Watching the News Carefully |
By Bill Bonner |
Published
11/22/2007
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Currency , Futures , Options , Stocks
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Unrated
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Watching the News Carefully
We’re watching the news carefully. Why? Because we think something is going to happen.
The markets are in an uncomfortable – and potentially explosive – position. On the one side, the unstoppable force of inflation seems ready to collide into the immoveable object of falling asset prices.
What will happen when they meet?
We don’t know, but we want to be in the front row when it does.
Yesterday, the price of oil rose to $99. That’s inflation, dear reader. The price of oil affects almost everything in the economy – everything that uses power...and everything that moves. Meanwhile, the US dollar continues to slide. That too, is inflationary. Because as the dollar goes down, prices of things that dollars buy go up. Lower dollar = higher consumer prices, especially for imports, which are a huge part of the U.S. retail market.
What else is inflationary? Well, the price of gold rose over $800 in the aftermarket yesterday. Gold is real money. When the price of gold goes up, the value of the stuff that buys it – paper – goes down. People are buying gold because they fear inflation is going to get worse. Typically, gold holds its value in an inflationary trend. Then, it rises in real terms...as more and more people turn to it in order to protect themselves. Finally, gold skyrockets as speculators try to get rich on it. So far, we’ve only seen the beginning of this trend. If we’re right, there’s a lot more inflation where that $800 gold came from.
Inflation looks unstoppable. But it is heading for something that looks like it won’t budge – deflation. Housing is falling in price, not rising. And a small percentage decline in housing takes a big chunk of “wealth” out of family budgets.
While the price of gold and oil were going up, the price of bonds was too. The yield on the 10-year note fell below 4%. That is deflationary action...reminiscent of the way bond yields fell in Japan as the country sank into recession, depression and deflation. And get this, while stocks generally held up yesterday, Fannie fell again. So did Countrywide. And the 2-year interest rate swap spread reached a 19-year high. This too is telling us that lenders are running scared...as they tend to do when credit shrinks and prices fall.
And what’s this? October retail sales were weaker than expected. Corporate profits seem to be falling. (Both of these things we regard as inevitable.) And word on the street, via Bloomberg, is that this “holiday season may be the grimmest retail season in 5 years.”
Everyday brings new estimates of the losses from the credit crunch. Yesterday was no exception, with a report from the OECD putting mortgage-related losses at $300 billion. The Financial Times adds that 1 in 10 hedge funds may go broke. (Only one in 10? We bet far more will go bust...)
All of these things are warning us that rising rates of inflation may not be a done deal, after all.
*** “How could the credit-rating agencies be so wrong consistently?” asked New York Congresswoman Carolyn Maloney. “[They were] wrong on Mexico, wrong on Asia, wrong on Enron, wrong on subprime.”
The next thing you know, she’ll propose a law – requiring the credit agencies to do a better job. She might as well pass a law against sin.
Here is a comment from Charlie Gasparino, at TraderDaily.com:
“The bond raters make money through one of the most flawed and conflicted business models in corporate America. The bond raters are supposed to be working for investors (hence the name Moody’s Investors Service, for example) by assigning letter grades to a bond’s ability to make principal and interest payments. The reality is much different. In rating-world lexicon, AAA means that barring nuclear war, the bonds are good. D means they’re either nearing or in default.
“This conflict has posed huge problems. Municipalities have canceled contracts with rating agencies that took a negative view, and hired those who were easier graders. All that saber-rattling had an impact. I can remember how former New Jersey Governor Christine Todd Whitman attacked a particularly tough rater at Standard & Poor’s, who subsequently withdrew from the team that gave the green light to some suspect financing by the state.
“Such conflicts were at the heart of the rating agencies that missed Enron and a passel of other financial catastrophes. Kenneth Lay, after all, was a valuable client.”
Herewith another thought about why the credit agencies make such colossal mistakes. Credit rating agencies are really no different from house appraisers. They are called in when an independent judgment is needed. How much is that house really worth, the lenders want to know? How good are those bonds, the buyers ask? The question is essentially the same. It is the answer that varies – depending on which way the wind is blowing.
When the housing market was flying, appraisers learned that if they went along with high appraisals their phones never stopped ringing. If they refused to grease the deal through, on the other hand, spiders could build their webs over the appraisers’ doors and never be disturbed. Likewise, the rating agencies are under similar pressure. And being human, the people who operate them yield to it whenever they can get away with it.
In the great credit boom of 2001-2007, the risk of a friendly rating seemed practically non-existent. Asset prices – notably houses – were rising so fast, if the appraisal was high, they’d soon catch up! And in the corporate debt and derivative market, who could lose money when the price of money was going down? There were plenty of bad deals financed during that period, but they couldn’t go broke – lenders wouldn’t let them. Instead, they dealmakers were offered fresh financing on even better terms. What this accomplished, of course, was merely to put off the day of reckoning. And make it worse. Instead of settling up on all those bad corporate loans, bad private equity deals, and subprime mortgages right away...billions, maybe trillions, more were added. And now that the bills are coming due, people aren’t very happy about it. Sanctimonious members of Congress are ranting and raving at the credit-rating agencies...as if they were supposed to single-handedly dump the punch out of the bowl and turn out the lights.
No, dear reader, it doesn’t work that way. When the party’s rolling, everyone wants to join in. Rating agencies. Appraisers. Wall Street. Washington. Investors. Speculators. Fannie, Freddie and the whole host of clowns and con-men that make up our delightfully entertaining financial markets.
Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.
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