There was a fantastic universal sense that whatever we were doing was right, that we were winning. . . .So now, less than five years later, you can go up on a steep hill in Las Vegas and look West, and with the right kind of eyes you can almost see the high-water markâ€”that place where the wave finally broke and rolled back.â€ Hunter S. Thompson, Fear and Loathing in Las Vegas
The Great Bull Market is winding down much in the same fashion as when the World moved past Hunter Thompsonâ€™s Go-Go Sixties and slipped into the stagflationary dystopia of the 1970â€™s. No better bellwether of this phenomenon is given today than the transformation of Facebook (Nasdaq: FB) from IPO darling to abused foster child in the few short days since the shares made their debut. Today with the Nasdaq ending flattish, Facebook moved lower for the second day and its shares are now changing hands at more than 17% below IPO levels despite frantic efforts by the dealer group to hold the line on price.
With the shares trading north of 75 on a P/E basis and earnings proving hard to grow rapidly, the Facebook IPO was probably a major disconnect with financial reality much in the same way that other disconnects are playing out across the globe.
In fact this â€œFacebook Flopâ€ could be the sign of a major top.
More evidence of a â€œdisconnectâ€ comes from Greece. For example 75% of the population want to keep the Euro; while 75% of the population want to abandon austerity – the condition precedent the previous government bound the country to precisely in order to stay in the Euro. In a similar vein, polls in the Hellenes are still showing that more than half of the population expect a civil war there in the near future.
So, it looks like we will likely be in for some â€œshooting and lootingâ€ before this is over.
In what has now been framed as a debate between the supporters of the Hair Shirt of Austerity , mostÂ notably Frau Merkel and her German countryfolk; against the Growth crowd, championed by Krugman, Obama, and many Euro countries, it is increasingly hard to maintain any confidence in the longevity of the EU in its current form; or for that matter the ability of politicians to chart a stable path to renewed prosperity.
In fact, the probable contagion impact of events that are flowing out of this policy impasse should be feared Â because Europe and the US will not achieve a way out of this quagmire through either growth OR austerity, unless and until a key pre-condition for restarting those regional economic engines is met.
This is quite simply that we must have a reckoning and write-down of bad debts. Until now this has been resisted at all costs by banking and investor interests, aided and abetted by the worldâ€™s largest central banks and the IMF. Surely, the experience of Japanâ€™s two â€œLost Decadesâ€, as an object lesson of what happens when you avoid the reckoning and write-down, should be reason enough to swallow the bitter pill and get on with the task at hand. Nonetheless Europeâ€™s policymakers dither while patching over problems in place of applying durable solutions. What in fact was the Greek Bailout other than a mechanism to buy some time for the creditors? What was the failed effort to get Iceland to swallow its IMF-led bailout, other than a thinly-veiled attempt to hang the costs of bad bond positions on Icelandic taxpayers instead of the offshore banks that had gotten themselves burned? Why is the US Government not addressing the bank solvency problem that it has been obscuring from public view, or its structural deficit problem? Are any of these policies in any way socially sustainable beyond the very short run?
The answer is â€œNoâ€.
Not surprisingly therefore, it looks like no one has confidence any longer that that the current set of plans will stick. Some are now suggesting a Greek exit (â€œGrexitâ€) as a way out coupled with a â€œfirewallâ€ for the rest of Europe to contain the contagion. This is fantastical thinking. In the first instance, the time window for that type of a move has long since closed – as we had repeatedly advised early on in the crisis, the best strategy would have been for the Greeks to have defaulted and negotiated a â€œsoft exitâ€ from the Euro some two years ago. This did not happen in time and now the terms of the Greek Bailout and the much larger size of the Greek liability make a default a very risky prospect for the Greeks, and for Europe. In the second instance the concept of a â€œfirewallâ€ is simply not credible in the current context. The only true “firewall”, to the extent it is possible to implement such a thing is: adherence to sound risk management, non-invasive but effective regulation, and a neutral â€œHands-offâ€ government policy posture that sets the stage for stable economic growth, development and trade.
At present, more, not less, European sovereigns are looking shaky, the EFSF/ESM bailout mechanism in Europe is unfunded and unworkable and the ECB is stretched. The recapitalization of Europeâ€™s banks which last summer was being trumpeted to be completed by October 2011 has not progressed at all. In the US the situation is hardly different with many more insolvent banks being allowed to continue in business on the pretence that they are OK; the US economy is in â€œNowheresvilleâ€, vast swathes of the personal sector suffering under some form of financial duress and the Fed is increasingly looking at a significant diminution in its menu of available policy options.
No one will be sheltered and no economy will properly recover until the rot and ruin of past excesses are carved away such that new shoots of durable economic activity can take root. This will not happen as long as there are zombie borrowers and zombie banks feeding off of the productive parts of the global economy at everyone elseâ€™s expense.
* Cognitive dissonance is a discomfort caused by holding conflicting cognitions(e.g.,Â ideas,Â beliefs,Â values,,Â emotional reactions) simultaneously. In a state of dissonance, people may feel surprise, dread, guilt, anger, or embarrassment.Â The theory of cognitive dissonance inÂ socialÂ psychology proposes that people have aÂ motivational drive to reduce dissonance by altering existing cognitions, adding new ones to create a consistent belief system, or alternatively by reducing the importance of any one of the dissonant elements.