All around the world this Friday, investors are wringing their hands. The papers are full of the cause. More job losses. Slower growth. Bankruptcies. Debt.
There. Don’t you feel better now?
Economists surveyed by the Wall Street Journal said things are going to get worse before they get better, but that they should start getting better around, oh, say, mid next year. "For the household sector, this will be the worst event we’ve had in the post-World War II period" says Bruce Kasman of J.P. Morgan Chase & Co.
Event? A rock concert is an event. A wedding is an event. A spelling bee is an event. A recession/global depression is not just an event. It’s a way of life, at least for awhile.
In the stock markets, Aussie stocks followed the negative lead set by New York overnight. And boy was it negative. It wasn’t so much the size of the fall in New York (the S&P was only down 2.85%). It was the news that Bank of America would be laying off 30,000 people.
Then there was the news that GM has hired bankruptcy lawyers. Then there was the news that Bernard Madoff was charged by the FBI with running a $50 billion ponzi scheme-a term he apparently used himself when confronted by senior employees. He also said the business was "one big lie."
You get the drift. And to be fair, there’s been a whole lotta lying going on everywhere over the last few years. The net result is wealth destruction and, at least for some people, a real sense of shame. But people are resilient too. They’ll get back to the business of making ends meet. More on that below.
It’s not all bad news. The U.S. dollar called in sick again yesterday. Gold and oil, however, showed up bright and early and took advantage of the greenback’s illness to rally. Gold was up $17 and is up over 12% in the last month. Oil is trickier. But January crude futures were up over 10% as well on a weaker dollar and a possible OPEC production cut.
Gold, oil, and yields. These are the signals and prices we’re watching for signs of stress and leakage in the bond bubble. We mentioned yesterday that the popping of the bond bubble would unleash financial chaos. But that’s not a very useful term. So what did we really mean?
Well, the popping of the bond bubble is going to lead to a kind of financial Diaspora. Capital will flee from bondage to the U.S. government. But where will it go? Where is the land of milk and honey? Forty years is a long time to be wandering in the desert with a bunch of cash in your pocket.
This raises an interesting question. There are 14,600 days in forty years. You could wander a long way in that many days. What in the world were the Israelites doing the whole time? Going in circles? Arguing over directions?
Hmm. Maybe it took them so long to find the Promised Land because they didn’t have a map. That map, you could argue, came down in the form of the ten commandments Moses brought with him. Even peripatetic nations need laws. It is hard to have order with them (even if the laws are unwritten, they’re still there.)
What are we getting at? The investment laws of the universe have not been rewritten with this financial big bang. But you have a whole generation of personal, corporate, and government behaviour that’s not fit for the purpose of living in a world where money is tighter. People will have to learn new habits, live within their means, and not rely on access to debt to improve their standard of living.
Investors have already begun the switch, with a preference for income and safety over capital gains and risk. The equity premium-what investors get over and above the so-called risk-free rate of return on government debt-is going to have to widen considerably to tempt people back into the capital markets with their savings.
But this is what happens with market cycles. Investors and institutions over indulge in the boom phase, using leverage to buy financial assets because the equity premium is so high. Now, the equity premium has all but collapsed. Some stocks have compelling value. But no one is interested in buying them.
What breaks the cycles? Entrepreneurs. Keep in mind the great Austrian economist and economic historian made a great distinction between capitalists and entrepreneurs. The capitalists provided the capital. But in Schumpeter’s theory, it was the entrepreneurs who unleashed the gales of creative destruction that blew down failed businesses and replaced them with newer, more competitive firms, better adapted for the world.
Right now, one set of failing institutions (governments) are trying to prop up another set of failing institutions (financial companies, auto makers, etc). This effort actually retards the very process that would cleanse the world of all its misallocated capital and investment. Real Schumpeterian capitalism is being gelded by a new generation of Keynesian socialists.
These socialists have always feared the risk of personal failure that’s inherent in any wealth-producing system, where there have to be winners and losers in the game of enterprise. Instead of accepting the naturalness of failure-and softening the blow where they can-they instead institutionalise failure.
So that’s what we have now. Welcome to the State of Failure. Your mission, should you choose to accept it, is to avoid citizenship in this State and carve out a semi-sovereign State of your own, at least financially. More on this ambitious plan to find the Promised Land next week. Until then…