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Monday August 3, 2009 - 14:18:28 GMT
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Forex Blog - Time Machine Deployed for Great Recession

Time Machine Deployed for Great Recession


It may not be what Jules Verne had in mind but officials in the US and China have approached the Great Recession with an approach reminiscent of winding back the clock to 2006.  The key to recovery is driving risk assets ever higher on a massive infusion of liquidity (and in China credit) and in the process propping up imbalances.  The way to prevent an asset bubble from bursting in an unwelcomed fashion is to simply put as much air back in as is escaping. 


Whatever looked like a transformational period for basic relationships like government footprint in the economy, household savings, labor market conditions, leverage in the banking system, bank lending, bank risk taking, healthcare reform, executive compensation and regulatory reform is rapidly being pushed aside or watered down.  US stocks up 50% from the March low and Chinese stocks up 100% is all we need to know.  Even home prices in the US are turning in key depressed markets and in China they never really looked down. 


On one issue after another the activist US President is walking back from the generational changes (New New Deal) that so many predicted as polls show support for the President slipping…an even marginalized GOP seems to have retained a disproportionate influence over the electorate on talk radio, cable TV and the conservative press.  If Rahm Emmanuel said never waste a crisis (to usher in your wish list of reforms), he might now say what crisis? 


The new normal that PIMCO’s El-Erian and Gross constantly mention and seemed appropriate now seems like a bad Madison Avenue sales jingle.  The new normal is just like the old normal. 


The Obama administration at times (from the President to NEC’s Summers) says bankers are showing little humility in the wake of the crisis and the government’s largesse in saving their behinds and are back to their old bad tricks in paying large bonuses and taking inordinate risk.  But the reality is the government, especially the executive branch, never lowered the boom on bank compensation and risk taking.  If they had Goldman would not have had record Q2 results and is expected to pay record bonuses for 2009. 


And one has to ask does the administration really want to trim the sails of Wall Street?  What if stocks were up only 25% from the March lows?  What would NY, NJ and CT finances look like if bankers’ compensation were permanently reset sharply lower?  Where would the recovery be if higher asset prices did not lift household and firm confidence?  If the Democrats really wanted to shape a new system (and a sustainable one) it would have led a broad effort to foment system deleveraging.  Instead we get cash for clunkers where consumers, already steeped in debt, are encouraged to go out and buy a new car for $3500-4500 tax credit…let’s just reduce that savings rate.  Ironically the savings rate may rise on this little gem in year one if one assumes the average (financed) cost of a new car per month is $250 times 12 = $3000. 


US crisis politics is all about do what is least painful and LCD, not what should be done or even could be done, much less anything that requires a pound of intelligence to explain and an ounce of intelligence to understand.


China has even fewer choices in its one party system – keep the growth machine running or risk regime change.  By any means necessary is a cornerstone of dictatorships and China’s is no different.     


So we are condemned to repeat the mistakes of the past with the most shortsighted approach to public policy.  China’s asset bubbles in real estate and equities have only gotten bigger.  Bubbles in equities, high yield, EM, commodities and credit spreads are inevitable…the seeds are not just planted, but germinated, watered and fertilized. 


David Gilmore


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