The 1929 & 2007 Bear Market Race to The Bottom

黄河之水天上来

The 1929 & 2007 Bear Market Race to The Bottom
Week 68 of 149

Bretton Woods Monetary Accords are Still Here
Only the Gold is Missing - So What?

The Bad Business of Floating Currencies
Foreign Central Bank's US Treasury Holdings
Fed Credit BEV Chart Portends DJIA Problems in 2009

Mark J. Lundeen
Mlundeen2@Comcast.net

30 January 2009

Color Key to text below
Boiler Plate in Blue Grey
New Weekly Commentary in Black

Here is the BEV chart for the Bear Race.

I look at this chart and I see Bear Envy and Resentment. Envy as the 1929 bear breached the BEV -40 & -50% lines long before the 2007 Bear broke under -40%, and resentment at the "policymakers" who keep getting between the 2007 Bear and its destiny.
This Bear has been shown some serious disrespect. To show the world it's not "policy's" punk, it might just have to breach the -60% line before the 1929 Bear did in Week 87 of this race. That would be in mid June of 2009.
Can he do it? I hope not! But when you read my comments on derivatives and bank reserves below, there is a damn good chance that this Bear is going to take all the "policy makers" to the woodshed and give them a proper spanking in 2009.
The weekly closing price BEV (Bear's Eye View) results for week 68 in the Dow Jones' 1929 & 2007 bear market's race to the Bottom are as follows:
1929/32: -55.57% from its weekly closing high price of 380.33
2007/09: -43.23% from its weekly closing high price of 14,093.08
Below is my volatility chart comparing 2007's 40 & 200-day moving average closing price volatility with 1929 bear market volatility.

Note: 2007 values are actually positive. They were inverted so 1929 would fit on top and 2007 on the bottom. So for 2007, please forget the negative valuations and focus on the percentages.

(Remember, with the 2007 data up is down and down is up!)

1929/32, Wk 68 200 Day Moving Average Volatility: 1.30%
2007/09, Wk 68 200 Day Moving Average Volatility: 1.82%

The chart above suggests that volatility is calming down, but the chart below tells a different story.

Of the past 200 trading days, 68 of them have been +2% days. There were 66 last week.
To illustrate the extreme volatility of this market since July of 2007, I've made the next table showing the 2% days occurring in a standard 5 trading day sample. Remember, a 2% day can be an up or down day. Bear Markets have plenty of powerful up days and the table below includes the 3 months leading up to the October 2007 DJIA BEV Chart's Terminal Zero. It was in July of 2007 that +2% days became a common event.

In early December 2008, there was a string of seven >2% days in a row. That got everyone's attention! We couldn't get the "policy makers" off the TV News. But that was seven weeks ago, so who cares?
Like any good horror movie director, the Bear knows that terror has to be carefully rationed during the movie to make his final scene's chainsaw-wheeling fiends really effective. If this market, with its 1 or 2, 2% days per week, is beginning to lose it thrill for the Bulls watching the Bear's movie, rest assured that the director has some surprises still to come.
Historically, daily 1% swings from the pervious day's closing price in the DJIA, while not uncommon, should not occur on an almost daily basis. The stock market is running a fever with its "Persistent, Extreme Volatility."

The Lundeen Bear Box and Step Sum is below.

The "policy makers" want the DJIA to stay above the -40% line while the Bear is looking real hard at the -45% line and below. Normally, buying put options would be the thing to do here, but options are derivatives in a world with major derivative counter-parties dying a little each day. You only get paid with options if your counter-party survives your market victory!
This is not a time to get fancy trying to maximize your trading strategy. Buy some gold and silver coins or bars and watch CNBC's "experts" tell others how to lose money.
The Step Sum is an indicator of market sentiment. When the underlying sentiment is bullish the Step Sum will rise. When bearish it falls.
Think of the "Step Sum" as the sum total of all the up and down "steps" in a data series as prices change over time. An Advance - Decline Line for a data series derived from the data series itself. Logically, to have more up days than down days during a bull market makes sense as does having more down days than up days during a bear market. Understanding the Step Sum is no harder than that.

The Bretton Woods Monetary Accords are Still Here
Only the Gold is Missing - So What?

I've often written when President Nixon broke the link between the dollar and gold in 1971, it signaled the end of the Bretton Woods Monetary Accords (BWA). When reading history, that is how it's always put - the BWA was ended in 1971 when Nixon closed the gold window. But if we really consider what happened in 1971, we see that this is not the case at all. The Bretton Woods Monetary Accords are still here, only the gold is missing. The three points below are BWA creations, and they are still major factors in a world dominated by US, CinC dollar inflation.

• A US dollar standard for international trade
• The World Bank
• The International Monetary Fund (IMF)

The ability to convert paper money into gold existed long before the BWA. So technically speaking, the ability to convert a quantity of paper money into gold coins of set weight and purity is not an invention of Bretton Woods. But the above three institutions have only existed since the BWA was ratified. It's * in-accurate * to say that the Bretton Woods Monetary Accords has ended until the above three institutions are as extinct as $35 gold.

The Bad Business of Floating Currencies

The current "policy" non-sense of allowing currencies to float within a free market is just the current non-sense spouted by today's ethically challenged academics, bankers and politicians. Floating exchange rates have never been, are not now and will never be a good idea for productive businesses and wage earners. Floating exchange rates are the outward manifestations of systemic corruption that will ultimately prove disastrous to even the academics, bankers and politicians who've promoted them.
What is best for industry and commerce is:

• Low & stable interest rates
• international currency exchange rates bolted tightly together.
• low CPI and asset inflation

Global industries, by necessity, need to plan their operations years ahead. They would benefit greatly if the above three variables are constrained by an honest dollar. So too would have the employees and customers of these businesses.
The building of huge industrial infrastructure has always taken years to complete. When gold was money, a manufacturing concern financing their increased productive capacity would only have had to obtain financing for a long-term project. In the 19th century, with its gold standard, the industrialist didn't worry if changes in the cost of labor, or materials would have made his original loan insufficient a few years into a project. His fears that the intended customers for his products in other countries would be ruined by domestic inflation were minimal. Nor did a 19th century industrialist fear that interest expenses for the company, or its customers, would swing wildly at the whim of academics.
Things have changed greatly with the debt-backed dollar. The current monetary system has introduced all of these risks in the 20th Century. Business today is forced to control them by "hedging" with derivatives.
To understand how devastating the breaking of the link between gold and the US dollar has been, one only needs to know that the notional value of the derivatives now necessary to hedge these risks are in the hundreds of trillions of dollars. We frequently hear on CNBC and other retail sources of financial news of problems with the banking system's assets and corporate earnings. The never asked question is exactly what are these problems? An honest answer would have to include derivative hedges that have blown up balance sheets of companies listed in America's stock exchanges.
Knowing the extreme swings in valuation for financial assets and commodities in the past year, I suspect one reason the banks refuse to lend their TARP money is that it has already been spent to honor their counter-party obligation from these derivatives. But keep that possibility just between you and me.
The derivative market is an over 500 trillion dollar market in specific performance contracts. A puny 1% swing in the wrong direction could result in cash calls of trillions! This was the market, we were told by the Academic Dr. Greenspan and Banker Rubin when testifying before the Politicians in the Congress over 10 years ago, that made FDIC and the Glass Steagall Act obsolete. The Unholy Trinity, and the financial media are now blaming capitalism for the catastrophe they created and failed to properly report.
The current debt-backed dollar monetary standard is a bad business that benefits only members of what I call the Unholy Trinity.

• Politicians who have financed their re-elections by expanding the money supply beyond what a gold standard would allow.
• Bankers who have created huge and lucrative markets in derivatives made necessary by floating exchange rates, CPI inflation and whimsical changes in interest rates.
• Academics who have taught students for generations that gold was bad and debt was good. For their success in deceiving the world, they have been amply rewarded by both politicians and bankers, and given a seat at the table of power as their reward.

Of the three, academics (meaning the social scientists) are the worst. Let me be clear here. I have only admiration for true scientific disciplines that have brought real benefits in life sciences, and engineering. Since 1945, physicists, engineers, chemists and medical researchers have transformed the world we live in. But since 1945, those charlatans who fancy themselves as "social scientists" have changed our world too, but not for the better. The dollar is but one of their victims, our once thriving inner-cities another.

Foreign Central Bank's US Treasury Holdings

Monetary reserves world wide are typically debt-backed US dollars. The current American "monetary policy" is one of currency debasement, and so is the world's.

My data for Foreign Central Bank's (FCB) US dollar reserves held at the NY Fed starts at May 1995. Below I've charted FCBs reserves and Total Fed Credit. Note that the FCBs reserves below are their dollar reserves. I assume that the euro is also a significant reserve asset, but one I have no data on.

In the chart above, we're observing an inflationary global monetary system spiraling out of control. These grotesque expansions in monetary reserves would be impossible with a gold standard. For producers and consumers of products, there is no advantage in having an expanding money supply.
Let's see how international trade under a gold standard would work. In my example economy, there is only France selling wine and the US selling Microsoft software.

This is how the gold standard managed international trade. There is no room for "policy" in the above table that allows for decades of trade imbalances. Also, with a gold standard global money supply rises only as fast as explorers and miners of gold could find and mine it. Here is the reason for removing gold from the monetary system.
For politicians and bankers chafing at the restraints of a limited money supply, it made perfect sense to make room at the table of power for the social scientists who declared their genius could stand in for gold. The university system was more than willing to corrupt our money, and confound generations of students entrusted to it with their quack theories of money.
So today, central banks managed by academics, expand our money supply by purchasing a reserve asset whose ability to expand is bounded only by human gullibility - the US dollar. This Keynesian inspired reserve has been a boon for "policy makers" world-wide as all politicians and bankers benefit from inflation, until the bubble pops. The current global real estate crisis is directly a result of the US breaking the dollar link to gold in 1971.

Central Bank Reserves BEV Charts

BEV charts force every data point to be expressed in percentage terms bound by 0% for each new all-time high and negative percentage terms for all other data points that are not new all-time highs. This is why I use the term "Terminal Zero" for the last all-time high of a bull market. The Terminal Zero is the last 0, or all-time high, on a BEV chart for that bull cycle.
The charts below are from the exact data series I used in charting central and Fed reserves above. Note how the BEV chart compliments the charts plotting nominal values.
In the chart for FCB US$ reserves, the big spike down in 1998 was from the "Asian Tiger Economies" stock markets and economies faltering. It was called "The Asian Contagion" at the time. Many loans were called in, and the "Asian Tiger" central banks had to raise money by selling US Bonds.
Eleven years later, during a similar economic situation, but one that is global in scope, no FCB is selling bonds to raise cash. What does this mean? Simple. In 1998 banks were calling in loans from the Tiger Economies. To pay for these loans, US Bonds were sold.

Today's defaulting debtor's foreign bankers have decided to roll over the bad loans and not demand payment, for now. It's a "policy" thing. If the FCB were to sell 15% of their bonds today, as the US is seeking to sell trillions of dollars of new US Bonds in the next few years, domestic US interest rates would soar and set off a chain-reaction of credit and derivative counter-parties defaults. In 2009, US Bonds are to be bought, not sold. What kind of reserve asset is that?
Not much of one when one considers that Wall Street has created a multi-hundred trillion dollar notional value derivative market to hedge:

• currency
• interest rate
• CPI inflation risks.

If the FCBs were to sell off their reserves of US Bonds, it would result in waves of counter-party defaults that would strip the Earth of its ozone layer and cause storms of pure sulfuric acid to fall on the rain forests. Well, maybe I'm exaggerating. But Dr Bernanke would tell congress I'm exaggerating by only a bit if that is what it took for more bailout money for his banks. Congress, as usual, would take him at his word. He's from Princeton and an expert on the Great Depression.

Fed Credit BEV Chart Portends DJIA Problems in 2009

Comparing the chart above with the chart below, we see that the FCBs have not sold down their portfolios of US reserves below 2% since 2001 while the Fed below, as always, does its own thing.
The interesting thing to note about the chart below is the big 13% reduction of reserve assets in January 2000. This is related to the Y2K fiasco. It looks like a tiny bump now in 2009 when viewed on the current chart of Fed Credit (above). But in January of 2000, this spike rose up like a mountain on the plot. The Y2K thing was the final Greenspan "monetary injection" that drove stock valuation to their peak in 2000. The BEV chart doesn't do justice to how much Greenspan expanded Fed Credit. From Dec 1998 to Jan 2000, Fed Credit expanded 28.40%.
All during 1999 and up to the DJIA's 2000 BEV Terminal Zero, the credit junkies on CNBC were party animals from these "liquidity injections" of Dr. Greenspan.

But after 01 Jan 2000, the Y2K Crisis had passed. So Dr. Greenspan started draining reserves from the credit system. The Credit Junkies on Wall Street went into immediate withdrawal and the High Tech and Dot.Com stocks crashed.
I bet most of you have never seen the 2000 stock market crash with a Bear's Eye View (BEV) of Total Fed Credit before!
As we can see, a similar situation is being set up at the beginning of February 2009. Dr. Bernanke made lots of credit junkies get well in the past year (if not succeeding in making them party animals) by expanding Fed Credit by 160.92% in 2008! But like all addictions, as the junkie goes deeper into their private hell of "liquidity injections", it takes more and more to get less and less from their drug of choice.
It's now obvious that Dr. Bernanke is now withdrawing his "liquidity" from the junkies as we speak. The next few months, or maybe weeks, we may see some action in the DJIA. But remember, Dr Bernanke has a new monkey wrench so the old rules may not apply anymore. Also, Bernanke is not raising short-term interest rates, but note below that the bond market is raising long term rates.

Maybe the real reason Bernanke is thinking of buying long-term bonds is to save the ozone layer. I know he's not trying to manipulate our "free markets."