Thursday, October 09, 2008


Frequent contributor Harun I. recently introduced me to a concept he terms "snapback": the sharp, sudden reversal of divergences or unsustainable markets back to historic correlations. (SInce Harun coined this phrase, I hope he gets credit in all future references.)

Why is this something worth pondering? Many smart, experienced market commentators are now suggesting that the "bottom" in the stock market is close at hand, citing various extremes in valuation and sentiment. Yes, the usual indicators (oversold, etc.) can be interpreted to support the notion that the markets are near a bottom--if these were typical times. But these are not typical times.

There are a number of correlations between various markets, and Harun provided the Australian dollar as an example.

Please go to to view the excellent charts.

Notice how the Aussie dollar maintained a correlation of trend relative to gold until 2006, when the currency rose sharply and its value relative to gold moved in the opposite direction, i.e. declined.

The sudden re-convergence to historic correlations is "snapback".

Harun provided another potential setup for "snapback": the Yankee dollar and its correlation to its relative value in gold. The two have risen and fallen in near-perfect unison for years. Now we see the dollar has moved up sharply as its relative value to gold has stayed flat. Harun's comment:
"This bounce in nominal price (i.e. the dollar) has not been followed by real value (gold). Should they stay divergent, the rally in the USD will wane."

If markets are due for a "snapback" then the bottom could be farther away than most suspect possible. For instance: by at least one measure, the ratio of the Dow Jones Industrial Average (DJIA) to gold, the Dow Jones Industrial Average's historical "snapback" would take it to around 5,500-- fully 4,000 points below the "bottom" so many are seeing in the present. A decline to even 4,000 is certainly possible if you gaze at this chart:

Harun also made these comments about yesterday's entry:

"The thesis stated again and again in the mainstream media (MSM) is that the U.S. economy can't get back on its feet until housing "recovers"--which makes the question "when will housing recover?" of paramount importance." (From Why Housing Is Far from Bottoming: Depression, Demographics, Defaults and Dumps (Part III) (October 8, 2008)

The MSM's thesis is flawed. Yours and Pangolin's analysis helps to unmask the flaw but we must not be distracted from the singular cause. Examining the charts you have posted in comparison with the exponential progression chart should make it clear that the problems facing us did not appear suddenly because of a few recent mistakes -- they were systemic.

These problems were predictable as they were inevitable. But no one had the courage to admit the error and commit to the painful change of course that was needed to avert disaster. Instead they chose to do what the system demanded which was to find whatever way possible to maintain the exponential expansion of debt as the real economy collapsed.

To peddle the idea that all we have to do is to get housing back in balance with incomes and there will be happy days again ignores the fact that the economic premise under which we operate is tragically flawed. And so all we will accomplish is to hit the snooze button for another 70-80 years.

Fractional reserve lending is a fraud. Stated another way, lending against something you don't have and charging interest and fees is deceptive at its roots. The question I pose to my fellow Americans is, why, in a democratic republic do we allow this?

The Federal Reserve is nothing more than a private banking cartel partnered with the US government. It has a monopoly on printing money out of thin air and lending it to the government (taxpayer) and now anyone at interest. Allow me a Joe Biden moment: I repeat. They charge us interest on nothing. (emphasis added, CHS)

And fractional reserve rules allow this fraudulent lunacy to propagate throughout the financial system tenfold. The debts never get paid off they just get rolled over until everyone is borrowing to service debt instead of retiring debt through productive means.

FDR may have been well-intentioned but his policies did not solve any problems, they merely reset the game. And now we are busy trying to enact quasi-FDR policies in an attempt to stop the bleeding.

If we truly want change we must first and foremost develop a system that is not predicated on fraud and insolvency at the outset. The question remains whether we are willing to up our mental game and uncompromisingly demand those with whom we entrust the privilege of leadership to carryout their foremost duty of protecting the Constitution of the United States.

Because had we adhered to the Constitution and heeded Thomas Jefferson's admonition about bankers controlling our currency we would most likely not be where we find ourselves today. So how does Harun's analysis of the systemic problems relate to "snapback"? Just this: perhaps the system of massively leveraged credit is about to "snapback" to much lower levels, effectively eviscerating the global economy and all asset values other than gold.

Here's an example of "snapback": housing prices falling rapidly toward a historical correlation to rent and income. Note the drop is not even halfway finished; prices will have to return to pre-bubble levels. As the global economy tumbles into the abyss of Depression, then incomes will fall and credit costs will rise, precipitating a fruther decline in housing as it maintains its correlations to incomes and mortgage rates/availability.

And here we have an extreme of leveraged credit which appears to be a surefire candidate for "snapback":

As correspondent/contributor Riley T. recently pointed out, this is a ratio of credit and GDP; thus the sharp peak in the Great Depression reflects not credit expansion but GDP contraction.
Thus even as leveraged credit contracts with ferocious force in our current economy, this ratio may stay high as the GDP will be contracting with equal ferocity.

So how does all this connect to this week's theme: how long will the Depression last? Here's how: this ratio of credit to GDP has to drop all the way back down to historic correlations.

Put another way: credit will have to fall even faster and farther than GDP. Since our entire "consumer economy" is based on cheap, easy credit, the contraction of credit will cause a massive contraction in GDP, thus strengthening the contractions in a feedback loop.
How long will it take to rebuild savings and capital, i.e. wean ourselves from a leveraged-credit dependency? A long time; and even longer if we follow Japan's path and try to sweep the insolvency of the system under the carpet and act like everything's just peachy. That will guarantee decades of stagnation and Depression.

Thank you, Tom S. ($50), for your outrageously steadfast and outrageously generous donations to this site. I am greatly honored by your ongoing support and readership.

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