Social Mood Interactions and A Surge in Bullish Unanimity

It is a phenomenon we have observed many times. The stock markets recent performance history is the main factor determining how people – including economists – view the future performance of the economy. It may be that they erroneously believe that the stock market is 'discounting' something. More likely though it is just another side of the same coin: the optimism that pervades the minds of traders bidding up stocks infects all of society.


Our point of view is generally more contrarian and therefore represents a minority opinion. We look at the biggest post WW 2 era deficit spending spree, the biggest exercise in monetary pumping (in absolute terms) in all of history, and then look at how pathetically weak the recovery has been so far and feel compelled to ask:


Is that really all we get out of it?



The recovery so far in terms of unemployment – this is all we get out of all that money printing and deficit spending? We should be very worried it seems – click for higher resolution.



If that is all, so we reason, then it must mean that the sequence of boom-bust cycles that has bedeviled the economy and the enormous growth in unproductive debt and the supply of money since Nixon's abandonment of the 'gold anchor' in 1971, have finally conspired to consume so much capital that even the most massive exercises in deficit spending and money printing can create nothing but a pale shadow of the previous artificial credit-expansion driven booms. It seems the effort is akin to feeding Viagra to a corpse – no matter how many pills you stuff into it, it won't get an erection anymore.

In all likelihood, the economy's pool of real funding has suffered great damage.

And yet, the monetary pumping has not been without effect. The liquidation of  malinvestments has been arrested before it could be completed and relative prices have become so imbalanced that factors of production are once again drawn toward the higher order stages of the production structure, creating what we term the 'echo boom'. The distortion of relative prices is most visible in commodities and titles to capital – i.e., stocks.

The performance of the stock market is at the same time a mirror of the change in what Bob Prechter calls the 'social mood', and its performance in turn influences this social mood in a  feedback loop – a virtuous cycle if one is among the myriads of speculators holding extremely leveraged positions betting on more gains to come.

As a sign of how extreme these bets have become, consider that customers' 'free credits' at the NYSE have just fallen to their third lowest level in history – only bested by the extremes seen in early 2000 and late 2007. As Jason Goepfert at recently reported, the respondents of the Barron's 'Big Money' poll have never before been as optimistic as they are now. It is not so much that they are all bullish, but that there are simply no longer any bears.

A similar story is told by the NAAIM survey of fund managers. These managers   are asked about their positioning and can give replies ranging from '200% short' to '200% long'. What has never before happened in the survey's history has happened in recent weeks: for four weeks running, there was not a single bear. It simply can not get any more lopsided.



The aggregate NAAIM survey chart. What the chat does not show is that the 'most bearish' manager was simply 'flat' – not a single manager responded that he held a net short position – click for higher resolution.



A chart of the Barron's 'Big Money' poll from Jason Goepfert's excellent site – The 'Big Money' has never been as bullish as it is now. Similar to the NAAIM survey the main factor that has driven the net bullishness up so much was the complete lack of bears.



The Ultimate Contrary Indicator – Mainstream Economists

After more than two years of rising stock prices, the same economists that utterly failed to see the crisis coming, then were darkly pessimistic as the stock market bottomed out in March of 2009,  are now so optimistic that they state that 'nothing can derail the recovery – except a further rise in oil prices to the $150 level'.

The AP published a survey of economists today that reflects this unanimous opinion, under the heading 'Only Oil Shock Can Stop the Economy Now':


“The American economy is now strong enough to withstand Middle East turmoil and the Japanese nuclear crisis. Only a big rise in the price of oil could stop it now.

Those are the findings of an Associated Press survey of leading economists, who are increasingly confident in a recovery that is nearly two years old. They expect the economy to grow faster every quarter this year.”


What makes these economists so confident? It can not be the slew of recent negative surprises in economic data, which has led to a plunge in Citigroup's global 'economic surprise index' from about 100 points to almost zero – a three month low.

It can not be the massive destruction of wealth in Japan after the tsunami either – except for those economists who still believe in the broken window fallacy (you'd be surprised how many of them do – one of the most prominent is even a Nobel Prize recipient – Paul Krugman). It can also not be the recent massive deterioration in the sovereign debt crisis in the euro area's periphery.

So what accounts for it? Simple – the rise in the stock market. Economists have been led astray by rising stock prices many times before. Famed US economist Irving Fisher believed that 'stock prices have reached a permanent plateau' and that 'nothing can stop a further expansion in prosperity' – right at the top in 1929. J.M. Keynes lost his shirt in the stock market after 1929, evidently believing the bear market to be an aberration (not coincidentally, his pleading for government intervention in the economy and the adoption of inflationist policies became very pronounced right after this episode). What did the stock market 'discount' in early September of 1929? We can tell you what it didn't discount: the Great Depression. In fact, by September of 1929, the US economy had been in contraction for well over a month already.

The failure of economists then and now is to realize that a boom due to credit expansion and inflation of the money supply is in fact not increasing wealth but doing the exact opposite: it consumes wealth. The inflation masks this capital consumption by creating fictitious profits – once the inflationary policy is stopped – as the Federal Reserve finally did in 1929 by raising its discount rate to 6.5% – the wealth destruction is unmasked. It is however important to realize that it is not the bust that is the destroyer of wealth – it is the boom. The bust merely reveals the investment mistakes of the boom and is a period of reorganization and healing. We know both from economic theory and the countless examples of history that once a bust begins, the best thing that can be done by the government is – absolutely nothing. When the first big government interventionists entered the scene in the form of presidents Hoover and FDR, the economy was deprived of the chance to heal itself and the Great Depression ensued. Robert Murphy has written a highly recommended article that is once again dispelling the falsification of history that is today so popular among the interventionist Left, namely that Hoover was allegedly a 'laissez faire liquidationist'. He was the exact opposite, and as Murphy shows, the pro interventionists don't even seem to realize that in relating what Hoover did and didn't do, they  themselves paint the picture of the interventionist Hoover really was. The idea that he trusted the market is preposterous. For this reason we resorted to calling today's interventionist brigade 'Hoover's Heirs' back in 2008.

In any event, one should be extremely suspicious of the show of optimism on the part of economists. The effect of the Fed's monetary pumping on prices is creating an illusion of prosperity that will once again be rendered asunder as soon as the inflation stops. Mainstream economists were very optimistic during the housing bubble as well – very few of them saw the disaster coming. However, we should all have learned a valuable lesson from the bust: namely that the profits generated by inflation are indeed fictitious. The financial sector accounted for 40% of the profits of listed corporations in 2007. Over the next two years all the bubble profits and more disappeared back into thin air.

It isn't 'different this time' – which leads us the the next topic.


Is There A 'Paradigm Shift' In Commodities?

Jeremy Grantham, a money manager we otherwise greatly admire, has just come out with a new report (pdf) in which he asserts that the enormous rise in commodity prices indicates that 'something is different this time' compared to previous commodity booms. As we noted above, even great men frequently have such sudden epiphanies that make them think that 'something is different' when in reality, they merely observe the effects of vast monetary inflation. 

In his report Grantham observes:


“The history of pricing for commodities has been an incredibly helpful one for the economic progress of our species: in general, prices have declined steadily for all of the last century. We have created an equal weighted index of the most important 33 commodities. This is not designed to show their importance to the economy, but simply to show the average price trend of important commodities as a class. The index shown in Exhibit 2 starts 110 years ago and trends steadily downward, in apparent defiance of the ultimately limited nature of these resources. The average price falls by 1.2% a year after inflation adjustment to its low point in 2002. Just imagine what this 102-year decline of 1.2% compounded has done to our increased wealth and well-being. Despite digging deeper holes to mine lower grade ores, and despite using the best land first, and the best of everything else for that matter, the prices fell by an average of over 70% in real terms. The undeniable law of diminishing returns was overcome by technological progress – a real testimonial to human inventiveness and ingenuity.

But the decline in price was not a natural law. It simply reflected that in this particular period, with our particular balance of supply and demand, the increasing marginal cost of, say, 2.0% a year was overcome by even larger increases in annual productivity of 3.2%. But this was just a historical accident. Marginal rates could have risen faster; productivity could have risen more slowly. In those relationships we have been lucky. Above all, demand could have risen faster, and it is here, recently, that our luck has begun to run out.”


(our  emphasis)

Below is the chart of commodity prices the above quote refers to.



A chart of commodity prices by Jeremy Grantham. What he calls 'war effect' or 'oil shock effect' should be more correctly called 'inflation effect' every time. In all the historical instances when commodity prices boomed as a group, the culprit was without exception massive monetary inflation – click for higher resolution.



The part of the quote from Grantham's report we highlighted above is in our opinion erroneous. It was not a 'historical accident' that commodity prices declined, but the logical outcome of the adoption of free market capitalism. Of course one could argue that free market capitalism – an economic system based on voluntary exchange and social cooperation –  itself was a 'historical accident'. However, we do not believe it was. The adoption of  free market capitalism on the contrary is the outcome of man's faculty for reasoning. It is the result of human beings realizing that by means of social cooperation and the division of labor, they could gain far more material wealth than they could ever hope to gain by conquest or autarky.

Neither the adoption nor the success of capitalism are a 'coincidence' or a 'historical accident'. Grantham mentions the increase in demand for commodities from emerging market economies such as India and China as having forever changed the equation. Perhaps he should have looked at the data underlying China's boom. Guess which datum is the most important? You can see it in he chart below:


The growth of China's broad money supply measure M2 over the past several years. Note that neither this measure nor the US M2 measure depicted below tells the whole story, since the true money supply has in all likelihood risen even faster (it certainly has in the US, but we do not have TMS data for China at present – a defect we will soon try to do something about given China's growing importance) – click for higher resolution.



No-one should be too surprised that an economy with a fixed non-convertible exchange rate and an exploding domestic money supply experiences a concomitant explosion in the demand for commodities. We would suggest that the exchange rate of the yuan if it were freely convertible would most likely have declined in view of such enormous money supply growth, raising the prices of commodities for Chinese consumers to such an extent that their demand would have cooled by now (this is always assuming that the inflationary policy doesn't go 'overboard' into a complete annihilation of the currency).

Similarly, as we have previously mentioned, the US 'Austrian' money supply measure  TMS-2 has increased by nearly 150% since the year 2000. We have just experienced a decade of record monetary inflation relative  to the entire post WW2 era. Why would commodity prices fall under such circumstances?

As to 'peak' oil and similar concepts – as Bob Hoye frequently reminds us, another great economist – Stanley Jevons – was worrying about 'peak coal' as early as 1864.

Grantham also points to the work of Thomas Malthus on population growth, to which we note: Malthus and his disciples have been proven wrong for two centuries now. How much more proof is required? Another century of their dire predictions not coming true? In fact, Malthus' error was precisely that he completely underestimated human ingenuity and the power of the free market. If anyone had told him that one day the planet would be able to feed over 6 billion people, he would have called such a proposition a preposterous fantasy. And yet, this is precisely what happened. Even if it is true that supplies of hydrocarbons are limited and insufficient for our projected future needs, there is no reason to assume that human ingenuity won't win out once again and a solution to the problem will be found. In fact, that is what we would bet on.

There is of course a great danger that must not remain unmentioned: because so many people today confuse our present system of state or crony capitalism with the ideal of free market capitalism – i.e. because capitalism has been given a bad rap that it doesn't deserve –  there is a great danger that the free market will be further diminished by political means. We already commented on a recent speech by IMF chief Strauss-Kahn in which he pleaded for the 'pendulum to swing toward the State from the free market'. Clearly the pendulum has been swinging toward more statism and less liberalism for about an entire century now, so this seems a completely superfluous exhortation on the part of the IMF chief. At times though the tendency is at least braked a bit, and the free market can regain some of its lost vitality. This has been most evident in the great blessings brought to humanity by the large increase in world trade in recent decades. Hundreds of millions have been lifted out of abject poverty by this development and finally can look forward to a dignified life.

At present it appears however that we are hurtling headlong toward more and more statism, as the system of state capitalism has recently been fortified via the bailout of the failed banks and other well connected industries following the 2008 financial debacle. In that sense, Grantham may have a point – there is possibly a 'paradigm shift', but it has nothing to do with the market's ability to lower the cost of production of commodities over time. Rather, it has to do with the fact that more and more obstacles are put in the free market's path. Not coincidentally,  the US 'shadow economy' has grown to an estimated $1 trillion – clearly, people are trying to escape the heavy hand of the State.


Greek Fantasies

Just a brief note on Greece: EU commissioner Olli Rehn likened a possible debt restructuring of the European peripherals to 'taking a drink to put off a hangover. He said that it would give short relief, but would not help the countries in the long run'.

Now we would agree that in the long run, all these countries need to cut back their government spending and introduce wide-ranging reforms if they want to get back on their feet. Alas, what the EU is doing now is handing them even more cheap debt. And that isn't like taking a drink to put off a hangover? If not, what is it?

Meanwhile Greek ECB board member Athanasios Orphanides is plainly fantasizing:


Greece has made significant progress in implementing an EU/IMF austerity programme and any suggestion of restructuring its debt would be wrong, ECB Governing Council member Athanasios Orphanides said on Wednesday.

"A restructure would be wrong. It would be undesirable for the Greek economy, for the economy of the euro zone, unnecessary and it is just a very bad idea," Orphanides told a news conference in Nicosia.”


Whatever he is smoking, we want some.


Chart Update:

We are updating the most important charts of our usual collection below, so readers can see where things currently stand.



5 year CDS spreads on Portugal, Italy, Greece and Spain – the rise continues – click for higher resolution.



5 year CDS spreads on Ireland, the senior debt of Bank of Ireland, France and Japan – Ireland still rising toward the previous all time high – click for higher resolution.



5 year CDS spreads on Austria, Belgium, Hungary and Romania – click for higher resolution.



The Markit SovX index of CDS on 19 Western European sovereigns – at just below 200 basis points it is at a new high for the current move and once again approaching its all time high of early January – click for higher resolution.



The yield on the Greek 2 year note – yet another new high, now residing at over 25% – click for higher resolution.



A long term chart of the Greek 2 year note – click for higher resolution.




We want to point readers to an article that has caught out eye in the Telegraph, 'Economics is far too important to be left in the care of academics', in which Roger Bootle discusses the pointless work of many mathematical economists resulting from their 'physics envy'. Needless to say, we agree with his critique.

Also very noteworthy, a recently published list of '25 questions and answers to Free Banking' by  Dutch economist Dirk-Jan van Enk, which we think is a great summary well worth reading. We strongly recommend it as a 'quick guide to Free Banking and why we should adopt it'. 


Charts by: Bloomberg,,



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5 Responses to “The Magic of the Echo Bubble”

  • SMaturin:

    Love that Viagra analogy, Dark One!

    When zombie banks get erections, who do they screw?

    Just doing God’s work on the taxpayers…..

  • Thanks Pater. The sentiment data is simply astonishing. The contrarian investor has got to be thinking about executing on the short-side of the stock market from here. The problem is resisting the widespread feeling of ‘It’s going up! It’s going up!’ in the meanwhile.

  • Floyd:

    Pater, a great article as always.
    Yet, I beg to differ a little.

    It is hard to tell what is the carrying limit of Planet Earth, and it is subject to dynamic constraints and multiple variables.

    However, peak oil is difficult to argue with. While it is believable that alternative energy sources will be developed, the transition doesn’t seem smooth (especially with the lack of truly free markets).
    Further, exponential population growth must have limits on a finite planet. Managing the population size may be a workable approach, but it doesn’t seem feasible with the counter attitudes in large sections of the glob (promoting large family size).

    • I would argue that the peak oil problem is less acute that it is generally portrayed as – for the simple reason that resource economics preclude a determination of the level of extant reserves beyond a certain number of years (this is why e.g. some gold mines that 20 years ago had 10 years worth of reserves left are still producing gold today). Moreover, technological innovation is not standing still – I would note that oil sands and the production of natural gas from shale are two recent examples showing that the planet’s fossil energy resource endowment has still a lot of life left. As to overpopulation, experience has shown that once a society reaches a certain degree of economic affluence, its population growth tends to drop off. Generally I would say that both problems are perfectly amenable to free market solutions – I do however agree that government interference could potentially exacerbate any potential problems in these areas.

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