Doom & Gloom Report

Marc Faber Says Fed `Like a Bartender' Cutting Rates [¹]
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By Pimm Fox and Eric Martin | 27 October 2007

Oct. 23 (Bloomberg)—

The Federal Reserve acted "like a bartender" in lowering interest rates and its actions are contributing to a stock market bubble in the U.S., investor Marc Faber said.

"Each time you bail out, it becomes bigger and bigger, and the credit problems become much, much larger," said Faber, managing director of Marc Faber Ltd. and publisher of the Gloom, Boom & Doom Report. The Fed "feeds its customers with booze, and when they get totally drunk and are about to fall off their chairs, the bartender gives them more booze to keep them going. One day, it will lead to the ultimate breakdown."

The Standard & Poor's 500 Index has risen 2.9 percent since the Fed cut its benchmark rate by half a percentage point on Sept. 18 to keep credit market losses from spurring a recession. Faber said the action spared U.S. financial companies such as Citigroup Inc. from the consequences of bad lending decisions.

"If Citigroup made a mistake, let them be penalized, let the shareholders of Citigroup be penalized," Faber said in an interview in New York. "Then the shareholders will eventually put pressure on the board of directors not to do stupid things continuously."

The biggest U.S. bank dropped 12 percent last week after saying credit defaults will plague the financial industry for the rest of the year. Citigroup spokeswoman Shannon Bell declined to comment.

"The best for the system would be if a major player would go bust," Faber said. "Then there would be an example for investors and for the players, the Wall Street establishment, the banks, to be more prudent."

China, India

Faber said this year's rally in Chinese assets, including the 171 percent gain in the CSI 300 Index, will end by the August 2008 start of the Olympic Games in Beijing. He predicted India's gains will end by the same time. The Bombay Stock Exchange's Sensitive Index has climbed 34 percent this year.

"We still have the emerging markets going ballistic," Faber said. "The Chinese market could double here, but it doesn't change the fact we are already in bubble stage."

Faber said if bubbles in emerging markets deflate, the dollar may rebound from all-time lows against the euro as fund managers who have invested in emerging markets invest in the U.S.

The European Central Bank has raised its key interest rate eight times to 4 percent from 2 percent in November 2005, a "more responsible" policy than the Fed's, Faber said.

Track Record Faber told investors to bail out of U.S. stocks a week before 1987's so-called Black Monday crash, according to his Web site. He correctly predicted in May 2005 that stocks would make little headway that year. The S&P 500 gained 3 percent. He also told investors to buy gold in 2001, before it more than doubled. On March 29, Faber said the emergence of home loan concerns meant the U.S. stock market was unlikely to benefit from the conditions that supported its rally since June 2006. The S&P 500 climbed 10 percent between then and July 19, when it reached a record, and again reached new highs on Oct. 5 and Oct. 9. In February 2004, he said stocks in Brazil and Argentina were expensive because investors were overestimating China's demand for commodities. Brazil's Bovespa index has since more than doubled while Argentina's Merval Index has gained about 90 percent.

Credit Crisis Worse Than Long-Term Capital Management Collapse in ’98

By Marc Faber on Sep 20th, 2007 | 20 September 2007

Unlike all the Wall Street strategists who compare the current credit crisis to the credit crisis of 1998 (Long Term Capital Management), I believe that the ongoing credit problems will be far worse and of a longer-term nature. This will make it difficult for the market to reach new highs in the near future [[The S&P 500 again reached new highs on Oct. 5 and Oct. 9: normxxx]]. Moreover, even if the 1998 comparison were to hold, we would still be looking at a much deeper stock market correction than the 22% sell-off we saw in 1998.

The stock market peaked out in July 1998, after having been in an uptrend since the 1991 lows. It then sold off on the Russian default and on the LTCM crisis by 22% to its intraday low on October 9, 1998. When it became obvious that the Fed would bail out LTCM, and it flooded the system with liquidity, the stock market took off. Between the October 9 intraday low and the year end, it rallied by 33%, to achieve a new all-time high, and then continued to rise— interrupted by a correction in 1999— into the final March 2000 top.

Pundits who are likening today’s market rout to that of 1998, and who expect the market to rally strongly towards the end of this year and to close at a new all-time high, are failing to consider the very different economic and financial circumstances of today, compared to those of 1998. In the years leading up to the 1998 crisis the US dollar was in a bull market, and interest rates— which had peaked in September 1981— were in the middle of a secular decline. At the same time, gold and other commodities were still deflating. Also, in the 1990s, the US stock market had significantly outperformed the emerging markets, most of which had peaked out between 1990 and 1994 and had crashed during the Asian crisis of 1997-98.

Therefore, in 1998, the emerging markets and commodity prices were very depressed (unlike today). Moreover, in 1998, house prices weren’t elevated, the subprime lending industry was in its infancy, Japan and Europe were largely stagnant, and Asia and Russia were in depression (i.e. there was no synchronised global growth). The process of securitisation existed, but was very modest when compared to the present.

Today, the key difference is that the dollar looks extremely wobbly. In 1998, the US current account deficit was 2% of GDP; today, it’s hovering around 8%. This massive deficit puts continuous pressure on the dollar. Moreover, gold and other commodities are in an uptrend. There is another reason why conditions today are very different from those in 1998: in 1998, total credit market debt to GDP was 250%; today, it’s 330%. In addition, whereas debt growth averaged 4% per anum in the 1990s, it has averaged almost 10% per annum since 2002. In particular, household debt has surged from 65% of GDP in 1998 to almost 100% in 2007. Since debt growth has been so strong in the last few years, and because the system is now far more leveraged than in 1998 (not to mention the derivatives market), a tidal wave of liquidity would be needed to bail out the system, which would have to lead to even stronger debt growth; but, obviously, it would only lead to even larger dislocations and problems later.

Another difference: in 1998, the Fed had to deal with the bailout of just one institution— LTCM; today, who should it bail out: the subprime lending institutions (it’s too late), leveraged home owners, the US$2 trillion-plus collateralised debt obligation (CDO) market, or the financial institutions, which are now stuck with over US$200 - 300 billion of leveraged buyout (LBO) loan commitments which they cannot sell to investors? So, whereas it was relatively easy to bail out just one institution in 1998, today the task would be extremely complex and daunting. Of course, the Fed could try to bail out everybody by cutting the interest rate aggressively and taking "extraordinary measures", such as buying up the entire CDO market. [Editor’s note: Faber wrote the words above in late August, well before the Fed’s aggressive 50bp rate cuts.]

Aggressive Fed fund rate cuts may not help much for the following reason: from June 2004 to August 2006, the Fed increased its fund rate in 17 baby steps from 1% to 5-1/4%. During this period of "tightening", no actual tightening took place because credit growth accelerated as lending standards were eased and leverage increased. Moreover, as Bridgewater Associates recently pointed out, "globally, central banks have kept interest rate levels out of line with economic growth rates". So, even if the Fed were to cut rates massively now, it is unlikely that it would stimulate credit growth, which, as I have explained repeatedly in the past, must continuously expand at an accelerating rate in a credit- and asset-driven economy in order to keep the economic plane from losing altitude. Accelerating credit growth is most unlikely now, because I cannot see how financial intermediaries will ease lending standards any time soon after the losses they have recently endured and following their dismal stock performance.

In addition, being fairly familiar with the cowardly attitude of investors, it is most unlikely that investors will now wish to buy anything other than top-quality paper and solid companies’ shares [[hah!: normxxx]]. Therefore, I can see only one solution if the Fed really wanted to attempt to bail out the system, and that would be for it to drastically cut interest rates. Unfortunately, massive interest rate cuts at present may not help much and could potentially have very negative side-effects (an even weaker dollar, inflation, rising long-term interest rates, further widening of income and wealth inequity etc.)

The crises that build up in international financial structures always ricochet from country to country…. Boom, distress and panic are transmitted through a variety of connections between national economies: psychological infection, rising and falling prices of commodities and securities, short-term capital movements, interest rates, the rise and fall of world commodity inventories. These connections, moreover, can take various forms, and may be interrelated in various ways…. Boom and panic in one country seem to induce boom and panic in others, often through purely psychological channels…. Just as one huge bubble breeds others in a country, so a host of bubbles in a financial market seems to inspire the production of others in other countries. For the last several years, investors have enjoyed a massive global boom. But they should not rule out a massive global panic.

Normxxx    
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