The big guns came out on Monday. Mr. Market shot down almost every stock in the entire world.
He would have caused U.S. stocks to crash and burn too…but it was a holiday behind the American lines. U.S. shares never raised their heads.
And then, at dawn on Tuesday, the other side opened up with its big guns. The Fed made a “once in a generation” rate cut – taking it two key rates down 75 basis points each. Now, it’s official. Favored borrowers can get money for substantially less than the rate of consumer price inflation.
After this volley, it was still early morning in the Eastern Standard Time zone. We sat on the edge of our chair waiting to see how Mr. Market would react. Would the rate cuts be enough to stop him? Or would he still do to U.S. stocks what he had already done to those in Japan, India and France – that is to say, roughly what Sherman did to Atlanta?
In the event, the fireworks from the Fed slowed Mr. Market’s advance…but did not stop it completely. The Dow retreated down as much as 400 points…staged a counterattack…and ended up with a 128-point loss.
Which was enough for most commentators to pronounce the Fed’s counteroffensive as a success. We’d call it a draw.
The bigger news is that the forces of deflation – led by Mr. Market – are on the move. They’ve wiped out $5 trillion of value from equity markets all over the world in just the last three weeks.
This is the “biggest finance crisis since WWII,” says George Soros.
“Wall Street is in deep trouble,” says TheStreet.com.
The trouble now comes in waves – like a Soviet army assault. There are the ARMs…then the SIVs…then the SWAPS…then the credit cards…then the home equity loans…then corporate debt… One problem after another…one loss after another.
Each assault takes its toll on the defenders. Fannie and Freddie – two of the largest mortgage lenders in the nation – could see losses of $16 billion, says Credit Suisse. Wachovia has seen its earnings “vaporize,” says TheStreet.com. Bank of America’s net has been cut by 95%.
Mortgage defaults in California are running 114% ahead of last year. They’re at a 15-year high.
And dispatches from the front lines suggest that pockets of real estate holdouts are being overwhelmed and wiped out. The national figures show declines of only about 10% so far. But in some areas, the damage is said to be catastrophic. Houses go up for auction…and no one bids. Banks are taking back thousands of them. And when a house sells…it goes for only half of what it costs to build .
Against these crushing attacks…the authorities seem to be both out-gunned…and out-maneuvered. Mr. Bush’s rebate package is only $145 billion. U.S. stocks lost more than twice that much in the first few seconds of trading yesterday. And the whole idea of providing more cash and credit is the wrong strategy anyway. These efforts at Keynesian stimulus were designed to overcome a different kind of enemy…a case where consumer demand was low…or where consumers saved too much money. Keynes worried that people had a “propensity to save,” which needed to be corrected by reducing the returns to savers. But the real rate on savings now is less than zero. And the savings rate is down to minus 0.5% of disposable income.
No, dear reader, the problem is not that consumers spend too little, but that they spend too much they don’t have. Nor is the problem that consumers save too much, but that they don’t save enough. And while the feds might slow down Mr. Market’s deflationary campaign with more cash and credit…they will not be able to stop it.
In the meantime…the battle rages on…
Markets and Money