09 October 2008

On Gravity, and also on the Uses of Bailout Power

First, a quick update on this week's numbers and what they seem to mean. Most major stock market indexes, not just those here in the USA but around the world, are significantly down for the week. Heng Seng, for example, started the week at 17,600 and hit a low of 15,500. It was up yesterday, but that appears to be bargain hunting.

In fact, in general, the upswings you see in the indexes this week seem to be attributable to bargain hunting. The good news there is that it means that there are people out there still willing to buy stocks. This is important, because while my old friend Ian correctly pointed out elsewhere that the stock market is not the economy, the stock market's health is always a leading indicator, in either direction, of where the economy is likely to go.

So, what we're seeing on the markets right now is a generally downward trend. It's not always precipitous drops, but gravity is definitely still in charge. There is still no broad confidence that the stock market is a good place for investment right now.

Ordinarily, in a situation like this, there'd be a flight of capital to either bonds or commodities, or both. But of course, that's not what's happening now. The bond market is still frozen up like the Northwest Passage used to be. It's not so much that nobody's buying bonds, as that people can only be enticed to buy bonds by increasingly high rates of return. Now, the definition of "high" for the bond market isn't really all that dear--low single-digits. But considering that bonds could be floated just a few weeks ago at fractional-percentage-rate interest, 3% is high. So, the various entities that float those bonds--banks, businesses, colleges, cities, states--are thinking twice about selling because they don't know that they can afford to pay!

This, of course, gets us back into the credit frostbite situation I've been nattering about since I started this column. A college wants to build a dorm, but they can't float the bonds to do so. In the near term, that means no construction jobs, which in turn means those construction workers have less cash to spend in the retail world, which depresses retail profits, which affects their stocks. Meanwhile, the college either has fewer students, or fewer of them on campus.

So that leaves us with commodities, and even those are volatile. Gold is up noticeably over the last month, but on any given day it's had some precipitous falls, usually on days the stock and bond markets also tanked. Oil, you'll have noticed at the gas pump, is down significantly, around $88/barrel right now, although that's also a factor of the dollar--get this--strengthening versus other currencies. Of course, the only reason that's possible is that so many of the other major economic players are also suffering. If Europe's economy were solid right now, oil would probably be a bit higher because the dollar would be cheaper.

So, herein lies a danger I haven't heard talked about much yet. One of the ways Treasury is going to work its magic is by printing money, creating it from scratch. No-one else in the US can do this, of course, which is what makes Treasury special. The problem, of course, is that if you create too much money, you begin to fuel inflation, which is already high. The dollar begins to weaken because, as with anything, if there's more dollars, they're worth less.


The big news this morning economically was the Treasury's statement that it was prepared to actually invest directly in banks--that is, give them money in exchange for ownership stakes, as opposed to giving them grants or loans or buying up their bad paper. We're not the first to consider this: Britain's already doing it.

The important thing to note here is that Treasury hasn't said that it will do this, only that, thanks to the bailout bill law, it now can, and won't take the possibility off the table. Many lawmakers (notably Charles Schumer, D-NY) favor this notion heavily. On the one hand, they think it's a better idea than just buying the bank's bad debts and then letting them run free. On the other hand, more economically-left folks aren't afraid of a little nationalization if that's what it takes.

The idea, of course, is the put the full faith and credit of the US directly into the private banking system by having the Treasury directly bolster, and take partial control of, struggling banks. However, that theory assumes a market that's thinking optimistically, that's willing and able to trust the government, or indeed, anybody, to save their asses.

That's not the market we have right now. We have a very pessimistic, PTSD market right now that's pretty much afraid of its own shadow and abjectly terrified of the least bump in the night. A move like this could instead send the message that the banks Treasury is trying to shore off are in even worse shape than they appear, leading to a panic and a run on those banks. This, in turn, would trigger a broader panic, because that's how panics work. They play on the fact that somewhere in the depths of human genetics there's a pack animal that's going to freak out because other prominent members of the pack are freaking out, rather than because they themselves actually perceive a problem.

So why is this even being considered? Desperation. Paulson, Bernanke, and others hoped that the enactment of the Bailout would calm markets and bolster confidence. Around the world, various moves by various central authorities have similarly been tailored not just to rescuing specific institutions but toward convincing the markets that it's OK to come out from behind the sofa.

Yesterday saw a coordinated central interest rate cut aimed at the same idea. An unprecedented number of national central banks, including the US Federal Reserve, the Bank of England, the European Central Bank, and the central banks of Canada and Sweden all cut their rate by 0.5%, and P.R. China's central bank quietly went along with the idea and cut theirs 0.7%.

So far, the passage of the Bailout Law failed to win confidence. The interest rate cut yesterday produced, at best, mixed results that still look more like bargain hunting than real reinvestment. In short: nothing's worked yet. Granted, they haven't given it much time, but nothing's worked, yet.

And so, we have the spectacle of some of the most powerful men in the world frantically looking for ways to change course before we hit the rocks. But nothing they've done so far has turned the ship, and it's hard to see how panic, rather than clear, cool thinking, is going to make anything any better.

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