Death by a Thousand Cuts (But can we have a last flutter?)
In the past post, MOS ruled out the prospect of a quick recovery for global markets but are we at the bottom yet? I admit to being a bear, a six foot one. But I cannot help being so in recent times especially in seeing how ailing the US and by extrapolation, the global economy is or has become.
These days, I feel out of sorts and uneasy. There appears to be many other shoes waiting to drop; particularly in emerging/Eastern Europe where certain governments may be behind the curve in terms of policy moves. It is apparent from asset prices that capital markets are discounting bad news aplenty. Prior to the relief rally in the recent past month, global equities have tanked by approximately 40 - 50%. We all know that no one can catch the market trough; well, maybe except for Mister Liar. But that has not stopped many from trying to do so.
Elisabeth Kubler Ross introduced the world to the five stages of grief in her 1969 book "On Death and Dying". The stages are:
Doctor Ross is a psychiatrist and the Kulber-Ross model she developed was a process which people subconsciously use to deal with tragedy and grief, especially when diagnosed with a terminal condition. Over time it is apparent that these stages can apply to any form of catastrophic personal loss, from love (out of love to divorce) to even jobs (unemployment or income loss).
Given that financial markets are also driven by the manic emotions of humans (say hi to Mister Market!), wouldn't the Kulber-Ross model apply to market cycles and consequently asset prices too? Recall the famous "Death of Equities" magazine cover in 1981. It is at the "acceptance stage" of capitulation where a bottom in equities may be found. It is only at such extreme depths when the seed of the next super bull market is planted. In which stage do you think we are at for equities?
With regulators sleeping at the switch and sold out on the story of self regulation, the US maneuvered itself into a big tangle of having high leverage and deflation. Household wealth has shrunk with collapsing housing prices. Debt levels, unfortunately, remain somewhat unchanged. The resulting fire sale of assets will set off a reverse spiral in asset prices and trigger off more margin calls. Truth be told, this evil spiral has started and the US Federal Reserve is throwing the kitchen sink at it to stop the rot.
To fight the deflationary beast, the Fed has wielded the big axe by dropping policy rates next to nothing. If you think about it, zero rates implies free money! Its tantamount to Governor Ben going up to his helicopter and throwing down cash. Unfortunately, since no one has decided to pay another when the latter borrows, zero is as low as rates can go in setting monetary policy stimulus. In its breach comes the unconventional tools of "quantitative easing" through the use of the central bank's balance sheet.
Given that markets are so sickly, my mind cannot help but to conjure up another medical analogy. To fight cancer, there is front line conventional medicine and then, there are experimental drugs for the seriously ill. The fact that such unconventional tools of quantitative easing are being employed to resuscitate the economy indicates how bad the situation is and how desperate we have become. Are we all grasping at straws? No wonder bond futures are discounting in approximately five years of deflation!
We are all in unchartered waters today. Sadly like all test drugs, the efficacy is unclear. The same can be said with quantitative easing based on the limited empirical evidence available. Hence, the US and by virtue of our close interconnectivity today, global economies are a huge trial in Governor Ben's petri dish. Roll out the printing press! Crank up the bubble machine! I am no economist but short of the liquidationist policies which bordered on Darwinian style economic cleansing (ie, the weak must fall for the strong to rise again), what other choices do we effectively have when we cannot stomach the pain of bank collapses to purge the system's excesses? I, for one, will not be able to tolerate the systemic failures because I want to remain in finance and not go into farming just yet.
Compared to mainstream medicine, experimental treatments usually bring side effects which may not be tolerable. Will the global economy face a death by a thousand cuts? As this will probably go down as the most morbid post, allow us to explain the phase. It refers to slow slicing - a form of torture and execution originating from Imperial China where many cuts were gradually applied to keep the victim on the edge of death. Our economy had many recent near death experiences. The last was in 2002 in the aftermath of the tech bubble wreck. Today, besides the Fed, central banks all over the world from the Reserve Bank of Australia to Bank of England have all fallen over themselves to cut interest rates. Like a floored individual, the policy makers are hoping that timely cardiac cardioversion can jot the collapsing economy back to life.
If we succeed in getting the credit creation process going again (probably more likely than not), another rally in equities would be inevitable. This is not totally tongue in cheek but I cannot rule out the possibility of the largest ever January effect taking place next month!
That said, the direst consequence of this massive pump priming is hyper-inflation if the easing stimulus is not withdrawn in time. We are footing the bill today in 2008 because of the party we started in 2003. It is widely acknowledged that policy rates were held overly low for too long a period of time and it resulted in the housing bubble. So how confident are we in the authorities to pull back the life support this time as we tread the thin line between deflation and inflation? Weren't Mr Bernanke already on the Board of Governors of the Federal Reserve System in 2003?
Let's not for a moment forget the situation in Harare, Zimbabwe where the annual inflation rate is an astounding 231 million (no typo here, its over a two hundred million) percent. We agree that figure sounds pretty bleak and too much of a stretch but if it helps to put things in perspective and raise an early warning, it would have served its purpose.
I recognise that Christmas is upon us. It is this time of the year when we, as kids, would write to Santa to have our wishes fulfilled. But with time and age, we soon realize that Mister Claus is very much, sadly, only make believe, a figment of adults' fertile imagination. As things stand, it does also appear that our goal of having a Goldilocks economy of sustainable moderate economic growth with low inflation will also remain a fairy tale.