A Worrying Development for Stock Market Bulls



Broken Pumps

Last week, we showed how excess liquidity bubbled up in the mortgage finance market. As money was easier to come by – thanks to low rates and rampant securitization of mortgage debt – people bought more houses at higher and higher prices.

This pushed up the value of the collateral – houses – which enabled people to borrow even more… and it drove the industry to build more houses and sell them to increasingly marginal (subprime) buyers.

Debt and equity raced each other higher and higher until both collapsed in 2007-08. Home prices plunged. And the value of mortgage debt plunged along with them.

Today, thanks largely to the Fed’s bubble, home ownership levels are back to where they were nearly half a century ago. Now, we see the same phenomenon happening in other sectors. As we reported yesterday, student debt, auto debt, and corporate debt are all headed for trouble.

And the bigger picture is that the pumps just aren’t working the way they used to. The growth of the last 20 or 30 years came largely – maybe entirely – from expanding credit. Banks lent. Consumers, businesses, and government borrowed.


china forex reservesDrawdown in China’s forex reserves from the peak level (this serves to tighten monetary conditions in China) – click to enlarge.


Many of the factory orders went to developing markets, where costs were lower. This left these economies and their central banks with lots of dollar foreign exchange reserves, which they reinvested in U.S. Assets. Mike Dolan at Reuters:


“According to the International Monetary Fund, the dollar value of foreign currency reserves held by all developing nations ballooned by almost $7 trillion in just one decade to a peak of some $8.05 trillion by the middle of last year. While China was the main driver, accounting for about half of that increase, its economic boom created a commodity supercycle that flooded the coffers of resource-rich nations from across Asia to Russia, Brazil and the Gulf.As the vast bulk of this hard cash was banked in U.S. Treasury and other low risk, rich-country bonds, they were at least one critical factor in the halving of U.S. Treasury and other Group of Seven government borrowing costs over the same period.”


An Ominous Peak

You see? Dollars borrowed out of thin air in the U.S. ended up as foreign currency reserves in the hands of foreign central banks – mainly China’s. What could they do with them?

Buy more U.S. government debt. Drive down U.S. borrowing costs. And make it even cheaper for Americans to borrow dollars and send them overseas!

Here’s a graphic our research team created to help you get a clearer picture of what’s been going on…


china-USThe flow of goods and above all dollars from the US to China and back


So you could track much of the global growth binge by looking at China’s foreign exchange reserves. As they went up, more and more money flowed back into U.S. financial assets… and Americans borrowed and spent more and more. But whoa, whoa, whoa! Those foreign exchange reserves have now peaked. Dolan:


“Emerging market forex reserves fell by about half a trillion dollars between mid-2014 and the end of the first quarter of 2015, IMF data shows, and this is likely far from the end.Deutsche Bank estimated on Tuesday the high water-mark of almost two decades of reserve accumulation had now been reached and central banks will by the end of next year dump as much as $1.5 trillion to counter capital outflows.”


Of course, as we told you yesterday, we don’t know anything. And even as to that we have our doubts. But it appears that the end of this cycle is in sight.

Watch out.


Charts by: StockCharts, Monograminvest, Bonner & Partners, St. Louis Federal Reserve Research

Source: A Worrying Development for Stock Market Bulls - Bonner & Partners

The above article originally appeared at the Diary of a Rogue Economist, written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.


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