Thứ Tư, 19 tháng 5, 2010

Welcome to Weimar, District of Columbia

Economist David Rosenberg of Gluskin-Sheff passes along an email from an old business associate.

I don’t know if you remember but we worked together at Merrill. I ran emerging markets from 1985 to 1996. I’ve always been a loyal fan and kept up with your writings.

As you know, I used to specialize in what we called then toxic waste countries. Reality has obviously taken a turn and what was toxic now is golden and the prime is now toxic. Our best countries are being run like banana republics and the famed moral hazard issues are now at the individual level with the strategic mortgage defaults. Keep in mind that in Mexico, it moved to wholesale credit card defaults at the last stage of the correction.

It is interesting to note that back then (the 80s) without currency zones but a fixed dollar, the order was devaluation, default, restructuring and budget balance with exports beginning the process of recovery. It was not until Summers’ bailout of Mexico that we entered this ridiculous world of constant bailouts, raising the size of them at every turn and lowering the bar to what constitutes risk.

Now, it’s worst than ever. The developed economies have huge fiscal deficits with no state assets to sell. The balance sheets of the developed nations are over leveraged. The deficits have taken a permanence to them. In the case of Europe with no individual devaluation alternative and their new massive debt load, the EU must now make huge fiscal cuts to get credibility. This is very reminiscent of the pre-depression year. If the EU follows through it will push a weak world into a severe double dip and bring the question of capacity to repay to the forefront anyways.

Monetization or printing may end up being the only end alternative. I know, and agree with you, that to have inflation you need demand. Where I disagree is that you can’t have inflation with such a significant slack in the economy. For those of us that lived or worked in the hyperinflationary South American zone of the seventies and eighties, inflation comes when people lose faith in the currency and see material goods as a store of value. Because commodities rise and the goods can no longer be expected to be made at the same cost structure, people assume that they will be worth more in the future creating a self fulfilling upward spiraling effect. You can anticipate that these state governments will introduce price controls as well as potentially fixing exchange rates worsening the situation.

My biggest fear is that these politicians and advisors have little experience in this area and are more concerned about controlling the political short term without regard to the longer term implications. I see this like an attempt at covering holes in a cracking dam with your fingers while the cracks are spreading. Bonds in the thirties were not a safe haven because they were restructured into 30 to 40 year bonds at 1.0-2.0% interest. Ultimately spending habits must decline, debt must be restructured, and growth must be promoted through the private sector.

Political interests must be aligned with long term economic objectives and I don’t see that any time soon. Obviously, I’m very negative right now. What am I missing?


Related: Don't Cry For Me, America.

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