Roubini's Bad News Explained

Roy C. sent me the following message: “Roubini's bad news. Could you translate some of the harder stuff into something comprehensible?”
Lets try to make it better understandable:

The United States is up to its ears in an ever-increasing mountain of debt, both to its creditor nations in the Middle and Far East and, to an even larger extent, to its own citizens.

"Young Americans are in danger of finding themselves slipping downhill. Instead of expecting things to get better, they may find it hard even to hold onto what they've got. Instead of the 'Morning in America' that Ronald Reagan promised, they might find that it seems more like evening, both in their personal as well as their national lives."

Much of America's international influence was acquired during a time when the dollar roamed free and easy as the world's reserve currency. French President Charles De Gaulle once called it an "extraordinary privilege."

At its height, the US Dollar commanded a magisterial awe and its position were largely considered unchallengeable. But no challenge is too great for the mighty US government, especially the challenge to debase its own currency.

It is an axiom that extraordinary privileges carry extraordinary responsibilities. Within a single generation, the irresponsible fools in charge of preserving the dollar's integrity have destroyed almost all of its purchasing power. Measured against gold, it has slumped some 97% since Nixon closed the gold window in '71. And now, when Tim Geithner the Treasury Secretary of the United States of America tells a classroom of Chinese university students that his nation's currency is trustworthy and reliable, they laugh in his face.

Then, on top of an increasingly worthless currency, the younger generation also inherits about a quarter of a million dollars each in unfunded Social Security and healthcare obligations, the overdue infrastructure bills of a crumbling nation, a couple of distant wars to fight and die in, plus a world full of disgruntled foreign creditors.

In this economic climate of the Fed’s bailouts and stimuli to avoiding the Great Depression 2.0, the surplus of this money is invested in the stock market, with the result in accordance to the media obviously everything goes very well, as Roubini states:

“Every investor who plays this risky (investment) game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.”

“Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage-backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR (risk factor) again looks low.” Of course there is no risk the money used belongs to the feds – taxpayers’ money- and in the end, it is not investors’ own money.

“So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles.”

However one day in the not too distant future this bubble will burst, leading to the biggest co-ordinated asset bust ever: if all those factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

Stocks prices are very much too high, which means that the collective anxiety of investors is very low. Authorities in charge don't mind that a rising stock market is adding trillions of dollars to the asset side of the balance sheets, because that's good news. But the worrisome part is that a falling stock market could erase those trillions from the ledger just as quickly as they first appeared. And as correctly is stated, rising share prices are the result, but this once will coincide with falling investor anxiety, which usually adds up to a big, fat stock market selloff. Everyone is warned to get out before. This is not a doomsayers' warning but a very realistic one to take note from.

Which confirms Roubini as follow:
“ This unravelling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.”