US news is abuzz with Q2 2010 earnings season. The asset bubble has been re-inflated. The policy makers Faustian deal needed to achieve the re-inflation has 2 critical levers:
1. The Savings Tax – Drop interest rates to near zero. Given a horrible choice - consume despite your fears or find some way of saving for tomorrow at ~0%, individuals have chosen to invest in risky assets. Find an asset, any asset – stocks, junk bonds, gold, commodities - and buy.
2. The Greater Fool – And the confidence to buy was provided by ensuring a greater fool was available. The history of bubbles shows rational individuals continuing to trade in the belief that a greater fool will pay a higher price. In 2009-2010 that greater fool was the US taxpayer (and some others around the world). The Fed bought MBS > $1 Trillion, recently released AIG documents show other assets purchases at 50-1000% inflated prices, etc.
But, two significant events happened last week. First, March 31 was the official end of the Fed’s trash (MBS) buy back policy. Second, Germany and the rest of the Europeans are hesitating on whether to fully support the greater fool charade – at least as far as Greek debt is concerned. They will likely cave-in, but the unwavering solidarity of the global bankers is now in question.
So how do we get to a next jump up in asset prices?
From here forward, for all intensive purposes, we are back to looking for other fools to propel asset prices higher. Higher earnings are already priced in (Firing 5% of the country - and US government stimulus growing corporate revenue by 5+% of GDP - has to show up somewhere in profits!). Accounting mark-to-fantasy and other rules (Repo 105 is fascinating) will continue to let us sweep debt problems under the rug – but we don’t have any new accounting rules to count on.
My candidate: China. The US Treasury Secretary has taken the confidence game to China this week, pushing for currency devaluation. The real question is whether the Chinese use their savings to buy up US (and other) assets -- as the Japanese did a couple decades ago--, since their economy is already over-heating. Will it be wisdom or folly?
