Treasury Secretary Steven Mnuchin. (Photo: AP)

What’s up with the markets?

Flash back 30 years to October 1987, when Treasury Secretary James Baker spoke about devaluing the dollar over the weekend before 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 the greenback in late January, said Richard Bove, a bank analyst with Vertical Group, in an interview with ThinkAdvisor on Monday, after the Dow Jones industrial average took a record 1,175-point dive. 

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

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

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

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

(The U.S. dollar currency index was down about 2% this year as of Feb. 8; it fell 3.3% in January, after declining close to 10% in 2017.)

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

Such talk puts the entire financial structure at risk, since a pullback in foreign purchases means that the U.S. government may need to raise taxes or curtail spending — all at a time when interest 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, like Joseph G. Carson, the former global director of economic research at AllianceBernstein.

“Two radical policy experiments are colliding, as unconventional monetary policy accommodation that led to near zero official interest rates and record purchases of debt securities is reversed at the same time as a bold and risky fiscal spending plan is being enacted,” Carson explained in a Bloomberg commentary.

“The net effect should be a major shift in liquidity flows with more money being directed and used in the economy, leaving less liquidity — 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 care about 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 in trouble.”

He points out that the Reagan administration initially cut taxes and then had to raise them afterward, while the Clinton administration raised them from the start. “Whose economy was better for all eight years?” Bove asked, adding that the correct answer is Clinton’s.

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

U.S. government debt stands at about $20 trillion, and that figure is set to go up by $1.5 trillion due to the recent tax cuts.

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

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

‘Blind Money’

Over the past six to 12 months, “Blind money has been moving into the markets … It’s a clueless move based on the idea that you’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 had the Volcker Rule or the Fed stepping in to borrow money.”

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

— Check out The Advisor and the Quant: How Should Advisors Prep for a Crash? on ThinkAdvisor.