The Politics of Denial meet the Economics of Hypocrisy
When the Blind lead the Blind, both will fall into the water…….. Old Chinese Proverb
Several months ago we referred to market psychology as being in a State of Denial as regards the Death of the Bull Market. This diagnosis can now usefully be extended to the New Administration and Congress. At every turn this Administration, similar to the last, is making decisions believing that somehow everything will turn out alright in the end that the massive deficits will be financed overseas, that we in the West are not vulnerable to further financial disruption, that missteps now could never produce social dislocation, not to mention risk heightening geopolitical stress and the probability of conflict. In short, the intent of their public communications has been to assure the US electorate and those beyond its shores that life will go an as before.
Don’t Worry; Be Happy
The actions and public pronouncements of the American Leadership however belie this unfounded optimism. Throughout the current crisis, and at each critical stage, US policy-making authorities have taken steps that are in violation of a basic rule of decision-making under uncertainty.
Specifically, at each of the recent major decision points the US Leadership has opted for alternatives and commitments that cannot be changed very easily, They have done so in place of pursuing more flexible, better advised policy options that are consistent with the substantial uncertainties that still swirl around our current predicament. In so doing they have constrained possible future courses of action, increased the risk of even worse problems occurring in the near future and made the World a more dangerous, as opposed to, a safer place.
Let us examine this hypothesis in somewhat more detail:
Son of TARP
Pity poor Secretary Geithner. His plan got panned. The reason for this is that it fell far short of the Scale and Detail needed to adequately combat the current problems.
The reality of the present situation is that we are in a Global Solvency Crisis. We are not in a Liquidity Crisis. There is ample liquidity, there just isn’t a whole lot of capital left. In the United States there is on the order of $3.0 to $3.5 Trillion of losses still unannounced and sitting in the financial system. This dwarfs the remaining $400 billion or so of financial institution equity that remains on balance sheets following the debacles of the last year. To be sure much of what is bring counted as equity would make even Andy Fastow blush. Take for example the $44 Billion of deferred-tax assets that Citigroup is claiming as Tier 1 equity. This is an amount that represents accumulated losses that the bank hopes to use later to cut its tax bills. The number accounts for over half of Citigroup’s reported Tier I Capital, is more than three times what it was a year ago, and more than double the company’s $19 billion stock-market value.
Citigroup is not alone in this situation. The entire banking system in the US is effectively insolvent. This is why it makes more sense to conduct a comprehensive Stabilization and Triage operation as soon as possible instead of trying to ram piecemeal pieces of legislation through Congress that address in part but not in totality or in scale the various issues that need to be addressed and the way in which this must occur. The steps taken so far borrowing vast amounts of money to prop up zombies; being unduly concerned about micro issues like executive pay and perks and making various pronouncements to the markets regarding the size and scale of the problems without disclosing the how of the bailout only serves to sap market confidence. Most importantly the recent announcement reflects a fundamental failure to understand that banks aren’t going to lend (and neither is anyone else except the Fed) as long as collateral values are falling and/or are still unknown.
Parenthetically, the Congressional Oversight Panel recently disclosed that assets bought by TARP are now worth $78 billion less than they paid for them. Not bad for a three month turn!!
The Stimulus Package
President Obama is on record as saying he will not run in 2012 if the package fails to deliver the intended benefits. His Staff better tell him to stop making these type of promises. Such rants are in fact best confined to election campaigns and later forgotten.
The Stimulus Package is anything but, but you would not know it, listening to the Obama-ites and the One himself. This past week ahead of his first Press Conference, President Obama lobbied hard for the Stimulus Bill. In fact, the numbers show he spent about 3½ minutes out of his 7 minute address talking about all of the roads and bridges that were going to be built. From that one would have thought that about $350-400 Bn of the total package would be devoted to infrastructure renewal and other shovel-ready projects. No such luck. The infrastructure spending total is around $30 Billion or less than 5% of the total vote contained in the Bill. The remaining monies are being largely spent on items that the Democrats hope will allow them to tighten their grip on power in the next mid term elections and some other initiatives that will not kick in for years.
However this only begs the question of why they are engaging in this spending in the first place. Every available shred of evidence from Weimar to Hoover to Latin America to Japan’s Lost Decade to Gideon Gono in Zimbabwe shows that you cannot spend your way out of this type of a predicament. Add to this the fact that the severity of this Depression is being made even worse by the Fed’s policy of holding interest rates at artificially low levels, which discourages savings the exact opposite of what we have for some time being saying is needed.
One Trick Pony?
The scant weeks since the Inauguration have not been kind to the new President. The Stimulus Bill passed without any real bipartisan support. Several of his high ranking cabinet nominees have had to abandon their candidacy. President Obama has been given a rough ride in the foreign press, and received a public bollocking from President Ahmadinejad of Iran. And, although he still enjoys a high degree of public support, the President is down 20 points in the opinion polls,
Candidate Obama promised Change. President Obama gives is the same old spin in a different package.
Candidate Obama promised fiscal probity. America saw its debts double under George Bush. Under President Obama they are going up at a faster rate.
Candidate Obama promised bipartisanship. America gets to see partisan politics at their worst with President Obama leading the charge.
Candidate Obama promised fairness and transparency. America gets a President Obama who recently appeared to want the White House to have a say in the use of Census data and the redistricting of electoral boundaries.
We could go on. Suffice it to say that no one (except the Obama-ites) in the US is still in Campaign mode and we are hoping the President Obama is soon going to snap out of it too. Let us further hope that the new President is a fast learner, and that the first thing he now starts learning and doing is to get some substantive and workable policies in place. The World is waiting.
The Bottom Line
We are not the only pessimists. Many prominent politicians, economists and thinkers are joining the ranks of those that perceive the West to be in the midst of an unfolding crisis of vast proportions that is being fed by a sequence of serious policy failures.
Recently in Malaysia, IMF Managing Director Dominique Strauss-Kahn said the world’s advanced economies — the US, Western Europe and Japan — are already in depression, and that the IMF would slash its global growth forecasts further.
Jacques Attalli, the former inaugural Head of the EBRD stated recently “The major powers think that the crisis is only fleeting, and that we’ll soon return to the old order. No one really wants to undertake the profound changes necessary to resolve it. Although the world’s public debt should be cut, now it is only being increased.”
The result is that Foreign Investors who are being asked to foot the bill for all of these shenanigans in the United States are becoming increasingly impatient with the leadership there. We have revised our earlier expectation that the US might be able to run this game for a few years and now believe that they are going to be tested much earlier. In the absence of immediate, substantive and effective policymaking it is highly questionable, due to the speed of the unfolding crisis and competition for limited investment funds, that the US can play at this for much longer before foreign sources of capital dry up and it is forced to decide whether to bite the bullet and to then implement a set of appropriate policies or to keep rolling the dice.
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