The Bernanke Pout

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After a six-day losing streak, the ASX 200 finally rallied on Friday. But why the pessimism during the week? Well, Slipstream Trader Murray Dawes has been predicting the move. He sees it as a continuation of the range the ASX 200 has been in for about 20 months.

ASX 200


Source: Yahoo Finance

You can find out how Murray currently sees the market by watching his free video here.

Your editor has a new theory to explain the recent price action. It’s called the Bernanke Pout. Namely, that Federal Reserve Chairman Ben Bernanke doesn’t seem as willing to prop up asset markets as analysts expected.

Since former Chairman Alan Greenspan, investors have grown used to a Federal Reserve that is willing to jump into action at the slightest sign of trouble. By promising to create liquidity when asset markets struggled, the Federal Reserve essentially limited downside risk for equity investors. At least that was the perception. Market commentators called this the Greenspan Put, named after put options, which limit downside risk for investors who buy them.

The irony was that this ‘Put’ was what inflated the credit bubble, which caused the financial crisis. Enter Greenspan’s replacement, Ben Bernanke. Bernanke’s attempts to inflate asset markets at the height of the crisis through Quantitative Easing (QE) were his version of the put. By printing money, Bernanke has created an impressive rally in stocks – his stated goal.

Fast forward to today. In the face of poor data, investors had expected Bernanke to signal more of the same stimulus in his speech on Wednesday. Or at least give them a hint that he might. What they got instead was a very odd speech.

On the positive side, household incomes have been boosted by the net improvement in the job market since earlier this year…Increases in household wealth, largely reflected in gains in equity values and lower debt burdens have also increased consumer’s willingness to spend.’

Completely contradicting himself, in the next breath he mentioned declining home values, tight credit markets and poor job growth!

Any mention of more QE was absent. And so equity markets fell. The Bernanke Put turned to a Bernanke Pout.

What investors realised was that Bernanke’s put wouldn’t come into play until things got worse. Possibly much worse. And so they probably will.

On the wrong end of all this is Australia. That’s because we’re a resource reliant nation. Everything has been going our way lately. Money printing inflated resource prices, Chinese stimulus created demand and overseas investors love the high yielding Aussie dollar. All three of these have the potential to reverse.

If Bernanke continues to Pout instead of Put and China continues to slow over inflation concerns, we’re in trouble.

Then there’s Europe – another source of worry. The European Central Bank (ECB) inherited the tough attitude of Germany’s central bank, the Bundesbank. The ECB isn’t quite so willing to support the Portuguese, the Irish, the Italians, the Greeks and the Spanish after their respective debt binges. Heck, Europe’s central bank is even threatening to raise rates!

Countries used to default on their bonds without technically defaulting on them by devaluing their currency. They paid the borrowed amount in full. But by devaluing the currency, they effectively lowered the value of the amount repaid.

Printing presses were a part of this. The US is trying that now and it’s working to some extent. The cheaper US currency has led to a surprise surge in US exports as American goods get cheaper overseas. But the debt-troubled southern European states can’t reduce their debt burden by devaluing their currency because they don’t control interest rates in Europe.

Europe shares a single currency and a single monetary policy. So if the debtor nations cannot default through inflation, they will have to default by defaulting. That, as you will know by now, brings the world’s banks into the line of fire. They rely on ‘safe’ sovereign debt to sure up their capital structure.

But why don’t the banks that are most vulnerable just sell their Greek debt? Friday morning’s German news on SBS informed your editor that the German banks have in fact dumped a third of their holdings of Greek debt. This was something the banks promised the politicians they wouldn’t do.

But much of the Greek debt remains on German and other European bank balance sheets, particularly on the balance sheets of banks that are too big to fail.

Keen to solve these problems, the European Union has been busy revising bank capital rules.

This must-read article outlines the ridiculous state of bank capital requirements in Europe to date and what’s to come. And, true to form, the proposed rules will make the problems worse. Instead of acknowledging sovereign debt as risky, ‘lending to euro zone governments continues to have a zero-risk weight. This will only increase the bias in bank lending towards government debt and against lending to enterprises, especially small and medium-size businesses.’

Just like with sub-prime, the government is in effect mandating banks lend into a particular asset class, creating a bubble that will burst taking down the lender and the borrower. This time, the borrower is the State. And when State’s roll over, you get violence.

Nick Hubble
Daily Reckoning Australia Weekend

Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
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5 Comments on "The Bernanke Pout"

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Lachlan
Guest

asx 200 should get a bounce of some type from 4500.

Earl Mardle
Guest
A couple of questions NH. 1. If the German banks sold a third of their Greek (or GREED as you have it) debt, who bought it? 2. What discount did they get to take on this truckload of rotting souvlaki? If the debt is moved, we should know who bought it and for how much, the one thing that has not changed is the likelihood of default. The other issue is the effect on the German banks’ own solvency. If they had to sell at (say) 80 cents on the dollar it must affect their asset position and any discount… Read more »
Dan
Guest

“But why don’t the banks that are most vulnerable just sell their Greek debt? Friday morning’s German news on SBS informed your editor that the German banks have in fact dumped a third of their holdings of Greed debt. This was something the banks promised the politicians they wouldn’t do.”

Imagine my shock.

Sir Correct-a-lot
Guest

Just a nitpick, fifth paragraph from the bottom of this article reads:

But why don’t the banks that are most vulnerable just sell their Greek debt?… German banks have in fact dumped a third of their holdings of [sp]Greed[sp] debt.

Guessing you meant ‘Greek debt’ instead of ‘Greed debt’ :)

Nick
Guest

‘Greed debt’ has been corrected.

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