Credit bubbles are different
Not only are credit crises different from other cycles, they also differ from other bubbles.
As Dan Gross explained in “Pop! Why Bubbles Are Great for the Economy,” the typical investing bubble leaves behind something of value. Whether it was thousands of miles of railroad tracks in the 19th century or thousands of miles of fiber-optic cables in the 1990s, usable infrastructure survives the bubble. Assets get scooped up out of bankruptcy for pennies on the dollar. Eventually, all of this overinvestment in the bubble du jour becomes a productive part of the economy. All that cable laid by Global Crossing and Metromedia Fiber and other bankrupt firms? Today, it is the bandwidth infrastructure that supports Google Maps, Netflix streaming video and Twitter.
Compare that with what gets left behind after a credit bubble bursts: No physical infrastructure, innovations or research breakthroughs; just soul-crushing, economy-sapping debt. And not just regular old balance-sheet obligations, but huge piles of counterproductive consumer and government liabilities.
Credit bubbles produce the exact opposite of productive resources. Deleveragers — those folks formerly known as consumers — spend the next decade paying down these obligations, rather than buying additional goods and services. And heavily indebted state and local governments are similarly thrifty, adding further pressure to the post-crisis economy.
Confusion about this is already taking a toll across the pond. The Irish, British and, soon, Greeks have bought into a misguided belief in austerity — that they can somehow cut their way to growth. In the United States, we have seen states and municipalities slashing head counts of teachers, cops and firemen. The “paradox of thrift” has morphed into a misguided economics of austerity. Hence, even when the private sector manages to create some jobs, its offset by public-sector job cuts.
Painted into a corner
In the not too distant past, the market might have been inclined to rally following a horrific data point such as June’s NFP report. The assumption was that the Fed, or perhaps Congress, would respond to economic distress with its usual largess. But the immediate market reaction — selling off on the “surprisingly” bad number, and then having difficulty all last week — suggests that traders are no longer expecting a cavalry charge to save the day.
Indeed, the Federal Reserve is in no position to do much more without great distress. Markets briefly rallied Wednesday when Fed chief Ben Bernanke suggested that a QE3 was possible. But soon after he finished his congressional testimony, Federal Reserve Bank of Dallas President (and FOMC voting member) Richard Fisher said the Fed had “exhausted our ammunition.” And Thursday, Bernanke scared markets further, saying the central bank wasn’t yet ready to take additional steps to boost the economy.
Markets gave up most of their rally on the recognition that the cavalry might not come this time.
Even with the Fed out of the picture, investors should not expect any relief from Congress: The legislative body in charge of taxing and spending seems incapable of accomplishing much these days. We are more likely to see counterproductive austerity measures than anything else.
Investors, it looks like you are on your own this time.
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He runs a finance blog, the Big Picture.
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