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Monday, 29 September 2008

The Great D word is in play.

It's my working assumption that a new agreement will be reached in the U.S. and/or the Fed, US Treasury, the ECB, BoE and other central banks will now work on an international/global version of the TARP concept. The international dimension was lacking anyway, and might not require any parliamentary scrutiny, debate and votes?
Equity values are a major part of the 'own capital' of publicly quoted financial institutions. Banks, especially publicly quoted banks, need to replenish sizeable chunks of their capital (regulatory reserves) urgently, ideally by replacing toxic own assets with AAA government treasuries, any OECD governments' treasuries.
Assuming some global scheme can be cobbled together over the next few days, I would then expect the stock markets to recover substantially from this week's sell-off and end the year in positive territory. Equities are also now getting to extreme valuations where fundamentally there is an awful lot of value for those prepared and sufficiently flush to buy on or below book values.
Meanwhile I bet many millions of private and institutional investors will be crowding into Treasuries, Gold and other safe harbour money protection funds such as the bigger most reputable money market funds, just as Hedge Funds have done, by parking sums equivalent in size to what TARP envisaged investing. Millions too will be looking up the 1929 Crash and the Great Depression. Few experts believe that is where we are headed now, at least not any distance downwards beyond the initial crash ratios. In 1924-'29 stocks rose by 120% and then in two days in October (Black Tuesday and Black Thursday) lost 30% and then continued sliding so that by 1932 a further 60% was wiped i.e. 90% of stock market indices gone.
I recall from my economics studies that Irving Fisher, the leading US economist was heavily invested and bullish, but lost his entire wealth (including his house). In the UK, JM Keynes also lost heavily. Were lessons learned? Samuelson admitted half a century later that "playing as I often do the experiment of studying price profiles with their dates concealed, I discovered that I would have been caught by the 1929 debacle." Hence, then and since, market collapses (almost by definition) were not foreseeable, whether or not they were inevitable! Moreover, that big brain economists, then and now, can neither anticipate the timing nor explain big market drops, the idea that stocks were obviously overpriced and had to fall to regain true value is a myth, and yet one of the objections by US legislators as well as the IASB accountants is that today's mark to market valuations of toxic assets are their true values? This was a major objection to the US Treasury's TARP scheme; the idea that it is not a waste of tax dollars to buy assets at prices above their current (distressed) market valuations.
What most people do not understand is that asset values are all market values and market values are produced by the economic system, its total circular, recycling of money stocks and flows plus confidence plus expectations, not by factory production productivity, or fundamental commodity or labour values. Wealth is not created by individuals or firms, but by all people and all firms within a gaming system of rules governed by expectations of how these apply normally.
If we take a casino analogy, Governments are 'the house' and they have to do whatever they can to attract everyone to remain winning and losing at the tables, rich and poor, all cosseted by their expectations and their confidence in the system and the rules, and with a few safety nets so that rich get taxed and the money recycled to the poor to keep them playing too, otherwise the rich will become poor too. A small majority of Congressional legislators ignored such circularity and all were attracted or compelled by the idea of changing the odds dramatically so as to protect Main Street versus Wall Street, and too by conservatives who identify freedom with the laws of chance operating freely with only minimalist government intervention. Some of them also want to replay the political-economic game of The Great Depression, this time without FDR's New Deal, which is their by-word for Socialism; to this time round prove that pure capitalism works.
If economic history taught me anything, I learned that Capitalism to survive needs Socialism in the engine room, just as Communism or Socialism need Capitalism in the engine room!

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