Marc Faber Calls the Fed a "Liquidity Drug Dealer"

Anyone nicknamed Dr. Doom is likely to be a man after my own heart, and Marc Faber is no exception. The Swiss investor has a good record of market calls (for instance, he was a staunch commodities bull till late in the spring, when he reversed his view) and perhaps as important, has a broader historical perspective than most of his peers and a propensity to be blunt.

His latest comments to CNBC are no exception (hat tip reader Dean):

The Federal Reserve, which has encouraged excessive borrowing, is to blame for the credit crunch that has gripped world markets for more than a year, Marc Faber, the author of the Gloom Boom & Doom Report, told CNBC on Tuesday.

“About 15 percent of U.S. households have negative equity. Who supplied the leverage into the system? It’s called the Federal Reserve Board,” Faber said.

“If I’m the drug dealer I’m not responsible that everybody takes drugs, but I facilitate it, especially if I give it out free of charge, I can enlarge the market share, and that’s what the Fed has done.”

Liquidity will dry up even more, volatility will stay high and financial assets are going to suffer as the crisis continues to unfold. The bailout plan is unlikely to work and the global economy will take the hit, he predicted.

“People rely on the people in Congress, at the Fed, at the Treasury, people that brought us into this trouble, to take us out of trouble. I don’t think they will succeed,” Faber said. “We can have recovery rallies but a new high on the S&P is practically out of the question for a very long time. In real terms, equities are still very high and economically, I think the world will go into a slump.”

The main provider of global liquidity was the U.S. current account deficit, which increased at a fast pace over the past 10 years, but this will no longer be the case.

“Next year, if the economy in the U.S. is as weak as I think it would be, the trade and the current account deficit will continue to contract,” Faber said. “When global liquidity contracts, it’s not a good time for financial assets.”

Other sources of funding, such as foreign reserves of resources-rich countries, are also likely to dry up, Faber said. “I think sovereign wealth funds are going to be very busy supporting their own markets, they won’t have much money to buy assets around the world.”

Volatility comes from the fact that, as the private sector tightens lending conditions to adjust its risk management, central banks are injecting liquidity in the money markets to grease the system, he said, adding that banning short-selling will not contribute to reducing volatility and was a “stupid measure.”

“Short sellers are not responsible for current problems. The current problems are caused by the US Fed (Federal Reserve), that was sitting there and letting credit growth go out of bounds,” Faber said.

“We have to see very clearly that the cause of the problem was excess leverage. The biggest hedge funds were Fannie Mae, they had the leverage of one over 150 and under the eyes of Congress, under the eyes of the SEC and everybody… and nobody did anything about it. Then, people go and bitch about the short sellers,” he added.

The fact that the rules on short-selling are changing nearly daily, with new names added to the list of securities in which short-selling is banned or with specific rules regarding hedging and confidentiality contributes to adding uncertainty, he said.

The problem is also exacerbated by the fact that nobody knows how long the emergency measure will last or what is next.

“The next emergency measure will be that Americans are not allowed to buy foreign currency and transfer money overseas, and the next measure will be not permitting Americans to buy gold and so on and so forth…. It creates even more uncertainty in the market place when you continually change the rules,” Faber said.

See the video here.

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  1. Anonymous


    I believe that this link hasn’t been shared here…oh the irony.

    The securities regulator has asked China’s two stock exchanges to submit final plans for the introduction of margin trade and short-selling of shares, people with direct knowledge of the situation said.

    China preparing for stock margin trade -sources

  2. Anonymous

    ***Off topic too here:

    The bailout plan is passing tomorrow.

    US Democrats claim Wall St. bailout breakthrough

    “We now have between House and Senate Democrats an agreement on what we think should be in the bill, and we have a meeting scheduled at 10 a.m. tomorrow to meet with the Republicans,” said Frank, chairman of the House of Representatives Financial Services Committee.

  3. weichristineliao

    Hi Yves,

    Thanks! Here is a related piece by Andy Xie (from his Chinese blog site). You might be interested:

    Saving America/

    The U.S. financial system could go under without swift action from the global community.

    By Andy Xie, board member of Rosetta Stone Advisors Limited
    Banning short selling, establishing a government entity for warehousing bad assets, and guaranteeing money market funds have brought relief to financial markets. But this may be temporary. The U.S. still needs to find money to pay the losses from disposing of bad assets, decreasing leverage in the real economy and financial sector, and finding a non-debt-driven method to make the economy grow. The road ahead will be long and hard. The global community may have to work together for a solution.
    Market pressure has forced the U.S. government to adopt the barrage of new measures. The origin of the crisis is excessive leverage, especially at Wall Street brokerages. Short sellers have learned to bring them down. They short their shares to create a panic that sends their trading counterparts fleeing. The resulting loss of liquidity bleeds the highly leveraged brokers to death. Obviously, banning short selling allows them to live longer. Ironically, Wall Street created the short sellers or hedge fund industry after the hi-tech bubble burst to juice up its businesses. Like a modern day Oedipus tragedy, they have come home to slay their parents and take their homes.
    However, technical changes don’t alter the fundamentals. Businesses that live solely on increasing leverage are no longer viable. Deleveraging is inevitable, which could lead to a gut-wrenching recession. Every sector in America is overleveraged. Where can they find the money to recapitalise the economy?
    The solution to America’s crisis must involve the countries that own US$ 10 trillion in foreign exchange reserves. The U.S. economy is undercapitalised. An internal solution is usually one form of debt replaced with another. The current proposals fall into this category. When the shell game runs out of options, printing money is the only way out. That will eventually lead to the U.S. dollar collapsing and hyperinflation in the U.S. economy.
    The world should come together to prevent such a tragic ending. Countries with big foreign exchange reserves like China, Japan, Kuwait, Saudi Arabia and the United Arab Emirates, for example, should sit down with the U.S. government to find a way to recapitalise its economy. They should swap their U.S. dollar assets in debt instruments like treasuries for equity assets like stocks.
    The world has a vested interest in ensuring an orderly resolution to the U.S. crisis. If America prints money to solve its problems, it will lead to the destruction of other nations’ wealth in U.S. dollar assets and a global depression of unimaginable proportions. Rising leverage in the U.S. has driven the demand growth in the global economy in the past decade. The high foreign-exchange reserves of its trading partners and the excessive leverage of the U.S. economy are two sides of the same coin. It seems that both sides need to participate in a solution.
    The U.S. needs to change its policy towards foreign investments. Its xenophobia about investments from non-western nations is a major barrier.
    The magnitude of the debt-equity swap needed is massive. The U.S.’s non-financial sector debt rose to 226 percent of gross domestic product (GDP) last year, up from 183 percent of GDP 10 years before. The financial sector debt surged to 114 percent of GDP, from 64 percent during the same period. The real economy may need 40 percent of GDP in extra equity, or US$ 5.5 trillion, equivalent to one-third of America’s stock market capitalisation. Foreign capital should be sought for at least half the amount needed.
    The capital requirement for the financial sector depends on how much it deleverages. The required deleveraging is probably between US$ 5 trillion and US$ 8 trillion. A significant portion of that is bad assets. As the total losses could be similar to the total amount of capital in the U.S. financial system before the crisis began, it may be necessary to let foreigners become majority owners of its big financial institutions. During the past year, U.S. financial institutions have sold minority stakes to sovereign wealth funds around the world. With no control over these institutions, other nations are of course resentful of the terrible losses they have suffered. In future fund-raising, U.S. financial institutions may have to sell controlling stakes to foreigners.
    While the above proposal is a win-win for the world, the odds of it being implemented are quite low. The U.S. still has an unrealistic view of itself. Its domestic politics are too insular and xenophobic. Even though the U.S. is the largest debtor in the world, it behaves like the largest creditor. Americans may need much more hardship to change their attitude.
    The next step seems to be to shift private-sector debt to the public sector. The proposed government body to take over bad assets provides such an instrument. In theory, it unwinds by selling bad assets along the way. But who would the buyers be, and who would be responsible for the losses? Everyone in the U.S. has too much debt already. Only foreigners can provide the equity capital required for the final debt-equity swap. However, the unwillingness to accept capital from non-western countries may push the U.S. to print money. The Federal Reserve can purchase whatever papers the federal government issues to cover the losses in the bad-asset disposal. That will lead to high inflation. When foreigners dump their U.S. dollar assets, the dollar will crash, and the U.S. may experience hyperinflation and economic chaos.
    To protect themselves against such a scenario, foreign governments should switch their treasury holdings into stocks. These preserve their value better during inflationary times. U.S. stocks are valued fairly. They may decline in the coming months, but they are better value than treasuries now. Central banks should put wealth preservation ahead of all else.
    Ironically, if foreigners switch from treasuries to stocks, it will ease the equity-capital shortage in the U.S. economy and discourage the Fed from printing money by pushing up treasury yields. Perhaps foreigners can save America.
    First published in Southern Morning Post on September 23, 2008.

  4. Lewis B. Sckolnick

    The United States government in its takeover over of Freddie Mac and Fannie Mae stopped paying the dividends both companies paid to their shareholders. Lehman Brothers was one of their major shareholders and it depended on those dividends for day to day expenses etc. as our government well knew.

    We have only been hit by the first wave of the Lehman fall there will be many more. Companies which have bought positions in Lehman will in the short term want their team in place working for them and there will be more layoffs. Firms in New York are not now making new jobs and mortgages on condos there still have to be paid.

    This has been a game of ‘Time is of the Essence’ which is showing the rest of the world just how out of touch and uncaring our government is in this game of over reaction where We the People are the chips.

  5. Lewis B. Sckolnick

    Mr. Xie does not understand the USA, its citizens and the nature of its relations with other countries. His comment that we would not accept aid from non-western countries says much.

  6. Richard Kline

    Faber’s most chilling remarks are the near-toss offs in the final paragraph. Think what it would mean if the US bans private buying of foreign currency and/or gold. “We can’t have you saving there when there are Confederate bonds at .25% going begging.”

  7. Matthew Dubuque

    Matthew Dubuque

    The first week after Greenspan was appointed to chair the Fed, I stated in a televised segment that we would look back and describe the legacy of Greenspan’s tenure and describe it with just one word. That word would be “chaos”.

    We live in chaotic times, the crazed result of stupid mathematical assumptions at the heart of our economic system stating that prices and shocks are distributed in bell-shaped curves.

    We AMPLIFIED the effects of this meta-mistake with HYPERleveraging and the events we are living through is the catastrophic result.

    Remember, Alan Greenspan is a free market FANATIC who wrote the introduction to Ayn Rand’s most popular jihadi text.

    Matthew Dubuque

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