levels that are incredibly low.

Ben Bernanke was desperately trying to reflate the real estate centric bubble with his rates cuts in the fall of 2007. This was a hopeless task, since once a bubble begins collapsing it usually takes many, many years before it can be reflated. What does occur is another bubble gets created elsewhere in the financial system. The Bernanke bubble would turn out to be in inflation.

Next: China's Olympic Size Bubble

Daryl Montgomery
Organizer, New York Investing meetup

Please see our web site for more about us: http://investing.meetup.com/21

The Markets React to Helicopternomics and so does New York Investing

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The U.S. Federal Reserves 50 basis point rate cut on September 18, 2007 would prove to be a seminal event in U.S. economic history. As is the case for many actions that have potentially disastrous impacts, there was a swift and stupendously negative reaction after the Fed lowered rates. It was clear immediately to almost everyone except the Fed and its Wall Street supplicants that the rate cut decision had been the wrong one.

Starting that day, the trade-weighted dollar (the value of the dollar against the currencies of the Americas largest trading partners) already down 33% from its peak level during the Bush administration, started selling off and looked like it was setting itself up for a potential collapse. On the Monday following the Fed’s move, the U.S. dollar hit the first of a series of all time lows By the end of September, the value of dollar would be down against almost every currency on the planet, including the Philippine peso, the Brazilian real, the Turkish lira and the Botswanan pula. People everywhere were desperate to get rid of their dollars and even preferred to hold currencies from countries that had previously been so monetarily irresponsible that they had experienced hyperinflation.

In the future, people would see this episode as the beginning of the end of the U.S. dollar as the reserve currency for the world. Years of excessive government, consumer and business borrowing and irresponsible U.S. monetary policy were finally turning the dollar into a currency that people wanted to avoid rather than hold. Loss of reserve currency status would be definitive once the world oil producers stopped pricing their wares in dollars. While this was still some time in the future, the inevitability of this outcome had now become a certainty.

The fallout from the Fed's monetary easing was unfortunately not limited to its impact on the U.S. currency. The falling dollar acted as the spark that ignited a rally in the commodity markets. Since most commodities were priced in dollars, everything else being equal, their prices had to go up as the dollar fell. A large basket of commodities tracked by the CRB index rallied over 8% during the month of the Fed rate cut, the biggest such increase since the high-inflation 1970s. It was perhaps even more disturbing that the commodities most sensitive to inflation, gold and oil, had some of the strongest rallies. Only three days after the Fed’s cut, gold hit a 27-year high. Oil hit a series of all time highs breaking through $80 a barrel and then $90 a barrel only weeks later. Most investors were so euphoric at the Fed’s largess to Wall Street, that they failed to notice that the markets were not just saying there was serious inflation on the horizon, they were screaming it.

The seriousness of the damage the Fed was causing and was intending to cause to the U.S. economy motivated the New York Investing meetup to spread it's message beyond its membership. After the September Fed meeting, New York Investing did its first videos on the topics of inflation and the falling dollar (See, "Protecting Yourself From Inflation and the Credit Bubble", http://www.youtube.com/watch?v=2d8k75N0qpA). The first of these five videos were done with Alex Paul Morris from MoMoney.TV interviewing organizer Daryl Montgomery. Subsequently, the New York Investing meetup would do its own videos and publish them on You Tube and in a number of other venues.

Next: More Collateral Damage from the Fed's First Helicopter Drop

Daryl Montgomery
Organizer, New York Investing meetup

For more information about the New York Investing meetup, please go to: http://investing.meetup.com/21

Bernanke Gets in His Heliocopter and Does His First Money Drop on Wall Street

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

On August 17th 2007, one hour before stock futures expired, the Fed announced a surprise cut in the discount rate beginning a new cycle of easing. While allegedly meant to help the financial system, which was reeling from the fallout from the subprime crisis, the immediate purpose of the Fed's action was to prop up a teetering U.S. stock market (it was not clear that even at this
point Bernanke and the FOMC realized how serious the subprime contagion was). There had been a mini-crash in Japan the night before and stock futures were pointing to a large drop in the U.S. markets.

The Fed's announcement of it's discount rate cut had the desired impact. Stocks futures on the Dow rallied multi-hundreds of points by the opening, wiping out the profits of the shorts and transferring that money to the sellers of the future's contracts (could this huge transfer of wealth have been a gift from Bernanke to the broker-dealers?). If the Fed had waited one hour for its announcement, there of course would have been no difference in the impact of the discount cut on the economy, but the impact on markets would have been considerably different. The message to market participants was quite clear, from now on the Fed will be trading against the shorts and its actions can wipe you out whenever we chose to do so. By February 2008, the New York Investing meetup would document approximately a dozen times when the Fed engaged in similar extralegal activity in the U.S. stock markets ( put on video , which can be found at: http://www.youtube.com/watch?v=Sobq7wCXjUw). This of course leads to the obvious question, "When a powerful government agency like the Federal Reserve acts outside the law, who is going to stop it?" Based on recent history, apparently no one.

The U.S. Federal Reserve under Bernanke was not the first central bank to try to manipulate the stock market, nor was Bernanke the first Fed chair to engage in this behavior. Greenspan himself was not above using Fed policy to drive the markets up, but he would let the markets reach some clearing price first before stepping in. He would not try to use Fed policy to prevent the markets from selling off, the crude approach clearly being used by Bernanke, realizing how risky this this could be for the financial system. It was in fact, Greenspan's policy of doing away with Fed secrecy that opened the way for Federal Reserve manipulation of the U.S. stock market. Once the markets knew instantly what the Fed was doing, traders would adjust their actions just as quickly instead of over a longer period of time as people gradually figured out that the Fed had made a significant rate move as had been the case in the past.

Perhaps the most egregious example of stock market manipulation in the recent times was by the Japanese financial authorities in the late 1980s and early 1990s. While interference in the free operation of the stock market, was beneficial in the short-term, the consequences in the long-term proved disastrous. A buy and hold strategy in Japanese stocks would have earned an investor nothing from 1992 to 2007. A similar result in the U.S. stock markets from 2007 to 2222 would mean the huge population of Baby Boomers retiring in that time period and counting on stock market gains to fund their retirement would be in for a very rude awakening.

Perhaps, the ancient Greeks had it right after all, when those in power acted like the gods, a tragic ending was always inevitable.

Next: Bernanke Shoots the Dollar Down; New York Investing Predicts Out of Control Inflation

Daryl Montgomery
Organizer, New York Investing meetup

For more about the New York Investing meetup, please go to our web site: http://investing.meetup.com/21