How It Will End
By Tony
Crescenzi
RealMoney.com Contributor
10/8/2008 11:04 AM EDT
URL: http://www.thestreet.com/p/rmoney/tcrescenziblog/10441392.html
The lack of follow-through to today's coordinated interest rate
cuts is not all that surprising in light of the deeply rooted anxieties that
exist among investors -- it will take time for frayed nerves to calm and for
emotions to catch up to facts. What are these facts? The most important include
the U.S. and U.K. injections of public money into the banking system, the U.S.
plan to remove troubled assets from the books of financial institutions, the
extraordinary expansion of the Fed's balance sheet, the cut in global
interest rates, and the elimination of the virulent worldwide inflation problem
and the related excesses in emerging markets that were threatening the secular
upturn in the global economy.
I've spoken since the summer about the idea that the U.S. was
entering what I have been calling a "dark period" that was likely to
be characterized by rising unemployment. This was tipped off by the spike in
jobless claims that began in August. A key theme I have had is the idea that it
would take between one and three months of bad employment data before investors
could feel comfortable that bad news was sufficiently priced in. I've also
stressed the idea that it tends to take about two months for investors to begin
to overcome financial shocks, as was the case in 1987 and 1998 (as evidenced,
for example, by the LIBOR/fed funds spread and the TED spread). In this
context, the inability of the financial markets to stabilize fits with the way
markets have functioned throughout economic cycles. If the pattern holds in the
middle of the current dark period, investors will see light seeping in and will
begin running toward it.
Whether market prices are sufficiently priced for bad news of
course can't be known, but in light of the unfathomable events that have occurred
of late and the drumbeat of bad economic news that has been marching out, asset
prices indisputably already discount a swath of bad news.
Two factors make it likely that the gargantuan efforts by the
Treasury and the Federal Reserve will eventually work. First and foremost, the
expansion of the Fed's balance sheet will almost certainly boost the money
supply. Milton Friedman said that inflation is always and everywhere a monetary
phenomenon. It is almost impossible to believe that the infusion of new money
into the banking system -- the seedlings for future money supply growth -- will
do anything but push prices higher, first financial assets, and then prices in
the real economy (this part is a long way off, say two years or so, but the Fed
has sown the seeds for a continuation of the secular bull run in commodities
prices).
A second powerful factor in the whole equation is the performance
of the U.S. dollar. None of what the Treasury and the Fed are working at would
work if the world were to give collective thumbs down. The dollar's 10% rally
(using the Fed's trade-weighted index as a gauge) is helpful in this respect.
It helps to keep the value of agency debt securities higher than they would
otherwise be as well as agency mortgage-backed securities, two channels by
which money flows to the housing market, which of course is of vital interest
to any recovery chances.
The doomsday scenario is that in the deleveraging process we will
find that more of the $20 trillion in debt accumulated by the U.S. private and
public sector over the past six years needs to be reduced (U.S. debts totaled
$51 trillion at the end of June, Fed data show). This is the unthinkable, but
so much else that has occurred of late has been unthinkable. Working against
the doomsday scenario is the gargantuan U.S. policy response (and now the
U.K.'s) and the Fed's use of its printing press. This makes sense on paper, but
the credit crisis has become less about numbers and more about the human
condition and its response to fear and anxiety.
For now, I will stick with the view that money will win.
Eventually, as Adam Smith would tell us, people will seek to better their lives
and collectively this will raise the wealth of nations. Capitalists will do
what capitalists do, and perhaps the Wells Fargo (WFC) and Citigroup
(C) battle over Wachovia (WB) and Warren Buffett's investments in Goldman
Sachs (GS) and General Electric (GE) are signaling it's already
under way, albeit ever so faintly for now.
Tony
Crescenzi is the chief bond market strategist at
Miller Tabak + Co., LLC, and advises many of the
nation's top institutional investors on issues related to the bond market, the
economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's
Livingston Survey of economic forecasters. He is also the author of the revised
investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The
Strategic Bond Investor. At the time of publication, Crescenzi
or Miller Tabak had no positions in the securities
mentioned in this column, although holdings can change at any time. Under no
circumstances does the information in this column represent a recommendation to
buy or sell stocks. Crescenzi also is the founder of
Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click
here to send him an email.
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