New Bubbles Are Brewing in Shanghai and on Wall Street

Since the historic 1987 stock market crash, the Federal Reserve has responded to every recession in the US economy by slashing interest rates, and funneling massive amounts of money into the hands of Wall Street’s aristocracy, - the ruling class that dominates the two political parties in Washington. The Fed’s cash injections have usually found their way into assets, including commodities, stocks, and mortgage-backed securities, and often fueling speculative binges into stratospheric heights.

But on March 12^th, US President Barack Obama warned a group of chief executive officers of the Business Roundtable, that the Fed “can’t continue with its policies of endless cycles of bubble and bust, and instead, must build a new foundation for future economic growth.” Obama blamed the lingering banking crisis on “reckless speculation and spending beyond our means, on bad credit, inflated home prices, and over-leveraged banks. Such activity isn’t the creation of lasting wealth. It’s the illusion of prosperity, and it hurts us all in the end,” Obama warned.

“We cannot settle for a return to the status quo. We must put an end to the reckless speculation, spending beyond our means; bad credit, over-leveraged banks, and the absence of oversight that condemns us to bubbles that inevitably bust,” Obama added. Yet only a few days earlier, Obama exerted maximum pressure on the Financial Accounting Standards Board (FASB) to let Wall Street bankers set their own prices for toxic assets in earnings reports, regardless of market prices.

By suspending the so-called “mark to market” accounting rules, concerning the value of toxic securities they hold, FASB’s new guidance would allow American banks to value assets using their own internal “mark-to-myth” models.This is, in fact, is the creation of a loophole allowing bankers to conceal their true losses and cook their financial books. By allowing the banks to claim their assets as fundamentally sound, the ruling elite expect the panic selling in the stock market will subside, banks will start lending again, and the US-economy will gradually recover.

So far, all the measures taken by Obama’s economic team in response to the financial crisis, have pointed their aim at protecting the wealth of the Wall Street aristocrats.Treasury Secretary Geithner announced a scheme to enable the banks to offload their toxic assets by subsidizing hedge-funds and private-equity firms to purchase them at inflated prices, using hundreds of billions of taxpayer money to cover any losses, and insure double-digit profits for the speculators.

The masters of Wall Street erupted into great euphoria and jubilation over the death of FASB #157, and Geithner’s scheme to loot taxpayer funds and offload the toxic assets of the financial oligarchs, - creating illusions of new found wealth. Obama himself went a step further to reassure the Wall Street titans, by quietly killing a bill passed by the House of Representatives that would have taxed 90% of the bonuses of wealthy executives and traders at AIG and other bailed-out firms.

By obscuring the accuracy of bank balance sheets, mixed with the Fed’s zero-percent interest rate policy, and the hallucinogenic “Quantitative Easing” drug, traders are taking collective leave of their senses, succumbing to delusions of ever-expanding wealth, and actively participating in the creation of new bubbles. And by definition, market bubbles can expand much farther than most traders can imagine.

Nobody bothered to ask how Wells Fargo (WFC) could post a record $3-billion profit in the first quarter, at a time when one in eight US-homeowners with mortgages, are behind on their loan payments, or in the foreclosure process as job losses intensifies, and California home prices are 40% below their peak levels. Instead, operating under the illusions of “mark-to-myth” accounting, and the hallucinogenic “QE-drug,” administered by the Fed, hedge-fund traders accepted the WFC earnings report at face value, bidding its share price 30% higher.

Former Fed chief “Easy” Al Greenspan and his prototype, Ben “Bubbles” Bernanke, hold the view that deliberate bubble-bursting is something between impossible and dangerous, and thus, is best avoided. The Fed is inherently opposed to hiking interest rates, to prevent bubbles from arising in the first place. Instead, the Fed allows stock market bubbles to inflate into the stratosphere, and patiently waits for the bubbles to burst under their own weight. Afterwards, the Fed moves to cushion the meltdown, by slashing interest rates and flooding the banking system with liquidity, - the infamous Bernanke / Greenspan Put.

The Fed operates under the belief that wealth in an asset-based economy is created by massively inflating the money supply and pumping-up the value of financial or tangible assets. Today, the Fed has joined the Bank of England and the Bank of Japan in printing trillions of British pounds, yen, and US-dollars in part, under the radical “Quantitative Easing” framework, designed to monetize their respective government’s debt, which in part, is used to bail-out the financial aristocracy.

Central bankers inflate bubbles in order to give households a fresh sense of wealth, encouraging them to borrow and spend more, and businesses to boost investments. The strategy is built around the massive expansion of the money supply. There are generally two types of bubbles, firstly, speculative excesses fueled by irresponsible bank lending. The second type of asset bubble is one in which bank lending plays a minor or no role at all, - usually related to the introduction of new technology or rapid industrialization that promises untold riches.

The Nasdaq high-tech stock bubble is an example of this second type. So was the spectacular run-up in the Shanghai red-chip index, which soared four-fold in 2007, mirroring China’s rapid accession as the world’s third largest industrial power and the biggest exporter. China’s vast manufacturing sector employs tens of millions of workers and functions as the cheap labor workshop for Asian and Western companies, and is the biggest customer for Australian and Brazilian miners.

But it’s the first type of bubble which Beijing is busy inflating right now, - with the ruling Politburo ordering its state-owned banks to lend yuan aggressively. China’s central bank said on April 12^th, it will ensure massive liquidity to sustain economic growth, squashing speculation that regulators might try to restrain bank lending that could lead to bad debts and asset bubbles. Chinese banks extended 1.9-trillion yuan in local currency loans in March, bringing the first-quarter total to 4.6-trillion yuan, ($585-billion), larger in size than Beijing’s 4-trillion fiscal spending plans.

In turn, explosive lending in China has fueled the explosive expansion of the Chinese M2 money supply, now standing +25.5% higher than a year ago, its fastest growth rate in 12-years. With the blessing of Beijing, much of this money is funneled into Shanghai equities and the property markets, thereby inflating prices. The combined fiscal and monetary stimulus, equaling about 30% of China’s GDP, is widely expected to lift the local economy out of its deep slump, through the traditional strategy of inflating market bubbles and indirectly boosting household wealth.

Indeed, China’s industrial output rebounded to an annualized +8.3% growth rate in March, from a record low of +3.8% in the first two months of the year, adding to evidence that Beijing’s stimulus plans, are starting to take effect. Still, China’s factory sector is structurally dependent on exports and therefore, highly vulnerable to any downturn in foreign demand, which is beyond Beijing’s control.

In fact, the spectacular growth of China might not have been possible without the massive expansion of household debt in the United States. But this growth of debt, which sustained the US-economy and global demand for 15-years, is de-leveraging, and morphing into the biggest banking crisis since the 1930’s. As a result, China's vast export machine is grinding to a halt. Without the government’s stimulus measures, the predicted growth rate for China would be closer to 2% this year.

So far, some of the big the winners from China’s massive stimulus plans are skilled operators in copper futures and base metal miners. Copper stockpiling by the secretive Chinese Reserves Bureau is rumored to reach 300,000-tons this year. China’s imports of the red-metal jumped 71% to 451,400-tons in the first two months from a year ago, customs data showed. On the Shanghai Futures Exchange, copper futures are up 85% above December’s lows. Meanwhile, copper inventories in Shanghai warehouses have dropped to dangerously low levels at 18,766 tons, prompting a fresh wave of arbitrage buying in London.

China is also riding to the rescue of the American farmer. In Chicago, soybean futures have jumped 15% over the past four-weeks, to $10.35 /bushel, whetted by China’s voracious appetite. Beijing confirmed that it bought 3.86-million tons of soybeans in March, up +66% from a year earlier, and the second highest monthly tally ever. More than half of this week’s US-exports, 10.4-million bushels, are headed to China. This comes at a time when US soybean stockpiles are projected to reach a five-year low of 165-million bushels this summer.

The PBoC is engineering a vast expansion of money and credit, to bolster its economy, and taking advantage of a narrow window of opportunity, - the collapse of factory-gate inflation, which is -10% lower than a year earlier. The stunning collapse of a broad array of commodity prices, including crude oil, gasoline, kerosene, diesel, base metals, food and clothing, provides the necessary cover for the PBoC’s massive money printing operations, - the traditional antidote for warding-off deflation.

The PBoC last cut its key one-year lending rate to 5.31% on Dec 22^nd, still much higher in inflation-adjusted terms than those pegged by G-7 central banks. The PBOC cut rates five times since September and reduced bank reserve requirements four times. It has also abolished credit quotas, triggering a surge in bank lending in support of the government’s 4-trillion yuan fiscal stimulus package.

With its command and control over the Chinese banking network, the PBoC has demonstrated its ability to burst bubbles in the Shanghai stock market, as it did last year, hammering the red-chip index 75% below its October 2007 peak. Now, the PBoC is printing money at a feverish pace, to re-inflate the stock market, endorsed by Premier Wen Jiaboa, claiming that China’s economy is on the road to recovery. What is involved here is an attempt to equate a rising stock market with economic recovery, even as unemployment continues to rise, and exports fall.

So far, China’s lending boom and efforts to re-inflate the Shanghai red-chip bubble, has coincided with its stockpiling of copper and soybeans. The Shanghai Index closed at 2,513-points, it’s highest since August, with over thirty Shanghai-A shares soaring by their 10% daily-limit, a sign that speculators, brimming with cheap bank loans, are returning to the roulette-table. Wuhan Steel and China Cosco both leapt 10%, as strong economic data configured by Beijing’s apparatchik’s stirred optimism.

Trade data released on April 10^th, was also of great interest to Nymex oil traders, - China imported 16.3-million tons of crude oil in March, up 33% from February’s 11.7-million tons. According to a three-year plan designed by the National Energy Administration, China’s stimulus plan would include building large oil and natural gas refineries, increasing its total oil refining capacity to 440-million tons by 2011, which might also be a prelude to national stock building of energy fuel.

But optimism for a Chinese-led crude oil rally, was delayed by an IEA report, predicting that world oil demand would fall 2.4-million bpd to 83.4 million bpd in 2009, the biggest annual contraction since the early 1980’s. Chinese demand for crude oil is expected to fall 1% this year, the first decline in decades. By all indications however, the IEA’s estimate of future oil demand is probably off-the mark, judging by the failure of OPEC to jig the market higher.

The OPEC oil cartel has slashed its output by 3.4-million bpd since August, but hasn’t gotten ahead of the supply curve, even with Mexican oil output slumping by 300,000-bpd from a year ago. Supply from OPEC members with output limits, is 880,000-bpd higher than their collective target of 24.8-million bpd.The biggest cheater within the oil cartel is Iran, pumping 400,000-bpd above its quota.

OPEC agreed on March 15^th to keep output quotas unchanged, as part of its effort to help mend the world economy. “We believe the global economy is still very weak,” noted Qatar’s Abdullah al-Attiyah on March 30^th. “The crisis has not reached the bottom so we have to be very careful. We are saying that $40-to-$50 /barrel is more pragmatic for the economic crisis. We cannot do more than that,” -- it doesn’t mean we are going to cut production in May,” he hinted.

US inventories of unsold crude oil are bloated at 361-million barrels, their highest levels since July 1993, weighing down on oil prices. US-oil demand in January was 989,000 bpd less a year earlier, tumbling to 19.1-mil bpd. In Japan and Korea, the world’s third and fifth largest energy importers, crude inventories have also risen due to the worst recession since WWII. Explaining oil’s rebound from $35 /barrel to around $52 /barrel today, Qatar’s al-Attiyah said. “The current oil price is not related to demand and supply - it is higher mainly because of a weak US-dollar.”

And while Beijing is calling on the G-20 to replace the US-dollar as the world reserve currency, the Chinese central bank is simultaneously printing vast quantities of yuan. The rapid expansion of Chinese M2 is buoying gold prices in Shanghai, since the Chinese yuan has no intrinsic value whatsoever, but for the fact that it has been decreed as legal tender. Instead, Chinese traders confronted with limited choices, are bidding-up Shanghai red-chips, even at a time when industrial profits are 37% lower in Q1, compared a year ago. Traders are intoxicated by bubble-mania, and acting out of fear of the inflationary impact of the PBoC’s printing press.

Shanghai gold traders are waiting to find out if Obama’s economic team will label Beijing as a currency manipulator, in the next semi-annual US-Treasury Department report. “I recognize that China’s currency manipulation and domestic subsidies give it an unfair trade advantage and has led to US- job losses. I am committed to tackling this problem and ensuring that all trade manipulations are addressed by the US government,” Obama said rhetorically ahead of the Nov 4^th election.

But given America’s desperate fiscal condition, Obama needs to convince China to keep investing its foreign exchange reserves in US Treasuries in order to help finance the bailout of failing US-banks and pay for the $787-billion US stimulus package. Yet China’s financial security is increasing intertwined with US Treasury bonds, which are fast becoming a risky option, inflated within a bubble of gigantic proportions. It will be too late to leave the game of musical chairs, when China and Japan decide to stop buying or begin selling the US Treasury bonds. Someday, Beijing might take pre-emptive action to buy gold directly from the IMF, to re-balance its portfolio.

Comments

[Fighting Yoda:]

So many bubbles, so little time.

Apr 15 07:10 PM

[Ishortyou:]

shoot if the chinese or japs sell massively the us treasury bonds we are going to have a massive inflation the ying and yang would be unavoidable...god save us all....

Apr 15 07:14 PM

[Samuri:]

Your data is impressive and well presented but I think it is the underlying, barely perceived political and historical currents that are more important.

I can't think of, for example, three cultures that are more different from one another than China, Japan and America.

Not to mention India, Iran, Saudi Arabia, Russia and various European countries.

Clausewitz said that war is politics by other means and he might as well have said the same thing about economics.

But politics reflects underlying historical and sociological forces which represent human aspirations towards better (or worse) conditions.

We have to turn to world politics now in order to make sense of the economic tea leaves that you present us with in the form of your charts and data.

Apr 15 07:46 PM

[Alan Young:]

So, let me see if I got this right. China complains about the instability of the dollar, but buys more Treasuries anyway. Meanwhile they are busy printing more Renminbai even faster than Ben can re-load the helicopter.
Let me guess--are they paying for US bonds in newly-printed RMBs? If so, they are one move ahead in the chess game. No one is accusing them of being stupid.

Apr 15 10:31 PM

[buddhabill:]

Inflated dollars bought with inflated yuan and yen. Got gold? got copper? Got a 30 year fixed @ 5%?

Apr 16 12:19 AM

[hondaicivic:]

What do you mean one move ahead of the chess game?


On Apr 15 10:31 PM Alan Young wrote:

> So, let me see if I got this right. China complains about the instability
> of the dollar, but buys more Treasuries anyway. Meanwhile they are
> busy printing more Renminbai even faster than Ben can re-load the
> helicopter.
> Let me guess--are they paying for US bonds in newly-printed RMBs?
> If so, they are one move ahead in the chess game. No one is accusing
> them of being stupid.

Apr 16 02:44 AM

[Rokjok777:]

Superb. Thank you, Gary. Sometimes it's hard to see that the Emperor is naked these days. Keynes famously said "markets can stay irrational longer than you can stay solvent", and that's a real problem right now. The level of government and shadow-banking system manipulation is epic. Many, many false signals, impossible to separate signal from noise right now.

Apr 16 05:37 AM

[DONE_SONZ:]

Since the end of the gold standard,asset prices have gone thru the roof.Hello,there is the real problem.

Apr 16 07:56 AM

[Larry House:]

I am afraid our president wants to avoid bubbles by keeping a straggle hold on business and our country in debt. Growth will be nonexistant, hence no bubbles.

Apr 16 10:12 AM

[MGA_1:]

Tiny bubbles......

Apr 16 10:19 AM

[Dustinian:]

Bubbles are no problem...as long as we don't get swept away by enthusiasm and stop looking for the signs of a pop.

The price of market capitalism is eternal vigilance.

Apr 16 11:13 AM

[John Lounsbury:]

A new national anthem: "I'm Forever Blowing Bubbles"?

Apr 16 11:45 AM

[ArtfulDodger:]

We've all known for a long time that the Fed's printing phony money is building a pyramid.

Now that they're buying TNs, too, surely the anchor of the pyramid is nearly complete.

The trick for investors will be to know when to get out of dollar-denominated investments entirely.

However, if the Fed were to go back to its original 1913 mandate: to keep a steady interest rate and a steady flow of funds running into the system, then they might could turn things around.

But at this point does anyone think they're going to do that?

Thank you for the thought-wrenching article, GD.

Apr 16 05:04 PM

[Steven Hansen:]

another great piece. with the usa and uk QE'ing; the structural defect of the euro; and the general strength of the dollar - the only weapon china has is their printing press to weaken their currency to export.

this is a complicated chess game which most everyone will be a loser.

Apr 16 08:04 PM

[Jason Rines...:]

Correct. The war is over the international monetary peg prize. When Congress asked both Bernanke and Geitner if they would support a new international currency, they hesitated but said they would. Why? If Volker said that in the 1980's, what do you think the response of the House of Representatives and Ronald Reagan would have said about such statements? Not even a peep out of Congress. The reason is at this point the U.S. is living on borrowed time to retain the peg. Most of you know this but like watching a bad horror movie playing out it is somewhat surreal.

The East is buying all the commodities it can while the dollar is strong and they are applying the stimulus and the recent looted wealth from the West correctly.

When the treasury bubble begins successive downward slide, of course they will begin dumping treasuries as the bubble deflates. Why does the East need our service economy? So much cheaper to ship oil over land then to put it up on the world market and ship it West via boat. Why are the pirates suddenly becoming a problem that the West can't seem to fix? We can invade and conquer a nation almost the size of the U.S. in less then two months but the U.S. military cannot destroy a nest of pirates in Somalia? Please....

Some here believe they will have a grand old time in the East as the U.S. economy pops in one last final bubble and implodes. They are wrong. The trend is not our friend in terms of global military misadventures following global systemic events.


On Apr 15 07:46 PM Samuri wrote:

> Your data is impressive and well presented but I think it is the
> underlying, barely perceived political and historical currents that
> are more important.
>
> I can't think of, for example, three cultures that are more different
> from one another than China, Japan and America.
>
> Not to mention India, Iran, Saudi Arabia, Russia and various European
> countries.
>
> Clausewitz said that war is politics by other means and he might
> as well have said the same thing about economics.
>
> But politics reflects underlying historical and sociological forces
> which represent human aspirations towards better (or worse) conditions.
>
>
> We have to turn to world politics now in order to make sense of the
> economic tea leaves that you present us with in the form of your
> charts and data.
>

Apr 16 10:36 PM

[Jason Rines...:]

Ha! General MacArthur should have studied economics for he would have know what monetary lending model to use the nukes on. Who told U.S. politicians to strip the citizens of it's wealth and ship it East? Elections have consequences. So does not paying attention to them.


On Apr 16 09:17 PM The Geoffster wrote:

> Gen. MacArthur was right. We should have nuked the Chi-Coms when
> we had the chance.

Apr 16 10:41 PM

[auto44:]

I think they are paying in the dollars we spent there. I doubt the US government holds any chinese currency. I could be wrong but I am not aware of this. Cheers


On Apr 15 10:31 PM Alan Young wrote:

> So, let me see if I got this right. China complains about the instability
> of the dollar, but buys more Treasuries anyway. Meanwhile they are
> busy printing more Renminbai even faster than Ben can re-load the
> helicopter.
> Let me guess--are they paying for US bonds in newly-printed RMBs?
> If so, they are one move ahead in the chess game. No one is accusing
> them of being stupid.

Apr 17 08:32 AM

[auto44:]

BO COULDN'T FIND HIS ECONOMIC BEHIND WITH BOTH HANDS. HE SAYS WHAT THE TELEPROMPTER TELLS HIM AND IS LOST WITHOUT IT.


On Apr 16 10:12 AM Larry House wrote:

> I am afraid our president wants to avoid bubbles by keeping a straggle
> hold on business and our country in debt. Growth will be nonexistant,
> hence no bubbles.

Apr 17 08:36 AM

[ray b:]

An alternative conspiracy...
The amendment to the mark to market rules was to prevent discounting values of cash flowing assets to zero.
The Obama team aims to save the financial system, not to save wall street aristocats.
Bernanke increased the money supply to curb deflation.
China increased spending because of its high population growth rate.
China appreciates the soybeans of the American farmer, and feels it gets good value. The same with Australian copper.
Perhaps these good men from China and the US are doing their best to attempt to stabilize the world economies.

May 03 09:09 PM