Monday, October 27, 2008

Time and Price

US markets finished down in a major way over the last week. Trading curbs had to be put in on the futures market in overseas trading Thursday night. Fear was in everyone's eyes and voices at the opening bell. Somehow though, buyers showed up on the open and we 'only' finished down by 3.5%. Both the Dow and the S&P 500 were able to stay above their October 10 lows. The Nasdaq, Russell 2000 and many foreign markets all made and closed at new lows.

So the capitulation that everyone was confidently proclaiming had been reached, is obviously still absent. As readers of this site know, 'capitulation' is not possible in an environment where everyone is looking for it. When it comes, we will only know about it with many months of hindsight and very little fanfare.

One aspect of this crisis that I completely underestimated was the strain it would put on developing nations. Already we hear of Iceland, Argentina, Hungary, Pakistan, Belarus and others needing assistance from the IMF. Two weeks ago it was rumoured that Russia was to bail out Iceland. Now we learn that Russia itself may need to be bailed out. So if all of these developing nations start defaulting, what's going to happen to all of the yield-chasing pension funds that had invested there? I suppose we'll just have to bail them out too.

In the meantime, people keep piling in to US Treasuries as they are, paradoxically, the safest place to hold money. But at some point that perception will change too. When? Who knows. Regardless of which way all these currencies are moving, the fact that they are moving by such large margins on a quarterly basis makes it nearly impossible for businesses to conduct trade.

Everywhere we look, the financial construct of the entire world economy is breaking down. No corner of the globe seems to be untouched. This should come as no surprise, given that this construct has been based upon a ponzi scheme of debt. Coming to grips with this shocking reality is happening slowly. Policy makers are still grasping to their security blanket of "what should work." Unfortunately for them, it hasn't worked and still isn't. No matter how much they blow, the bubble won't get any bigger without springing another catastrophic leak.

Austrian economists have known this as a "liquidity trap." It's also commonly referred to as "pushing on a string," or "pushing water with a fork." The cost of credit is eased by central banks, yet borrowers still have no incentive to borrow and lenders need cash to write down the inflated values of their balance sheets. So credit is not expanded as per the ponzi schemes demand. It is contracting and rejecting debt at every opportunity.

So what's the next domino to fall? Judging by the massive layoff announcements last week, it will be unemployment. Unemployed people don't tend to spend very much money, so although the financial recession may find a respite, the consumer recession will be hot on it's tail. At some point there will be a legitimate buying opportunity. But unless my time horizon was 10 years or more, I wouldn't consider buying at these levels.

Time and price are what is needed to cure our dependancy on debt inflated asset valuations. Trying to desperately prop up the value of those assets is guaranteed (by the principles of Austrian Economics) to be the biggest failure in the history of modern monetary policy.

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