The situation in the financial markets has not improved over night. In fact, the crisis seems to be accelerating. But toward what?
In the share market, we had a look back on the 2003 low on the ASX. On March 12, 2003 the index closed at 2,673. If the rally that began the next day and ended in October of last year was really just a multi-year rally in the midst of a secular bear market, you have to ask whether the 2003 low will be tested and/or taken out.
This would be the equivalent of “Ctrl+Alt+Delete” for global share markets: a system reboot that wipes out all of the gains from 2003 and before. Could it really get that bed?
Well, today alone in the U.S., some US$872 billion was wiped of the Wilshire 5,000, the broadest measure of U.S. stocks. It’s lost $2.3 trillion in the last seven days, and $8.3 trillion in the last year.
You have to keep in mind that the global boom of the last five years was almost entirely a product of excessive credit. Credit to households for residential real estate. Credit to Wall Street and the Masters of the Universe for speculation. And credit to governments in the Western world blowing out public spending.
The fictitious gains in global wealth were the product of leverage, plain and simple. That leverage is collapsing, and it’s doing so much more swiftly and comprehensively than nearly anyone imagined. Even deep value blue chips and stocks with strong intrinsic value and cash are not immune. Nothing is.
Every piece meal ‘solution’ designed to get credit flowing again has failed. Every attempt to recapitalise failing banks with slim capital bases supporting a tower of tottering assets has failed too. So now, governments are taking the next logical step in the progression of events. And what’s that?
The global banking system is quickly become another government agency. Governments in Europe have already bought equity in the banks. Now the Treasury Department in the States will do the same. For now the fiction exists that the banks can survive as private enterprises. But surely it is just a matter of time before that fiction gives way to a nationalised banking system.
This weekend’s G7 summit is the next best chance for global regulators and politicians to try and “save” the banking system. But what will they announce? We don’t know. It’s hard enough to get Europeans to agree on anything. Now you’re talking about coordinated global financial policy. Perhaps a new global currency will be one result of this crisis. As we’ve said before, a stock market holiday and a bank holiday, and/or a cap on withdrawals by mutual fund share holders and bank depositors in the logical end-game of the crisis.
But that is getting ahead of the game. The banks will effectively become arms of the government and finance will now be another government function. We wonder how well government will do allocating, considering its track record in delivering basic services like law and order and fiscal prudency. Perhaps we should look at other economies where capital allocation is done by the State, like China. Do you think it’s a coincidence that civil liberties decline as the State’s influence on the economy grows?
In any event, our contention from years back is that the modern nation state is singularly ill-equipped to deal with globalisation. It does not respond well to fast-moving crises. It is too cumbersome and complacent, more interested in self-preservation as an institution than anything else. Before States (like Iceland) begin to fail though, the private financial sector is going to be subsumed.
We wish we had better news to report today. But the truth behind fractional reserve banking, as my friend Dan Ferris says, is that it’s inherently leveraged and thus, inherently insolvent. To keep one dollar of deposits on hand for every ten you lend, and to be able to create ten dollars from thin air for every one that comes in via deposits…that is the nature of fractional reserve banking.
It is money that is not tied to metal. The money isn’t tied to anything at all except confidence. And when the confidence goes, the purchasing power of the money disappears. Governments try to restore this confidence, along with central banks, by printing more money.
They’re going to have to print a lot more. But sooner or later, we reckon they’ll just hand out pre-paid debit cards to everyone. It will be sort of like a credit ration card for the war on deflation. You can enlist if you’d like. You’ll probably be drafted eventually.
The only good news in all of this is that some good businesses have become absolute bargains. If and when the central bankers and bring credit spreads down (nationalising the banking system and commanding the banks to lend is one way to do it), then look for private investors to look for inflation hedges again.
That should favour energy and resource shares. But the question is when? When will the bottom be in?
Markets and Money