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January 13, 2015

How Long Can Markets Keep Gaming the System?

By Bill Bonner, Rogue Economist via David Stockman's Contra Corner

Pumping All Out

The Dow rose 323 points last Thursday, or 1.8%. People come to think what they must think when they must think it. But what do they think now? Why do they think stocks are so valuable?

Apparently, they believe that Janet Yellen, Mario Draghi and Haruhiko Kuroda – the powers that be – will continue to make stocks go up.

The Fed has stopped active liquidity pumping. But it still has its hand on the pump handle, just in case.
The European Central Bank is promising and preparing to pump as soon as it can get the Germans out of the way. And the Japanese – the world leaders in modern state finance – are pumping with both hands.

Gaming the System

Since 2009, the Fed has put more than $3.5 trillion to work on investors’ behalf. This – along with the help of the ECB, the Bank of Japan, the Bank of England, the People’s Bank of China, etc. – has helped lift stock markets by $18 trillion.

And corporate chiefs – now back in their cushy seats after the holidays – are borrowing more money to buy their own shares. They, more than anyone else, have figured out how to game the Fed’s system.
They take the Fed’s zero-interest-rate credit. And they use it to buy back their own shares. This pushes up the value of the remaining shares. Which leads to big, fat bonuses.

And so one of the wonders of the modern financial world unfolds before our dumbstruck eyes: borrowing from someone who has no money… charging it to someone else’s account… and pocketing a good part of the cash.

The average S&P 500 CEO got an $11.7 million compensation package in 2013. Last year must have been even better, though we don’t have the figures yet.

Meanwhile, the dollar rises and foreign investors move their money into US stocks and bonds, seeking safety and capital return in a market where the former is illusory and the latter is fraudulent.
Good luck to them all! Sooner or later Mr. Market will have his say. He always does.

The average worker/average CEO pay gap as of mid 2013

Bubbles Always Pop

But this may need explanation …

If central banks are committed to pumping more money into the system (birds gotta fly, fish gotta swim, the Fed’s gotta pump), why should stocks ever fall? Good question. Beneath the phony market created by artificial intervention is a real market. Real buyers and real sellers.

At some point, the supply exceeds the demand. Then the smartest people in the room get worried. They move toward the door… quietly.

Then the next smartest people notice that the geniuses have left the room… and they, too, begin edging toward the door. Then short sellers move in. Prices drop. And pretty soon, the market is in free-fall.

That is what always happens. Bubbles always pop. It happened to the dot-coms, to houses, to subprime mortgage companies, to oil and to the oil-slick debt.

South Seas bubble IndexThe grand-daddy of all stock market bubbles: an index of three stocks during the South Seas bubble of 1720, from Dimitri Speck’s “The Gold Cartel”. Concurrently with the South Seas Bubble, John Law’s Mississippi bubble took place in France, fired up by an early experiment in money printing by a central bank. After the collapse of these financial manias, a severe recession began in continental Europe. The ensuing bear market in stocks lasted for roughly 68 years – click to enlarge.

A Frightening Fall

“Prospects dim for US high-yield debt,” reports the Financial Times. We have no special insight into this process. But we have faith in it. Nothing lasts forever; of that we are sure.

We also have faith in certain reliable patterns of human behavior. No one escapes the cemetery. And markets follow boom-bust cycles. Always have. Always will.

We are now in what appears to be a boom cycle on Wall Street. It could last much longer… and go much further. Often, a boom of this magnitude needs an all-out, barn-burning, super-duper final stage before it blows up.

Our guess – and it is just a guess – is that there will be another big scare before the final top of the equity bubble is achieved.

We expect a frightening fall… a quick reaction from the Fed… and then the great race to disaster will enter its Last Looney Lap.


Via Elliott Wave International, the earliest financial mania for which a price history could be reconstructed: the Tulipomania of 17th century Holland. The bubble had many “modern” characteristics, such as an over-the-counter futures and options market that provided the possibility to speculate with extreme leverage. A century later, the price of the Semper Augustus bulb had plummeted to 0.10 guilders 

Charts by: Bloomberg, Dimitri Speck, Elliott Wave International

The above article is taken from the Diary of a Rogue Economist originally written for Bonner & Partners, via David Stockman's Contra Corner.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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