If history could talk, the first thing it would say is, “Enjoy the tranquil stretches because they’re always temporary.”
The past few years were, in retrospect, a case in point, one of those relatively drama-free periods that lull the unwary into accepting steady-if-unremarkable progress as the new normal. Lubricated by trillions of dollars of new currency – and some blatant government lying about inflation and unemployment – investors took stocks, bonds and real estate up to record or near-record levels, leaving just about anyone with a long position in just about any mainstream asset feeling like things might be okay after all.
Then a bunch of things happened to make “steady progress” the least likely scenario for 2014. In more or less chronological order:
The Fed Threatens to Check the Junkie Into Rehab
In July, with home prices and stocks both entering previous-bubble territory, the Fed finally began to worry about the impact of all the money it was injecting into the system and announced its intention to scale back the dosage. Since then, the interest rate on 10-year Treasuries has nearly doubled, mortgage rates have jumped from 3.5% to 4.5%, home sales have stalled and stock prices have plateaued. And all before the Fed actually cuts off the supply. Think of this as the tremors an addict feels as he walks up to the rehab center door, anticipating the real pain to come.
Hot Money Deserts the Developing World
This is part of the Fed tapering story but it’s so interesting that it deserves a longer look: When rich countries over-borrow and then create a lot of new currency to keep their banking systems from imploding, a fair bit of that money flows to relatively-cheap or high-yielding assets in less developed countries, which spikes local real estate, equity and currency markets. This is stressful but also an ego boost for countries like Brazil and India that find themselves awash in foreign cash. But when the money flows back out, as it is now doing, there is no upside for the countries thus abandoned. The Brazilian real and Indian rupee have plunged lately, forcing both governments to impose capital controls and/or use their foreign exchange reserves to intervene in the markets. This is only a temporary fix, since foreign currency reserves are finite and won’t last long at current burn rates.
Meanwhile, emerging market stocks and bonds are among the asset classes into which complacent financial advisers have been putting their clients, so the losses over there are about to be felt over here.
The US Threatens to Bomb the Middle East Some More
This is the strangest of all our self-inflicted problems. Despite having zero understanding of who stands for what in Syria – and hence what they’ll do if we help them win – the US seems determined to take sides and is actively trying to round up allies for yet another bombing campaign. (Maybe $105 oil is too cheap and the goal is to bump it up to $150 to help global warming. Viewing it as an environmental strategy makes as much sense as anything else.)
In an interesting (though no more comprehensible than any other part of this story) twist, president Obama has decided, instead of just going ahead and launching the missiles, to submit the plan for congressional approval. Meanwhile, the other big players, including Russia, China, Iran and Israel are weighing in with their own threats and counter-threats. For history buffs this should be a fascinating week.
[Hear More: JKC de Courcy: Three Big Geopolitical Threats for 2013]
The Debt Ceiling Game of Chicken Begins
No one doubts that the debt ceiling will eventually be raised, but apparently both major parties have decided that they can flat-out win on the issue of how and when to raise it. Republicans think they can extract spending restraint (but only on social programs; defense is untouchable while there are still Middle Eastern countries left to bomb), while democrats think they can force a “clean” increase to allow them to go on spending whatever they like with impunity. Each side thinks the turmoil generated by missing the deadline will work in their favor, thus forcing the other side to blink.
So the game is all but guaranteed to go into really messy extra innings, creating uncertainty about pretty much everything the markets hold dear, including interest payments on Treasury bonds. “Default” will appear in lots of headlines before this is over.
Chaos Ends When the Fed Refills the Syringe
So here we have rising interest rates, rising oil prices, troubled emerging markets, another Middle East entanglement (and maybe even a broader war), and a government that for some reason has decided to open its budgetary sausage factory to the press. Not the steady, linear progress to which we’ve become accustomed.
It’s always possible that congress simply refuses to bomb Syria and then turns around and crafts a timely budget, triggering a thunderous relief rally. But more likely is that some or all of the above produce enough uncertainty to spook grossly-overvalued financial markets, leading the Fed to refill the syringe and promise the junkie a nice big fix to make it all better. Nothing is solved, but withdrawal is delayed for a little longer.
Source: Dollar Collapse
