Monday December 12, 2005 - 11:29:44 GMT
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Black Swan Capital - www.blackswantrading.com
“All is not hopeless. Markets are turbulent, deceptive, prone to bubbles, infested by false trends. It may well be that you cannot forecast prices. But evaluating risk is another matter entirely.”
“Beautiful credit! The foundation of modern society. Who shall say this is not the age of mutual trust, of unlimited reliance on human promise? That is a peculiar condition of modern society which enables a whole country to instantly recognize point and meaning to the familiar newspaper anecdote, which puts into the speculator in lands and mines this remark: ‘I wasn’t worth a cent two years ago, and now I owe two million bucks.’”
Samuel Clemens and Charles Warner, The Gilded Age: A Tale of Today, (written 1873)
“Beautiful credit!” It is part and parcel to good times and bad. Our system doles it out to excess; then takes it back when stretched too far. Boom then bust! We call upon our central bank to control, or at least, stabilize credit. But when the means of credit expansion are so darn efficient, how do we define success from our bankers?
“The fact of the matter is that money, defined as means of payment in actual use, has been continuously expanded, and existing money has been used ever more efficiently in periods of boom to finance expansion, including speculation. This has occurred despite efforts of banking authorities to control and limit the money supply,” writes Charles Kindlebeger, in Manias, Panics and Crashes.
A story in today’s Journal exemplifies yet another credit expanding mechanism tied directly to the primary source of speculation in America—real estate.
“Hedge funds and other investors, many looking to make money on a downturn in housing, are driving a growing trade in Wall Street's latest invention: derivatives that rise and fall in value based on the likelihood that homeowners will pay back their mortgages.
“The market is still small in the context of the broader $4 trillion market for mortgage-backed securities, but it is growing rapidly. Dealers estimate that investors have bought and sold insurance on a face value of as much as $100 billion in bonds, from next to nothing earlier this year.” [our emphasis]
Many otherwise normal Americans have been swept up by real estate—the latest jewel of speculation. These good people once had real jobs—teachers, fireman, doctors, etc.—doing real and important work, but found it was “easy” to make money in real estate. This is very similar to those who quit their day jobs to become “day traders” during the Nasdaq boom. It’s often a sign that we are late in the game of whatever the primary speculative fashion might be.
Many knew the speculative frenzy in the Nasdaq would end badly—we just didn’t know how or when it would end. But no matter the primary source of speculation, the onset of crisis is very similar:
“Causa romota of the crisis is speculation and extended credit; causa proxima is some incident which snaps the confidence of the system, makes people think of the dangers of failure, and leads them to move from commodities, stocks, real estate, bills of exchange, promissory notes, foreign exchange—whatever it may be—back into cash. In itself, causa proxima may be trivial: a bankruptcy, a suicide, a flight, a revelation, a refusal of credit to some borrower, some change of views which leads a significant actor to unload. Prices fall. Expectations are reversed. The movement picks up speed,” writes Kindleberger.
The speed at which the players race to liquidity is a factor of the degree of leverage in the system.
“Americans increased their household debt at an annual rate of 11.6% in the third quarter, the fastest growth in 18 years,” the Federal Reserve said Thursday in its quarterly flow of funds report. Maybe gold is telling us something!
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