The Current Discussion:The global economy is quaking. Are we heading toward a global recession? Who's to blame?
The chain reaction in progress can be best described as a “deleveraging” of American finances. It is a uniquely Anglo-American development, not a global problem, and is likely to continue for two or three years before fundamental stability and realistic valuations fall in place. Alas, recession is a rusty description, originally coined for industrial economies. It is a misnomer for today’s American finances and post-industrial economy, isolated into a unique set of presumptions: rampant consumerism, service-based revenues, presumed constants in long-term forecasts (say, price of commodities or consumer demand), and herd behavior (mislabeled as competition); all glued together with liberal amounts of debt and stitched up with hype.
The current setting is a test of Greenspanism and an autopsy of lax attitudes towards regulatory oversight. The Greenspan era absurdly allowed markets to define their own regulatory limits. Somehow the duty of care for an equilibrium of all components was deemed as an obstruction to economic growth. Historic bankruptcies of Enron, Worldcom and Global Crossings were summarily rebuffed as one-off fraudulent conduct, or bad bookkeeping. Import therapy kept inflation, pegged to an old formula, at unrealistic low levels and let asset inflation rip to dizzying heights. Government spending pumped in trillions in fresh cash that fueled the asset inflation process, which in turn delayed a fair revisit of structural issues.
That doctrine is now turned on its head by the Federal Reserve as it hurries to rescue market functions, Bear Stearns, and the recipe used for valuations. (Can this government complement, the Treasury Secretary of Wall Street pedigree, be helpful as a regulator?) With an emergency guaranty of bad mortgages made by the private sector, the Fed affirmed its choice to rescue Wall Street, and not Main Street. It is a concealed nationalization as the Fed will absorb losses incurred by market players.
I believe it is “déjà vu all over again”-- the end of Thirty Glorious Years after WWII in France, the banking scene in late 1970s with two economist superstars, President Giscard d’Estaing and his prime minister Raymond Barre and their famous economic visions. America is following that script with rising unemployment, a heap of bad bank loans and the ensuing nationalizations by the succeeding president, Mr. Mitterrand. The plot thickens when the Napoleonic attitude of the American president and his costly war in Iraq reminds us of how the Russian War depleted the French treasury.
In hindsight, the overdue modernization of American regulatory systems (a common definition of risk and cross-spills), strategic assessment of global supply-demand and demographic changes were not prime concerns for Mr. Greenspan, the de facto chief economist and fiscal master of the U.S. markets. The result is the current scene on Wall Street: the average debt-to-capital ratio of investment banks, for example, is 30:1, so professional investment bankers owe 29 dollars for every 1 dollar owned, all on presumed and rosy valuations of assets with no buyers (sub-prime mortgages, glorified share prices, etc.). Thus the ownership society has transformed itself into a transactional, debtor nation.
It is time for America to reinvent its finances and craft a new American reality, as the American Dream is merely a home with negative equity value. This is not a passing, short-term problem that will go away with denial and talk therapy. The deep economic regress of America is not, and will not be, globalized even though a few foreign participants have lost money and reputation (the German IKB bank and the Swiss UBS). Foreign investors will continue to support in the background and buy American government debt. Nevertheless, they will shy away from transactions in the private sector of America until real valuations emerge. I don’t blame them: Bear Stearns assured the markets that it has plenty of cash on Monday. Its $70 shares on a Friday were worth $2 on the following Monday after a fire sale over the weekend after a realistic assessment and true weight of regulations were applied. The Fed had to throw in a $30 billion guaranty inducement.
As such, it is time for American people to accept the pain of responsibility and realistic valuations that will come along. In a realistic forecast, a modern New Deal will be necessary--higher taxes (a national sales tax or a wealth tax?), smart productivity (new energy industries?), a massive rescheduling of domestic debt (akin to Turkey in the 1990s) or conversion of debt to equity (Brazil circa 1980s) and a streamlined, transparent financial regulator (Department of Homeland Finance?). The dodge-and-blame from one bureaucracy to another will not buoy the sagging dollar, rebuild infrastructure or repay debt even at much lower interest rates. If needed, just go boldly ahead with “very un-American” nationalizations, debt-for-equity or recapitalization of the financial system by the public sector and cut through the taboo without posturing and wasting time. Blaming China, al-Qaeda, a dead Iraqi dictator or fabricated “enemies”, demands for cheap oil or talk about gay marriages will not replace the estimated $2 trillion froth on American asset values. Promises of dreams are no longer marketable commodities or securities that find takers with hyper-spinning. All dreams end as one wakes up to reality.
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