What’s up with the markets?

Flash back 30 years to October 1987, when Treasury SecretaryJames Baker spoke about devaluing the dollar over the weekendbefore the market crash.

“There’s no question in my mind that Treasury Secretary [Steven]Mnuchin did the same thing” by talking down the value of thegreenback in late January, said Richard Bove, a bank analyst withVertical Group, in an interview with ThinkAdvisor on Monday, after the Dow Jonesindustrial average took a record 1,175-point dive.

The average made several positive and negative swings Tuesdayand was down 55 points in afternoon trading.

The weaker dollar makes it less appealing for foreigners to buyU.S. debt, just as the need to sell more debt is on the rise due tofiscal policies such as higher spending and lower taxes.

“Don’t get caught up in [looking at] the results rather than thecause,” Bove said. “The question is who is going to buy ourdebt?”

It’s a hard sell when foreigners are poised to lose money as thedollar declines and the value of their Treasury holdings drops, headds.

(The U.S. dollar currency index fell by 3.3% in January, afterdeclining close to 10% in 2017.)

“Mnuchin doesn’t get it,” Bove said. “His main job is to findthe money to pay for the debt … and the product to do that is basedon the dollar. What are you doing talking down the dollar?”

Such talk puts the entire financial structure at risk, since apullback in foreign purchases means that the U.S. government mayneed to raise taxes or curtail spending — all at a time wheninterest rates need to be moving “meaningfully higher,” he said.“The market is coming to grips with that.”

His outlook is shared by other veteran market-watchers, likeJoseph G. Carson, the former global director of economic researchat AllianceBernstein.

“Two radical policy experiments are colliding, as unconventionalmonetary policy accommodation that led to near zero officialinterest rates and record purchases of debt securities is reversedat the same time as a bold and risky fiscal spending plan is beingenacted,” Carson explained in a Bloomberg commentary.

“The net effect should be a major shift in liquidity flows withmore money being directed and used in the economy, leaving lessliquidity — in the form of higher interest rates and less new flows— for the financial markets,” he added.

Tax cuts

“History might also say the tax cuts [caused the market swings]and that’s not so far off, either,” Bove explained. “All I careabout is fiscal responsibility.”

The fiscal outlook is not pretty, the veteran bank analyst says:“I see lots of debt coming, no one can pay for it, and we’re introuble.”

He points out that the Reagan administration initially cut taxesand then had to raise them afterward, while the Clintonadministration raised them from the start. “Whose economy wasbetter for all eight years?” Bove asked, adding that the correctanswer is Clinton’s.

“Taxation is not a game,” he said. “A lot of things go aroundtaxes.”

U.S. government debt stands at about $20 trillion, and thatfigure is set to go up by $1.5 trillion due to the recent taxcuts.

“The U.S. will not pay for that…,” Bove said. “The FederalReserve is shrinking its balance sheet, Social Security needs fundsand is not paying the U.S government.”

This means foreign buyers of Treasury bonds are critical, theanalyst explains.

‘Blind money’

Over the past six to 12 months, “Blind money has been movinginto the markets … It’s a clueless move based on the idea thatyou’ve got to put money into a rising market,” Bove explained.

But this money moves out “just as fast as it comes in,” he adds.“And the reversal is far more violent than if we hadthe Volcker Rule or the Fed stepping in to borrowmoney.”

As regulations put in place to soften “the blow” from markettroubles are removed or weakened, “we are going to get theblow.”