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    Beware The Great Central Bank Bubble

    I guess it all came to a head for me when I saw the story of the Thai billionaires.

    This pair has dropped about $27 billion in acquisitions this year. In April, one of them pulled together a $6.6 billion deal in a week.

    You can’t refinance a house in that kind of time.

    That’s when I realized this global central bank easing is starting to develop some very dangerous consequences.

    The U.S. Federal Reserve kicked off this money-printing frenzy to re-liquidate the very banks and financial institutions that started the whole mess. It then began to spread because no country wanted to see its banking system collapse.

    The last time that happened was during World War II, when the British handed over the global economy to the United States by pricing every major commodity in dollars. That meant every nation had to hold dollars to be in the global marketplace. The dollar became the world’s reserve currency.

    That was seriously challenged when the 2008 financial fiasco occurred. China, at that point, had managed to avoid the over-leveraging and derivatives shenanigans that the West had found so engaging.

    And its growth rate and internal demand was strong enough that there was a real sense that the country could de-couple from the West’s maelstrom and become the globe’s engine of growth moving forward.

    Close, But No Cigar

    Unfortunately for the Chinese, they missed by a hair.

    The West collapsed, and that had more of an effect on China than the nation anticipated. They started their wacky building programs to keep internal demand going to make up for the loss of outside business.

    But it got a bit out of hand.

    Meanwhile, the West has been pumping money like crazy into the pathetic institutions it felt compelled to save — for the good of all us little people, of course. And the institutions in their gratitude have made billions of dollars quarter after quarter and are still not rolling this money into the economy, where it was supposed to go.

    China’s challenge is the opposite. It’s deployed its money into the economy on massive building and infrastructure programs that have no real market demand yet.

    The Other Shoe

    The thing that really started to make this whole easy money thing scary was when Japan, the third largest single economy in the world, decided it was time to get in on easy money game with the United States and Europe.

    The Japanese have lived in a unique economic realm for almost 30 years. First, the citizens generally hold all their money domestically in Japanese postal accounts that are like retirement/savings accounts. Because interest rates are low to non-existent (as is inflation), there’s no real incentive to spend money. And since nearly all the nation’s debt is held internally, it has very low volatility since no one in interested in trading it.

    Well, trading it in a conventional way. Actually, the yen has become the world’s carry currency trading vehicle.

    Investopedia defines a carry currency trade like this:

    A strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates, which can often be substantial, depending on the amount of leverage used.

    Here’s an example of a "yen carry trade": a trader borrows 1,000 Japanese yen from a Japanese bank, converts the funds into U.S. dollars and buys a bond for the equivalent amount. Let’s assume that the bond pays 4.5% and the Japanese interest rate is set at 0%. The trader stands to make a profit of 4.5% as long as the exchange rate between the countries does not change. Many professional traders use this trade because the gains can become very large when leverage is taken into consideration. If the trader in our example uses a common leverage factor of 10:1, then she can stand to make a profit of 45%.

    But now that the yen has been opened up, Japanese are going elsewhere for value and the yen is being traded for the first time in decades in the open markets.

    And the markets — both bond and stock — are going nuts.

    Back To The Thai Tycoons

    So the reason the Thai spending hit me was I realized that these barons of industry can get their hands on this cheap, easy money. I mean who else could borrow $6.6 billion in a week? Most small and medium-sized businesses can’t get loans in the United States — to expand.

    From there, it’s simply doing the math. The easy money is getting outside the financial institutions and into the hands of big, safe (a relative term to be sure) corporate types who are borrowing big at crazy low rates.

    Unfortunately, the blowback here is that rates are already ticking up in the United States. And that trend will follow everywhere else.

    And in that great unwinding, bonds — from Treasuries to junk — will be in for a reckoning that will make the real estate bubble look like a blip.

    Now, this may not come to fruition. But given the short-term myopia of those that drove us into the past financial imbroglios and the fact that we’ve rewarded them instead of punishing them, I’m betting they’ll be at the trough until the end. And anyone not clear of their greed will pay the price.

    — GS Early

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