Small World

We are in a recession even if it has not been officially announced. Technically, that means two consecutive negative Qts. Details, details.

The so-called sub-prime crisis cut off the economy’s life blood in that it did away with trust. Bankers lied to each other, and, to their regulators. One banker in the UK suddenly regarded his counterpart in the US as a leper. The heart of the world credit system - inter-bank lending - came to an abrupt halt. A few weeks of this is enough to convert a slowing but positive growth rate into a corrosive event. However, the near-miraculous quick fix of two weeks ago put a floor under the free fall. How bad would it have been? The finance ministers knew; no way they would have sculpted a deal so quickly if they had not. We would have experienced a near depression (not a full depression in the sense of ‘29 - soup cans - only because of the lesson taught by Friedman and Schwartz some 40 + years ago).

The US plan is not perfect. "In the long run, Americans will always do the right thing after exploring all other alternatives," Winston Churchill said during WWII, as Americans were debating whether or not to enter the European theater. We are still grouping. For example, in the case of the 9 banks initially selected the injection of capital is through (non-voting) preference shares yielding an absurdly low 5%. In the UK, the taxpayers are getting 12%, and, with a gov’t-appointed board. Without voting shares, the gov’t has no voice in running these banks. And, it has no seats on their boards. And the whole shebang will be managed by a 35 year old. What?

Still, we know by monitoring the 90 day LIBOR rate that $’s are flowing again between banks. US, UK and EU banks have started to lend rather than hoard cash. We’re seeing the worst of the seizure in money markets come to an end. Clearly the global rescue effort is having an effect. This is a very good thing.

Over the near term we will watch world events because they impact most of us directly these days. Thus, we need to know that shipping is slowing world wide, that freight rates for grains, coal and iron are down substantially. We need to know that deliveries dropped 15% in Long Beach last month. We need to know that the IMF just had to rescue Hungary and the Ukraine. We need to know that the German economy is stagnant. We need not be surprised if we see Russia fail to pay its debts (again). We need to know that Brazil is in a free-fall, that Argentina may go into default next week. This and more will give us a clue about what is in store over the near term. But at this juncture there is reason for optimism. Here is why: The mkt crowd, after missing entirely what could have been a fatal flaw now feels suddenly enlightened, given to original insight even, and, as is almost always the way has rushed to the other extreme, that is, has priced in a far worse scenario for next year than reality, our view. Once again, more psychology than economics.

Robert Craven