Courtesy of Tyler Durden
The latest out of the Richmond Fed is a joke of a paper that while analyzing the possibility that the entire stock market and dollar carry trade is one zero cost of capital-funded bubble, skips over this possibility and instead goes on to analyze the "factors that could contribute to a fundamentals-based explanation for the recent rally in certain risky asset markets." Spoiler alert: No bubble – it’s all based in sound reality.
In what is likely a first, the Fed quotes Nouriel Roubini:
The near zero nominal interest rate in the United States, jointly with the expansion of the Fed’s balance sheet, have created resources available to be lent. Some investors have taken advantage of those resources by borrowing in dollars at very low rates and investing in foreign assets, especially in emerging economies and commodities. The expected profits from this investment strategy have been magnified by the expectation of a weaker dollar: Once it comes time to pay off the dollar-denominated loans, the investors can repay them using dollars that are worth relatively less. In turn, this trading strategy – referred to as “shorting” the dollar – has itself contributed to the decline in the value of the dollar since investors must exchange dollars to purchase foreign-denominated assets.
In explaining what Roubini means to his intellectually subprime colleagues, Richmond Fed analyst Renne Courtois provides this enlightening narrative:
The argument of Roubini and others is that this represents a bubble because the emerging markets and commodities rallies are fueled by easy money and the carry trade, rather than economic fundamentals. Under this view, several likely factors could cause this asset bubble to burst. After appreciating during the height of the financial crisis, the dollar steadily declined for most of 2009 but eventually will likely stabilize at some point. Stabilization of the dollar would reduce returns for investors with short dollar positions. Additionally, economic recovery in the United States will raise expectations of an interest rate increase. This would cause the dollar to appreciate (since higher interest rates raise the expected return of dollar-denominated assets, all else equal), and thus cause significant losses for investors short on the dollar.
The Richmond Fed goes as far as refuting Bernanke’s recent claim that low interest rates have never, NEVER, been responsible for this arcane concept known as a bubble: "Research has shown how a bubble fueled by low interest rates can exist under certain conditions." But then it promptly moves on to quash any lingering doubts that there is any validity to justifying that asset prices are grounded not in reality, but in the Fed’s flawed monetary policy:
It may be the case that investors have been learning that the crisis did not generate major structural problems in emerging economies. Such economies were resilient to the world’s financial problems at first, but eventually they experienced contractions at the end of 2008 and the beginning of 2009. In part, the contractions were explained by declines in commodity prices and the reversal of capital inflows. A 2009 International Monetary Fund study mentions that the historically low current account and fiscal deficits and the high reserve levels in emerging market countries offered some protection against financial stress in advanced economies and limited the impact on the “real economy” (for example, reserves can be used to buffer the effects from a drop in capital inflows or to pay back sovereign debt and avoid a default). It has been mentioned that reforms in the financial system in East Asian countries have also helped to reduce financial vulnerabilities. This apparent resilience of emerging market economies could explain the reversal in capital outflows and the fast recovery in equity values compared to what has been observed in developed countries.
Nothing like quoting the IMF to prove your point. And as for regulatory reform in East Asia – well, that surely accomplished some miracles.
Yet Courtois’ conclusion is the stuff that Coco would have field day, or night, as the case may be, with, were he not the savage victim of NBC’s lack of programming and ad revenue foresight:
There is intense debate within the economics profession about whether it is typically possible to know in real time, outside of lucky guesses, when asset prices have outstripped fundamentals. The argument against the ability to identify bubbles in real time is that if any information existed on which to gauge that the asset price run-up is not justified, markets would quickly uncover the information and it would, in fact, temper the asset’s price. This does not mean that asset prices cannot become overvalued – simply that it will be quite hard to judge when a bubble has emerged and how large it is.
So there you have it: all those who called the housing peak and warned against a market crash were nothing but coin-flippers and just lucked out. Since as the Fed says it is "quite hard to judge when a bubble has emerged" we must all accept this logic and move on. And lest the Fed is wrong, the consequences of their faulty conclusions would merely be "an important area of economic research" which would result in yet more totally worthless papers such as this one, funded by taxpayers’ dollars.
All in all, the Fed once again irrefutably proves that any arguments that promote its existence based on its deep economic insights are just as flawed as arguments that the Fed could possibly be responsible for asset bubbles. And while Richmond Fed et al crank out yet more such gibberish, the bubble, so fortuitously spotted by ever more people, will continue expanding, until such time as even the authors of this paper have to acknowledge that a 36,000 Dow coupled with 20% unemployment may not be quite the logical observations as was previously thought.
Full total waste of time paper below.
