What if the deleveraging process has much further to go?
The United States and the world are in an economic situation that is unprecedented, with massive deleveraging occurring seemingly everywhere and all at once. These extreme conditions have never existed since the rise of modern global banking. There’s plenty of blame to go around, but that’s for another day. Perhaps the situation will improve in short order; perhaps not. We don’t know. However, it is useful in these strange times to keep an open mind, and consider points of view that you might ordinarily dismiss. Nouriel Roubini, who has been somewhat of a broken clock on the current economic peril, has an analysis that merits thinking about; its implications are significant:
The world economy has been massively imbalanced for the last decade with the U.S. being the consumer of first and last resort, spending more than its income and running ever larger current account deficits while creating a massive excess productive capacity via over-investment. All the while, China and other emerging markets have been the producers of first and last resort, spending less than their income and running ever larger current account surpluses. With U.S. spending now faltering, a global glut of unsold goods may lead to persistent and perverse deflationary forces that may last for a longer time unless proper policy actions–mostly non-necessary monetary–are undertaken.
Thus, dealing with this deadly combination of deflation, liquidity traps, debt deflation and defaults that I termed a global stag-deflation may be the biggest challenge that U.S. and global policy makers have to face in 2009.
It will not be easy to prevent this toxic vicious circle unless (1) the process of recapitalizing financial institutions via temporary partial nationalization is accelerated and performed in a consistent and credible way; (2) such actions are combined with massive fiscal stimulus to prop up aggregate demand while private demand is in free fall; (3) the debt burden of insolvent households is sharply reduced via outright large debt reduction (not cosmetic and ineffective “loan modifications”); and (4) even more unorthodox and radical monetary policy actions are undertaken to prevent pervasive deflation from setting in.
There are many of a conservative bent who do not favor aggressive government action. Some observers see a bottomless pit of moral hazard being created by foolish bailouts; some see a Weimar-like hyperinflation risk. Maybe they’re right; we don’t know.
For our part, we think that some of what Professor Roubini is saying has merit. We don’t care so much about whether a Morgan Stanley or Citigroup, etc. survive as particular institutions, but in our view the recent mis-named “bailouts” have been essential to the functioning of the system. They are essential not because the world can’t live without one or another bank, but because the counterparty risk in the scandalous $60 trillion credit default swap market has created systemic risks in the global financial system such that letting a few of these huge institutions disappear in bankruptcy could cause the entire global banking structure to collapse. Indeed, this has come pretty near to happening already, as a result of inconsistent government action and particularly the Lehman debacle.
We were thinking the other day that maybe everyone was over-reacting to market ups and downs. Then Citigroup happened and the market was unsure how the new administration would act. That crisis passed, and there are indeed some signs that the worst could be over. But we’ve been down that road three or four times already this year, and it has so far emerged that there was another nasty surprise just around the corner.
If Professor Roubini’s analysis is correct, the amount of intervention in the economy in the future will dwarf the enormous amount we’ve already seen. Furthermore, if his views of the coming deflation and liquidity trap are correct, such radical intervention would become both appropriate and necessary. Let’s hope he’s wrong.
November 29th, 2008 at 1:30 am
And of course this time Wall Street bailed out by their friends in Washington, and the Fed, which hasn’t ‘turned’ the non economy economy around in, at least, 2 years of trying, and lastly, of course Washington with Barney ‘Hotbottom’ Fwank, Chris Dodd ( Democrat, Countrywide ) and Obama, saviour of the south side of Chicago and as far as Gary, Indiana, will.
Yep. People just can not give up the old gods, the old ways. I was watching a program on the last days of Berlin. They interview a now old German that was a kid. Russians within a mile or two of the bunker and he thought Hitler would still pull through with the old magic.
Wait until the Chinese Communist Greed-heads start selling off Treasuries by the boatload to buy time until their million dollar Canadian resident permits can be arranged.
November 29th, 2008 at 2:41 am
I think the big question to be answered is what type of global fiscal stimulus will get the wheels back under the global gravey train. If First World people buy more consumer electronics or recreation related assets, will that prime the pump? Not likely.
Do we increase transportation or energy related infrastructure to improve the quality of life around the world? What would that do to energy availability or prices? Is quality of life simply defined as a good meal with family and friends? Are we headed back to simpler times?
It seems to me that many First World youngsters want all the toys, enjoy them, and then die heavily in debt; relying on the insurance industry to pay the bills. I think this type of thinking has caught up with the world.
I suspect we are at the start of a long period of belt tightening, and ratcheting down of lifestyle expectations. In the end, debt loads will be manageable for those paying the bills. I don’t expect we will get there giving away too many free lunches.
Will a global stimulus package work? If it is seen as a global free lunch… not a chance.
November 29th, 2008 at 2:01 pm
All such analyses ignore the elephant in the living room.
The United States has just elected a Marxist as President. This particular Marxist just happened to have been present at the founding, and was instrumental in the founding, of the mortgage mess. When President Clinton relaxed the loose requirements of CRA 1977, Obama was a leader in developing the tactics of demanding mortgages for unqualified buyers. The Democrats in Congress were fully supportive of this particular Marxist spread-the-wealth scheme, and continued to block reform efforts after it was obvious that there was a lot of bad paper out there.
No investor would willingly leave himself exposed to the inefficiency and corruption of a Marxist regime, or the danger of confiscation. So, a whole bunch of investors bailed. Fast.
Did this put a strain on the system and on liquidity? Oh, yes. Has the recent crash of the markets reached bottom? Almost certainly not. The Marxists have been trying to capture the government of the United States since at least the time of the Great Depression. Having succeeded, they did not gain control of the government in order to continue old policies, even though Obama’s economic team and cabinet has some old faces. The Marxists are temporizing while they gain control of the Supreme Court and the economic and governmental levers.
So, an analysis of the current condition of the markets is useless without minding the major, radical change which has taken place in our system of government. Marxists are keen on supplanting the Constitution with the Communist Manifesto, which, to some extent, they already have. Marxists attack our Constitution and the Bill of Rights, ridicule all belief systems except their own, and deliberately try to destabilize the nation with Marxist redistribution schemes, such as the mortgage crisis.
Enjoy.
December 8th, 2008 at 12:39 am
The elephant in the living room is actually a rat with a megaphone.
America started becoming a fascist nation more than a century ago – to clarify, not Nazi, but fascist – with a small f.
Unfortunately, freedom’s life blood has slowly been draining out and the country has been surviving on artificial life support for quite some time. Vital signs are fading. At best, all the great physicians can do is keep the machines running, but the republic is basically becoming a vegetable.
Life will go on – Yes – but not the life that was breathed into the nation by the founding fathers.
Rather than dying a bloody and brutal death at the hands of European fascists as some did last century, we’re going out in a comatose state – thanks to a slow but steady overdose of socialist morphine – Assisted suicide I believe they call it.
Oh! – The “compassion” of our “progressive” guardians who have taken charge of our very life and well being.