At last the Dodo said, ‘everybody has won, and all must have prizes.’
‘But who is to give the prizes?’ quite a chorus of voices asked.
‘Why, she, of course,’ said the Dodo, pointing to Alice with one finger…Lewis Carroll – Alice’s Adventures in Wonderland [1865]
I’ve taken a step back from the markets for a couple of weeks to try and get a bit of perspective. In the meantime, global economic data have turned very ugly; a surprise to no one with a pulse.
The banks are still insolvent, and we must cover this with a TARP. Businesses cannot sell the goods they produce, so the government must loan them money to continue building these same goods. Consumers are overly indebted, so the government will cut taxes so they can continue to spend. All debts – banking, corporate, consumer – will now be assumed by the government. Who is going to (eventually) pay? Why, the future taxpayers – the descendants of this generation and any immigrants desperate enough to show up legally.
The whole thing seems a redux on the sub-prime bubble, but this time at the sovereign level. The US Treasury is taking out a 30 year mortgage on the US taxpayer at a record low 90 day teaser rate, but the median taxpayer increasingly has no income, no job, no assets. What happens when the rate resets? Can the taxpayers walk away? Do the foreign (and domestic) creditors foreclose? What do they get, other than green paper? Where are Fitch, Moody’s, S&P? What does “full faith and credit” mean exactly? I think we are all going to find out.
Buiter puts the cat among the pigeons by stating the obvious on the FT stage:
There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place. The notion that the US Federal government will be able to generate the primary surpluses required to service its debt without selling much of it to the Fed on a permanent basis, or that the nation as a whole will be able to generate the primary surpluses to service the negative net foreign investment position without the benefit of “dark matter” or “American alpha” is not credible… So two things will have to happen, on average and for the indefinite future, going forward. First, there will have to be some combination of higher taxes as a share of GDP or lower non-interest public spending as a share of GDP. Second, there will have to be a large increase in national saving relative to domestic capital formation… The US government is ill-placed financially and fiscally, to engage in short-term fiscal heroics. All they can really do is pray for a stronger-than-expected revival of global demand, without any major stimulus from the US.
Bill Gross at Pimco opens 2009 with a damning indictment: Western economies always were (and still are) an intertemporal and international Ponzi scheme. His pragmatic recommendation is to buy what the US government will have to buy, but do it first. At this point state and municipal bonds, TIPS, and bona fide corporates. I suppose the flip side of this is to sell what the US government will sell – Treasuries anyone?
Krugman muses: if the 14 point-years of employment lost in the 80’s slump (points of unemployment x years) resulted in pushing core inflation from 10% to 4%, what will the 14 point-years output shortfall the CBO is forecasting for 2008-1012 do when we start with a core inflation rate only 2.5%?
The United States will certainly experience its worst recession in decades, a deep and protracted contraction lasting about 24 months through the end of 2009. Moreover, the entire global economy will contract. There will be recession in the euro zone, the United Kingdom, Continental Europe, Canada, Japan, and the other advanced economies… equity analysts are still deluding themselves that the economic contraction will be mild and short… The credit crunch will get worse; deleveraging will continue, as hedge funds and other leveraged players are forced to sell assets into illiquid and distressed markets, thus causing more price falls and driving more insolvent financial institutions out of business. A few emerging-market economies will certainly enter a full-blown financial crisis.
The frustrating (and scary) thing is that these are the guys that have been right so far.
Turn of the year background reading (pdf’s):
Reinhart & Rogoff – The Aftermath of Financial Crises; It’s not good news.
Stiglitz on Paulson and Greenspan – “Capitalist Fools”, on GM – “Bridge Loan to Nowhere”
BIS quarterly – The Bank for International Settlements has the (dismal) facts.
BOC review – The Canadian banks have done a good job thus far.