Shaking Off the Market Correction Dust

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London England (Daily Reckoning): Today (and perhaps all week) the financial markets will be shaking off the dust from last week’s market correction…toting up the damage…and wondering what to do next.

Daily Reckoning readers already know what to do – batten down the hatches. Hold yen, Swiss francs, gold, property you want to own whether it goes down in price or not, and private businesses with good cash flow.

“Stock markets around the world entered a second week of volatility…” reports the International Herald Tribune. Asian stocks continued to quake and shake yesterday, while those of Europe and America either stabilised or registered only modest declines.

So far, the market correction has sopped up some USD $2.3 trillion in excess liquidity. This liquidity is a form of ‘inflation’ – and falling inflation means falling prices. Monday, just about everything went down. Stocks, oil, copper, the euro, and gold too. Gold fell below USD $640.

What went up was the yen – because the yen is the tap that has made much of the world’s liquidity possible. Speculators, who worried that their trades were going bad, were forced to sell off their positions in gold, Asian stocks, and so forth in order to pay back the yen they borrowed.

“Yen surges as carry trade unwinds”, is the Financial Times’ headline story on the subject.

What does it mean? How far will it go?

As usual, we don’t know.

“Goldman Sachs warns of ‘dead bodies’ after market turmoil,” was a headline in yesterday’s London Telegraph. The paper quotes Goldman’s chief global economist, Jim O’Neill:

“There has been an amazing amount of leverage on currency markets that has nothing to do with real economic activity. I think there are going to be dead bodies around when this is over,” he said. “The yen carry trade has reached 5pc of Japan’s GDP. This is enormous and highly risky, as we are now seeing.”

The yen went up almost 6% against the dollar and the euro last week.

All of a sudden, the world that looked so calm…so risk-free…so serene…is wiggling the seismographs. People are beginning to notice a bit of movement beneath their feet. Risks. Troubles. Last week was just a preliminary alarm.

Our guess is that the financial authorities will reassure most speculators. Prices will settle down. Speculators will go back to sleep. Then, the real quake call will come.

“Seven years after the stock-market bubble busted, the troubles in the housing market look strikingly familiar. In fact, everything is going according to the textbook – the textbook in this case being Charles Kindleberger’s 1978 classic, Manias, Panics, and Crashes,” says the Wall Street Journal.

“Mr. Kindleberger found speculative bubbles tended to follow similar patterns. First, there is some ‘displacement’ – such as the development of the Internet or a prolonged period of ultralow interest rates – that radically improves the outlook for some area of the economy.”

People take advantage of the opportunity – by buying dotcom shares or mortgaging their houses. What begins as a modest shift of financial emphasis ends in a reckless, greedy, hell-for-leather chase for profits. Investors begin to think that the opportunity is permanent, rather than temporary, and that they can get away with anything as long as they are on the right side of the trade. This attitude leads them to over-reach…and to ignore warnings. Finally, when the dishes rattle and the gas lines break, the roof caves in on them.

Stay tuned… it’s just getting interesting.

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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