Sunday, March 22, 2009

The Patient Will Recover But It's Gonna Leave a Mark

The last thing I want to do is dampen anybody’s spirits on a beautiful Sunday afternoon when you could be spending time with the family. But I have to admit that watching the last week or so of current events unfold has left me very despondent—and I’m an optimist by nature.

First, the good news. From a confidence instilling 60 minutes interview last Sunday, we could see that Fed Chairman Ben Bernanke is competent, understands the gravity of the situation, history and the role he must play in it. Most importantly, he will continue to try everything in his bag of tricks to prevent The Great Recession from turning into something worse. And so, with the announcement of Shock and Awe 3 just a few days later, taking the fairly radical step of monetizing the government debt to a previously unthinkable degree, the Fed’s balance sheet will expand to nearly $4.5 trillion by the end of the summer, a nearly 4X increase from the same time last year. As a student of hyperinflation, this gives me the willies but I believe it’s a risk worth taking given the alternative of a debt deflation tailspin and prolonged monetary cardiac arrest. With the degree of global excess goods’ and services’ capacity in the system after a prolonged period of easy money, it’s hard to imagine a serious threat of inflation for quite some time. But at some point, it will come and I don’t think the Fed will able to alter the trajectory with surgical precision---so either we experience another hard landing as the punch bowl is taken away too early or an even harder landing as it's taken away too late. But it’s far down the road and while I worry late at night, I’m staying in the moment, respecting both the educated wisdom and heroic actions. So, on balance and ceteris paribas (as economists like to say), I’m optimistic.

Here’s where the problems begin. Across the pond, Uncle Ben’s counterparts at the European Central Bank look in the mirror and see Nero staring back. The G20’s finance ministers met last weekend and decided to blame the United States and beggar thy neighbors (former soviet bloc nations), instead of stepping up to the plate and trying to win the game. Europe’s economy has slowed more quickly and deeply than the US and its financial system is far more leveraged and structurally difficult to fix. Yet, the patient refuses to accept the gravity of the situation and so take bold and decisive medical treatment. Simon Johnson of MIT agrees. At best, the region will act as a brake while the US (and China—more on them in a second) stomp on the gas, prolonging the adjustment and/or a potentially worse outcome if continued poor policy decisions lead to varying degrees of social unrest and nationalism. This IS a problem. Maybe they hope that China will come to the rescue --- but that’s a pipe dream. While the Chinese are taking very commendable and decisive steps to stimulate their own economy, on balance they will likely be offering less global credit (reduced exports means less need to recycle foreign currency reserves) and with their consumer base being one-tenth the size of American spenders (who bought almost one fifth of what the world had to offer before the downturn) can only provide so much of an offset to plunging world demand. So China’s helping but not going to save the world.

And here’s where it gets really depressing, for as Thomas Friedman wrote today
“We’re in a once-a-century financial crisis, and yet we’ve actually descended into politics worse than usual. There don’t seem to be any adults at the top”.
Nauseating to say the least. Our elected officials on both sides of the aisle seemed determined to snatch defeat from any jaws of victory. Nobody alive could have missed the kabuki theater of last weeks AIG Bonusgate affair, deflecting attention from the bigger picture to score minor voter points but laying land mines on the terribly bumpy road to recovery by hardening voter bailout fatigue. Not to mention, potentially trampling all over the constitution trying to punitively tax a minority and at that not actually getting the real scoundrels. This will come back to bite for as Robespierre learned too late, be careful how you incite the crowds.

Now, we await the official announcement (maybe tomorrow) of Secretary Geithner’s plan to rid US banks of their toxic assets to pave the way to recapitalization and start the heart of the credit system beating again. As has been widely leaked in the press since Friday morning, this is a complicated 3 pronged approach, leaving plenty of room for confusion and potential real or perceived failure---neither of which do we have the time to afford. You can read details about the programs here but let me just say that in one of the 3 flavors private investors may only have to put up ~3% equity in certain investments with tax payers providing the rest of the funding . If you thought Bonusgate got ugly, you can imagine how political football could be played with that scenario. And with the death threats received by AIG employees and Congress' lust to retroactively claw back legally awarded income, there is every chance that a fair number of hoped-for private investors may fail to show up for the party in the first place.

So let me say again, I’m an optimist by nature. And I remain convinced that we are not going to go where nobody in their right minds would want us to go. I believe that the US has the benefit of a national ethos rooted in finding opportunity, happiness and ultimately fairness and equality. We also have the institutional capacities to reinvent our market based system for the better and, while I know its hard to believe at the moment, will find the political will to enable that to happen. And I believe that the ascendant economies of the developing world, most notably China and India, will be our partners in this effort. But I worry about Europe, being a counterproductive deadweight, unproductively throwing stones. And I increasingly believe that this whole thing will take a very long time to work through and definitely leave a permanent mark on all our foreheads. With that I will go enjoy what’s left of family time before pushing the rock back up the hill come tomorrow morning.

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