The Roots of the Coming Crash 29 comments
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I’ve had a vague sense of late that there’s a connection between the weak dollar, on the one hand, and rising asset prices, on the other. But I took some comfort in that: Prices aren’t really going up as much as they look, it’s just that the dollar’s going down, so everything looks good in dollar terms.
Now, along comes Nouriel Roubini to burst my bubble. This isn’t a case of the weak dollar making asset prices look good; in fact, it’s the “mother of all carry trades”, setting up “the biggest co-ordinated asset bust ever”.
I believe him.
Nouriel’s analysis is quite compelling, given the way the carry trade works. In its most harmless form, people borrow at low rates in a funding currency and then invest the proceeds in a higher-yielding target currency. When that trade starts becoming crowded, the flow of money into the target currency causes that currency to rise, which makes the carry trade even more profitable — you not only pocket the spread between the two interest rates, but you also get a capital gain on the fx trade.
But this carry trade is even stronger still: not only are the target currencies rising, but the funding currency — the dollar — is falling. Players are making money on three different legs at once, and that means they can start investing not only in foreign currencies and local interest rates, but rather in a whole panoply of other asset classes, including commodities, energy, junk bonds, even equities. These assets might not yield much, but they don’t need to, if the funding currency is falling fast:
Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.
And it’s actually worse still:
The perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight… By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets.
We’ve seen this movie before, in 2006, and I, for one, have no desire to relive it. A market where everything is rising is not an efficient market: it’s a market which is failing to do its job of allocating capital efficiently to where it can be put to best use, and away from areas where it can cause big problems. But no one cares about that these days — not even Nouriel’s own chief strategist, Arnab Das:
Emerging markets are poised to extend their biggest rally in a decade as investors borrow dollars to buy stocks, bonds and currencies in the world’s fastest growing economies, according to Arnab Das of Roubini Global Economics.
Investors should take “overweight” positions in developing-nation assets, said Das, the London-based head of market research and strategy at RGE, the research and advisory firm founded by economist Nouriel Roubini. While emerging markets will have “occasional corrections,” the surge in asset prices “has many legs to go,” Das said in an interview.
Das, here, isn’t contradicting his boss. (Although having worked at RGE myself, I know that Nouriel doesn’t mind at all when that happens, and indeed encourages a wide range of views within the organization.) Nouriel isn’t saying when the current bubble is going to burst — and if history is any guide, it’s probably going to be a long time before the inevitable happens. Of course, the longer that a bubble continues to inflate, the more painful the subsequent bust.
In that sense, every move upwards in US stocks or gold or the Aussie dollar or junk-bond indices is another step in exactly the wrong direction: it’s a step towards yet another massive crash. And it’s all being turbo-charged by Fed policy. If there’s a painless way out of this situation, I can’t see it.
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This article has 29 comments:
P.S. I wrote a similar article, out today entitled, "The Mother of All Asset Price Bubbles" or something like that.
tinyurl.com/y95zmys
The flight from cash is simply because US cash is trash. It pays no interest, inflation is a threat.
However Gold is in prob. in bubble territory now and so are prob emerging markets. (funny an emerging market India has just bought 200 tons of gold) - bubble upon bubble.
On Nov 04 07:11 PM User 353732 wrote:
> Bubbles do not announce with a flourish of financial trumpets that
> they are going to burst.
> It is in the nature of a bubble to burst when the great majority
> of people least expect it to. A bubble is weakest precisely when
> it appears to be strongest....this is true whether it is a single
> company stock bubble, or an industry or an entire asset class or
> even a polity ,society or nation.
>
> Certainly there are always a very few voices warning that the bubble
> is going to burst but these voices are generally not heeded for 2
> reasons: there are false prophets and when a big lie is ascendant,
> truth is shunned.
>
> In 2009, the biggest lie is the fake dollar and the biggest bubble
> is the staggering self adoring hubris of the US Regime. From this
> lie and from this meta-bubble all other bubbles bud and inflate.
>
>
> True, we do not when the lie will finally become intolerable and
> when the meta-bubble will burst. Maybe not for years, but what if
> its sooner rather than later? How will ordinary Americans protect
> themselves and their families and communities?
2012 , It is true !
Thanks for the clear analysis of the Roubini FT article. I read it yesterday and was very concerned. Your deconstruction only confirms my fears. The US economy is going to crater and people will be stunned. We don't have capitalism here anymore...we have corporatism and quasi-fascism. The middle class--anyone earning under $250K is screwed.
Nik
The Fed's latest commitment to keep interest rates near zero for an "extended period" is accelerating the process by providing nitrous oxide to the dollar carry trades and further weakening the dollar and pushing up asset prices.... all under the guise of an "economic recovery".
The Fed dug themselves in a real hole this time. Even the exclusion of the words "extended period" at the next Fed announcement will probably be enough to send the dollar shorts looking for cover.....and the chain reaction begins.
International confidence in the US dollar is waning. Net creditor nations are becoming increasingly impatient with the pace of the U.S. efforts to bring its fiscal nightmare under control. So far, there are no credible plans to do so.
The U.S. dollar is getting hammered. Despite what many analysts are saying, the rate of deterioration of the greenback is NOT orderly. We are witnessing weekly movements that would normally take years. That is NOT normal.
The U.S. housing market is in a bubble right now. Yes, that's right. I said BUBBLE....despite its weakened state. It has been massively propped up with tax credits and artificially low borrowing rates. When these stimulus measures disappear, this sector WILL CRASH.
With the US dollar in a severely weakened state, it's only a matter of time (not years...more like months) when the inflationary effects show up in consumer prices, as input prices rocket upwards. Then the Fed will have to act. Unfortunately, by then, the dollar carry trades will likely be so massive (we're potentially talking about multiple trillions of dollars here), the crash will be unprecedented and globally destabilizing. The US economy will not be ready for it, nor will any other economy in the world.
On Nov 04 05:13 PM Mad Hedge Fund Trader wrote:
> zxb I almost stepped on a rattlesnake last night.
The market failed the second TARP was released. Creative destruction no longer exists in the US. Without it capitalism becomes but a shadow of its former self. Shame on Paulson. Shame on Geithner. Shame on the Treasury.
The seal on the coffin of capitalism in QE and zero interest rates. With one hand money ceases to provide its role to force people to properly evaluate the cost of risk while on the other hand it destroys any rational incentive to save. If you don't want to spend it on amenities then you are forced into commodities or equities merely as a store of value.
When there is no value for holding money then isn't the whole concept of a given currency shown to be nothing more than a thinly veiled pathetic lie? Thus the game of hoarding begins.
Of course, any currency carry trade will at the end of day result in a bursting bubble. Dr. Roubini is making a moot point, as if he was proclaiming that a baby will eventually die, knowing full well the baby was just born a few days ago. He is technically correct. But WHEN?
How big is the US dollar carry trade right now? A couple trillion dollars? I would rather say maybe a couple million dollars, tops.
How many of you, individual investors or fund managers, have actually take a bank loan, use the cash to buy gold, silver, or other commodities. Bring the physical stuff home, and dig a hole to bury them in the backyard? I have heard almost NONE who has done so. NONE.
Even the most die hard and most famous gold bug, James Sinclair, is NOT engaged in US dollar carry trade. He would buy gold on cash. But he would NEVER borrow US dollar and take a loan to buy physical gold.
Tell me there is a US dollar carry trade bubble, when James Sinclare mortgages his home to take an equity loan to buy extra gold at $2000 per ounce.
Tell me there is a US dollar carry trade, when half of your neighbors and colleagues not only empty out their US bank savings account, but rush to take another home equity loan to get exra cash to buy precious metals or copper, and stockpile them in the backyard. If that happens it's a bubble.
But talking about a US dollar carry tarde bubble right now, is purely a JOKE. I did not know a professor could be so humorous.
Why the US dollar collapse is now impossible to avoid:
seekingalpha.com/autho...
True the dollar short selling stampede may reach the proverbial cliff in the form of Bernanke rhetoric, but the true threat to the Greenback is the unwillingness of our largest trading partners (i.e. China, India, etc.) converting their trade surplus dollars into Gold rather than U.S. Debt, which has been the trend for the past 50 years. U.S. Debt is not what it used to be and the asset bubble is nothing more than dollar destruction, which will continue for a truly "EXTENDED PERIOD", regardless of the imminent short term lift from the abandonment of USD short carry trades.
The only real winners here are to go long foreign gold producers with commodity dependent currencies (i.e. BVN, Buenaventura Gold of Peru) or short long term U.S. Debt (i.e. TYO, Direxion 10-Yr Treasury Note 3X Bear ETF).
Those calling for a pullback in the WTI spot have plenty of evidence to support them and do not contradict my views. Crude oil is a commodity tied physically and psychologically to the strength of the U.S. Economy and the respectable equity market. Shorting crude with an ETF (i.e. DTO, Powershares 2X Short Crude) may play as a good hedge to protect against the potential snap back when the carry trade unravels and to give some fresh powder to further short the U.S. 10-Yr Note and go long Gold
For further analysis check out the articles on Diamond Slice:
www.diamondslice.com/d...
www.diamondslice.com/d...
On Nov 04 11:42 PM TraderRob wrote:
> All the talk of bubbles in asset prices is very poetic and all, but
> the Fed will most likely leave the interest rate low for a long enough
> period of time to start the chain reaction of inflation which will
> only extend the current rise in the price of gold. The reference
> to the exchange of 6.7 billion USDs for 200 tonnes of gold as a "bubble"
> example really excludes a very real macro threat to the value of
> the USD, much deeper than the short term carry trade effects.
>
> True the dollar short selling stampede may reach the proverbial cliff
> in the form of Bernanke rhetoric, but the true threat to the Greenback
> is the unwillingness of our largest trading partners (i.e. China,
> India, etc.) converting their trade surplus dollars into Gold rather
> than U.S. Debt, which has been the trend for the past 50 years. U.S.
> Debt is not what it used to be and the asset bubble is nothing more
> than dollar destruction, which will continue for a truly "EXTENDED
> PERIOD", regardless of the imminent short term lift from the abandonment
> of USD short carry trades.
>
> The only real winners here are to go long foreign gold producers
> with commodity dependent currencies (i.e. BVN, Buenaventura Gold
> of Peru) or short long term U.S. Debt (i.e. TYO, Direxion 10-Yr Treasury
> Note 3X Bear ETF).
>
> Those calling for a pullback in the WTI spot have plenty of evidence
> to support them and do not contradict my views. Crude oil is a commodity
> tied physically and psychologically to the strength of the U.S. Economy
> and the respectable equity market. Shorting crude with an ETF (i.e.
> DTO, Powershares 2X Short Crude) may play as a good hedge to protect
> against the potential snap back when the carry trade unravels and
> to give some fresh powder to further short the U.S. 10-Yr Note and
> go long Gold
>
> For further analysis check out the articles on Diamond Slice:
>
> www.diamondslice.com/d...
>
>
> www.diamondslice.com/d...
>
Raise your glasses! Let's toast again -- and stay high all the time -- with another glass of arsenic in new (re-inflated) clothing!
lets get the order of magnitude here right.. there are hedge funds out there, and bank trading desks, individual currency punters/traders
who are short dollar in the billions. how ? not the way you described it:
"How many of you, individual investors or fund managers, have actually take a bank loan, use the cash to buy gold, silver, or other commodities. Bring the physical stuff home, and dig a hole to bury them in the backyard?"
there are easier ways than that in the 21st century. you can trade foreign exchange on a forward basis with no delivery only a need to post margin.
the global currency markets trade around 1-2 trillion dollars turnover every day. this may be a bit bigger than you imagine. if you thought millions is a lot of money ("say maybe a couple million dollars, tops.") then let me tell you that its actually peanuts compared to the likely size of US dollar short in financial markets. i think it could be a trillion dollars, or at least a few hundred billion..
What if before one made any decisions asked them self " What would a prudent man do" this would change the dynamics of the market for that person because their decisions would no longer be dominated by fear or greed, maybe it would shed light on those items that otherwise would go unseen because of all the other intentional distractions placed in our way.
On Nov 04 07:11 PM User 353732 wrote:
> Bubbles do not announce with a flourish of financial trumpets that
> they are going to burst.
> It is in the nature of a bubble to burst when the great majority
> of people least expect it to. A bubble is weakest precisely when
> it appears to be strongest....this is true whether it is a single
> company stock bubble, or an industry or an entire asset class or
> even a polity ,society or nation.
>
> Certainly there are always a very few voices warning that the bubble
> is going to burst but these voices are generally not heeded for 2
> reasons: there are false prophets and when a big lie is ascendant,
> truth is shunned.
>
> In 2009, the biggest lie is the fake dollar and the biggest bubble
> is the staggering self adoring hubris of the US Regime. From this
> lie and from this meta-bubble all other bubbles bud and inflate.
>
>
> True, we do not when the lie will finally become intolerable and
> when the meta-bubble will burst. Maybe not for years, but what if
> its sooner rather than later? How will ordinary Americans protect
> themselves and their families and communities?
Aside from the Federal debt (about which more than enough has been said), there is the commercial real estate problem. If indebted REITs had to pay back their loans with strong dollars and/or refinance at higher interest, they would be unable to do so, and we would see a banking collapse à la 1931.
Roubini is right, of course, but for the moment that is the lesser of evils.
People are comfortable with a few bps a year ( and bonuses w/o claw backs in the meantime ) and they ignore infrequent events that wipe them out. The same is true to Short-volatility traders. The payoff profile is the same. Funding in Yen or US$ is equivalent to being Short event risk.
One only needs to see the Yen chart which is the strongest in 15 years.
Overall we are experiencing the restructuring of class warfare at "star wars" financial sector levels from the stratisphere and perhaps offshore cannon fire. Thank you Milton Friedman , Mr. Reagon and all your crony friends en league!
How the traders are able to borrow money at cheap rates for carry trades, when banks are reluctant to lend money for many business people. It looks like carry trade is a more viable business!! May be the banks are playing the carry trade
Money created from printing going to investors who produce nothing while soaking up the initial stimulus. When one factor or another reaches tipping point we have another crash, this time with no shots left in the magazine.
When? Sooner, months maby a year I would guess about 2 more Quarters and reality of the false recovery sets light to the powder.
On Nov 05 05:36 AM jeremiah74 wrote:
> "How big is the US dollar carry trade right now? A couple trillion
> dollars? I would rather say maybe a couple million dollars, tops."
>
>
> lets get the order of magnitude here right.. there are hedge funds
> out there, and bank trading desks, individual currency punters/traders
>
> who are short dollar in the billions. how ? not the way you described
> it:
> "How many of you, individual investors or fund managers, have actually
> take a bank loan, use the cash to buy gold, silver, or other commodities.
> Bring the physical stuff home, and dig a hole to bury them in the
> backyard?"
>
> there are easier ways than that in the 21st century. you can trade
> foreign exchange on a forward basis with no delivery only a need
> to post margin.
>
> the global currency markets trade around 1-2 trillion dollars turnover
> every day. this may be a bit bigger than you imagine. if you thought
> millions is a lot of money ("say maybe a couple million dollars,
> tops.") then let me tell you that its actually peanuts compared to
> the likely size of US dollar short in financial markets. i think
> it could be a trillion dollars, or at least a few hundred billion..
It seems that determining the size of the carry trade is IMPOSSIBLE to determine. Ned Davis Research has been talking about said carry trade for some time now, and I asked them what data they used to determine the size of the carry and subsequently attempt to gauge when the carry was running out of steam. For a independant research house that pride themselves on "going with the weight of evidence", I was dissapointed that they could not furnish any data and that they rely on "qualative" assesmnets and "prevailing view". Watch out when the carry trade implodes 'cos nobody is going to get out looking good.