A View from the Trenches, October 29th, 2009: "What are we correcting?"
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Yes, we are experiencing a correction. No news here. Yesterday too,
the Norges Bank raised its benchmark rate by 25bps, signaling the
beginning of the end in accommodative policies.
From wherever one sees the markets, profit taking is at the order of
the day. The minimal hint that the recovery process will take longer
than expected launches a new selling wave in risky assets and
strengthens the USD. Has anything material occurred during the last
week? No. Has the outlook on the recovery (slow) materially changed?
No. Has the Fed signaled that they are willing to err on the side of
caution and increase rates early? No. Has liquidity become more
expensive (3-mo Libor – OIS spread)? No. Have emerging markets engaged
in dangerous accommodative policies? No. Do we have political tensions
in the world? The answer again is “No”!
What then is driving the correction? The law of marginal returns,
mixed with constant risks. At the levels we had reached in equities and
credit, the risks outweighed the feasible short-term marginal returns.
And there is really not much more one can add here. Will central banks
find it harder to quit the monetary easing under a correction? Yes,
they will. Will governments see in the general weakness an excuse to
remain under deficit? Yes, they will.
Can a correction spiral into a more serious sell off? With the
information at hand, it is very difficult to see this happening.
Something more material should be here, interrupting the liquidity
normalization process. Could it be the idiocy of asking banks to be
better capitalized? When the 2001 crisis unfolded in Argentina, banks
had fractionary reserves of the order of 30% of assets, and of course,
that was not enough.
In general, if this correction continues, it may present us with an
opportunity to step in. For now, the general economic backdrop remains
constructive in my view, and although the new home sales figures or oil
inventories disappointed today, I see these issues anecdotic and it
would be naïve to expect a recovery process to go unidirectional, from
the lower left to the upper right.
Lastly, I thought I would quote here a paragraph found on Chapter XXXI
“Currency and Credit manipulation”, of Ludwig Von Mises’ “Human
Action”, published in 1949 (can be found at http://mises.org/humanaction/chap31sec5.asp ). These comments remain sooo relevant…:
“…The idea which generated what is called qualitative credit
control [p. 796] is to channel the additional credit in such a way as
to concentrate the alleged blessings of credit expansion upon certain
groups and to withhold them from other groups. The credits should not
go to the stock exchange, it is argued, and should not make stock
prices soar. They should rather benefit the “legitimate productive
activity” of the processing industries, of mining, of “legitimate
commerce,” and, first of all, of farming. Other advocates of
qualitative credit control want to prevent the additional credits from
being used for investment in fixed capital and thus immobilized. They
are to be used, instead, for the production of liquid goods. According
to these plans, the authorities give the banks concrete directions
concerning the types of loans they should grant or are forbidden to
grant.
However, all such schemes are vain. Discrimination in lending is
no substitute for checks placed on credit expansion, the only means
that could really prevent a rise in stock exchange quotations and an
expansion of investment in fixed capital. The mode in which the
additional amount of credit finds its way into the loan market is only
of secondary importance. What matters is that there is an inflow of
newly created credit. If the banks grand more credits to the farmers,
the farmers are in a position to repay loans received from other
sources and to pay cash for their purchases. If they grant more credits
to business as circulating capital, they free funds, which were
previously tied up for this use. In any case, they create an abundance
of disposable money for which its owners try to find the most
profitable investment. Very promptly, these funds find outlets in the
stock exchange or in fixed investment. The notion that it is possible
to pursue a credit expansion without making stock prices rise and fixed
investment expand is absurd…”
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