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Now back in August I said US stocks had reached a peak. I also noted that Bernanke and others were suddenly extremely generous with liquidity, even in the face of a supposedly good economy. Ergo, they knew things were not good. Other minor credit meltdowns in addition to the big one convinced me that Ben Bernanke has forgotten how to run a central bank. One of the key lessons of the Great Depression is not to let the money supply contract in the face of a business down turn. It turns recession in to a road to contagion.
Right now the global stock markets are over-reacting, precisely because they had been overly optimistic before. Decoupling is a nice word, it applies mainly to the decoupling from reality of both resources prices, which are wildly inflated, and asset prices, which have been wildy inflated for sometime.
Are we in a crash? The answer overseas is “yes”. The answer here? Quite probably very soon.
A crash has no widely agreed upon rigorous definition. There are rigorous definitions that are not widely agreed on, and there are widely agreed on definitions that are not rigorous. Therefore I am going to supply one of my own: a crash is when the destruction of value is sufficient to force a downwards spiral of selling to cover liquidity constraints. Basically, a crash occurs when worse investments expose bad investments in an acceleration spiral.
A “correction” is different, it does not have the spiralling quality, and therefore does not tend to overshoot on the down side. Stocks generally come back from a correction quickly, where as a crash requires the injection of fresh liquidity to counter act. In the absence of this injection of liquidity, they do not recover quickly.
Also important to the anatomy of a crash is an “Ohmstead Break”. This is a moment where there is a spike of selling that begins the downward spiral. Margin calls beget margin calls. We are now seeing this in markets around the world.
It is still possible this is merely a very sharp correction from inflated levels. However, if so, it should be seen as the climax of a long period of devaluation of the dollar, and the reduction in the real value of the US equity market versus the rest of the world. Taken in inflation and currency adjusted terms, the US stock market is considerably below where it was at the start of Bush’s term of office, and though not below the bottom of the Crash of 2002. Everyone else is in even worse shape, but the wealthy, despite a greater share of wealth, have less capacity to make effective investments.
The root cause here is simple a lack of investment supply. Not enough businesses that can produce a stream of revenue sufficient to pay the cost of money. Until this problem is addressed, the world markets can careen from bubble to bubble, but not make real progress.
What would it take to make a crash clear? Really the answer is generally too late, but the time the loan data comes through, the crash has already happened. This makes sense, people are not going to wait to find out, since if it is only a correction, they can get back in, and if it is a crash, they don’t want to wait until it is too late.
The market crash, viewed from the long term, is the discounting of the capital used to supply the US home bubble. Around the world people have been allocating resources and labor under the assumption that the US would keep buying and that the American consumer’s level of demand was suspended in air. In fact, it was just that there was too much easy money.
Many people think back to 1929. That is the wrong model. Instead, it is best to see the present period as an analogy to the series of panics that occured during the classical gold standard, where there was a tension between the monetary and capital base. Gold was obtained through colonial conquest, and technological improvement in extraction. This made it related to the growth of the economy in that resources and technology to together were a good proxy for an over all economy. However the coming of the petroleum age did a number of things. One is it decoupled mineral wealth from energy wealth, the other is that it decoupled resources from their traditional qualities. Petroleum changed the game too dramatically. By 1929, the coal economy was ready to give out, and the attempts to force the world back on to rock money were doomed to failure.
However, we are not there yet, there isn’t a clearly superior new economy ready to leap and take the place of the old one. Instead, we have pieces of it which are clearly distorting old values and valuations, but cannot properly be measured in our current base of oil-for-paper economics. Computers create happiness that is not measured in how much oil they convert into homes, but they don’t monetize easily either. This means it is hard for money based on monetizing oil-to-homes-to-paper to measure the real value they create. We keep over, and under, estimating what the new economy can do, because it won’t do the one thing that investors want it to do, and that is make the old petroleum economy more profitable. There’s no more profit to be had, only the ability to downshift older working zones in favor of newer ones.
This means that, as with the late years of the 19th century and early years of the 20th century, stock valuations, measured in absolute terms, are going to remain relatively flat, though with very wide swings. The petroleum and second wave electrical economy didn’t save the coal economy, but destroyed it with the same brute efficiency that German dive bombers and tanks would dismantle the Polish army in 1939.
This means that this crash is not the end, nor even the beginning of the end, of the present financial system. Instead what will be imposed is a massive bailout that will hobble US fiscal policy – the the delight of reactionaries who will let 8 years of discipline pass in the hopes that when there are goodies to be passed out they will take power and plunder the treasury to the tune of trillions of dollars more. It is only when that next plundering occurs, and the US economy does keel over from it, that we will really reach the end of American’s tether on this. Stupidity got us into the mess, and Americans are lining up to support yet more stupidity.
What should be done? Immediate, dramatic and forceful restructuring of the tax and entitlement systems, the banking system, and the energy system. Only by changing the incentives away from flipping houses, will we see a dramatic shift away from consumption and towards manufacturing. Historically this has taken a massive collapse in equities and a war.
Nothing seems to have altered that.
Short term? There’s no place to hide. Even petro-currencies will take a beating. This is a global contraction, and the best thing to do is have money in places, like the Swiss Franc, which are safe havens. Petro-currencies will bounce back first, and then the industrial currencies. While China will take a beating short run, its currency will be forced to appreciate in real terms, and therefore it is best to continue to seek Yuan exposure.
That the current fumbling attempts at stimulus are already mired in an attempt by Bush to force his misguided fiscal policies on the next administration shows that the present executive is worthless, and that Ben Bernanke won’t get up and say the obvious “excessive pandering to the wealthy has endangered the US fiscal position” means he’s not much better. The Congress? Well they managed to vote Bush a few blank checks, caved on the Constitution and on just about everything else in order to get one more year of pork, so it is wisest to presume that while they won’t do the worst possible thing, they may well do the second or third worst possible thing.
Fixing this is not difficult intellectually, it is getting a fat and torpid American electorate to realize that there are trillions in useless fat lying around the economy that have got to go, to be replaced by better and more efficient forms of economic activity.
The problem is that monetary policy can juice up what people are doing, but it has a harder time convincing people to do something else. It is a blunt instrument, the Fed can bludgeon the economy to stopping, or whack it into starting, but it is fiscal and regulatory policy which direct and shape the economy’s growth within the demands that people have. Bernanke and others have given to much authority to the monetary instrument, whose primary goal should be to maintain equilibrium, so that policy can be worked through stable and linear means.
The ultimate failure of Bernanke is that he hasn’t read his own papers carefully enough, and he has forgotten that economies can be guided by money supply, but not remade. A multi-trillion dollar world economy can be rev’ed on go pills, but while the fed can print money, it can’t print oil.