Thursday, October 16, 2008

Resession Will Not Be Deep

In Aladin, Lago, Jaffar's sidekick parrot, has one of my favorite cartoon slapstick bits: Why am I not surprised? I think I'll have a heartattack from not being surprised!

News came out today that Bernanke thinks there'll be a recession. And it's supported by retail sales number. The market had a heartattack from not being surprised.

I mean, is it news to anyone that we'll have a recession? We've been in one for a year. And we surely haven't seen its end yet.

But all this talk of DEEP, WIDE recession is nonsense. Human intuition is based on linear extrapolation. Gloom and panic are always at the height just before the bottom. But in the height of panic people have forgotten one key difference: the government finally got it this time.

Bloomberg had an interview saying "Bailout Is Big, Bad, Ugly, the Only Answer: Jane Bryant Quinn". I agree with Jane on everything except the "only" part. NONE of the government rescue efforts since last August was the only choice, especially the massive liquidity injection of the past few weeks, the $700B bailout and the latest comedy of banks being forced to accept government money for peanuts in return. But, be it as may, this latest mafia drama will break the logjam because it finally stumbled on one of the root problems. It will take some time for the massive liquidity and capital to flow down the money supply chain. But it will. It must. Banks need to make money, even if they're not allowed to fail.

The other root problem, housing price, has been helped by several give-away legislations, and will no doubt continue being helped by the new president and congress. These bailouts are equally morally suspicious and objectionable as the bank bailouts. But, again, they will work. As a result, housing price may still go down somewhat, but much slower than withoutthe help.

Government supported housing price plus government supported banks. Everybody is riskfree! It's a riskfree world! How can banks not lend and buy risky assets as long as there's no chain reaction on 10/21? In a few months, as the money flows down the pipe and banks begging everybody to borrow (they would do a Paulson if they could), how can companies not hire and expand?

And, remember the $400B write-downs by US banks and $300B by European banks? They're write-downs, paper loss. As soon as the housing price stabilizes and CDO market volume recovers, $350B of it will become write-ups. Bank quarterly numbers will go up so fast and furious, it'll feel like the good'ol times again.

This recession will be anything but deep.

So will we get out of this mess without paying any price? Of course there's a price. The price is prolonged inflation and massive debt for future generations.

Inflation will be mostly driven by commodities bubble, credit bubble, and housing bubble. Yes, we may very well have yet another housing bubble in front of us.

But what's the problem if we can keep the bubble going in perpetuity?

The only problem is we can't. At some point people will stop buying our debt and stop using our currency to settle trades. Sure, Saddam threatened to settle his oil in Euro and look where he is now. But unfortunately we got in so much trouble in Iraq, the lesson we intended to teach others has turned into encouragement, for Chavez at least. Yes, people have no alternatives since Euro is in even worse shape now. But desperate people find desperate solutions. Just as we've been doing unimaginable, desperate things to avoid the crisis, the world will find unimaginable, desperate alternatives if necessary. You can only count on others being suckers for so long.

The fantastically flawed and effective bailouts we've seen in the last few weeks have hastened the day of reckoning, or at least made it much harder to avoid or delay.

But that's our children's problems. For now, enjoy the new, riskfree world. Be bubbly.

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