Markets stuck on "The Shelf"; Lowering the global base
Monday’s markets were once again fairly dysfunctional as the range of questions on the table exceeds, by multiples, the number of solutions put forward. In the course of the day I asked the rhetorical question: If a market is where buyers and sellers meet, what one might call a place where there are only sellers?
The range of replies was delightful but the best answer of all was undoubtedly “A shelf”. My thanks to VS at Goldman’s for that gem.
Alas, in trying to work out what happens next, I shall try once again to step back from the hurly-burly of an offered only market and retreat to trying to remind of how we got to where we are. Unless we are quite clear in our minds as to what went wrong in the past and why, we will end up like the surgeon who suggests that the cure for a runny nose is to cut it off. Markets love to react to symptoms rather than causes which validates the assertion that East End barrow boys are no worse at this game than are PhDs with MBAs and CFAs attached. Perhaps they are even better because they don’t think that they know the answer before they have read the question.
It is simple; everyone was over-borrowed. Surely nobody can pinpoint any one single moment when taking credit flipped from being a privilege to becoming a right but somewhere along the way this happened and it happened for households, for corporations and for the public sector.
In many respects the subprime mortgage and the European sovereign bond have much in common – borrowers began to track the affordability of interest without accounting for any capital repayment. Unconsciously, everyone expected inflation, asset price or monetary, to lift them out. But this is just Part I – the pyramid which leverage created has been studied in great detail, not least of all in Michael Lewis’ highly entertaining and readable but rather self-congratulatory polemic “The Big Short”. The bit that all these reviews of the credit boom forget to look at is how much of overall GDP in the industrialised West was paid for on the credit card.
I don’t have the means to measure this number but I would not be at all surprised if, at the peak, 10% of our GDP had not been generated on credit, be that through domestic consumption or public sector expenditure (or “investment in public services” as the invisible Scotsman, the Rt Hon member for Kirkcaldy & Cowdenbeath – who in his time abolished the boom and bust cycle and saved the world – liked to put it).
Re-setting the global base
Possibly one of the greatest mistakes which government made was to misread GDP in the early years of the decade by assuming that the economy was normal when in fact it was in bubble mode. Hence, when the bubble burst they fell back on Keynesian theory which determines that you can raise deficit spending to smooth over downturns, only to pay back when the economy recovers. Simple. In fact, the public sector was running massive deficits in a period of economic hyper-drive and therefore the hit was double –- fiscal revenues collapsed while government was trying to increase deficits in order to sustain unsustainable GDP levels which were already off the planet.
As both households and corporations deleveraged, enthusiastic politicians tried to bridge the gap – Barry O’Bama is number one culprit although the realities of trying to keep electoral promises backed by American Express of Visa hit the European peripherals in the same way. Corporate management got the joke ahead of everyone else, cut costs and capacity and now, behold, earnings are strong. Government missed the boat by three years, paid lip-service to austerity and went on spending in some vein belief that a recovery in fiscal revenues was just around the corner.
It appears to me that the current crisis is a delayed reaction in understanding that we are not in a cyclical but in a structural correction to the economy and that Keynesian solutions do not and never did apply. It wouldn’t have taken a genius to work that out as early as 2007 and those who did looked on with horror as deficits were pumped up in something of an attempt to re-float the Titanic. Our economies will need to come out of this crisis with a base level lower than we are trying to sustain. The obsession with Retail Sales and other consumption driven indices is, to me, proof that we are all still looking the wrong way. When I wrote nearly five years ago that too many companies and too many jobs only existed because of both the populus and the authorities having spent money that they never had and that these would have to go, I was chided for being nothing but a miserable old sod.
Both the Euroland crisis and the debt ceiling crisis are driven by the refusal to grasp that the world really has changed – not only rhetorically but in a very fundamental way – and that all the putatively axioms which existed before 2007 have been swept away. It is not about bailing out or bailing in or even voting on austerity packages. It is about letting voters and markets know that the leadership of our countries have understood the paradigm shift and that there is a vision of something different and more befitting the altered states in the pipe-line.
Until then, it’ll all be about muddling along and hence about uncertainty. They all talk about export-driven growth. Great. Real export-driven growth is what you see in Germany which is even running a trade surplus with China.
Wake up time.