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October 12, 2008

BROTHER, CAN YOU SPARE A TRILLION? OR, WHY 2008 IS NOT LIKE 1932.

We flirted with my worst case scenario on Friday. Italy's Berlusconi even said it out loud, but Bush immediately slapped it down. But how low will the Dow go before Bush and Congress are forced to stop it?

I dunno. My scenario was a mental exercise to help clarify the choices and priorities. As that,  think it still holds up well. The two big unknowns are,  where is the bottom, and will we hit bottom before or after election? And if we hit bottom before election day, will that bottom be based on a priced-in Obama Soviet state (bad times ahead) or on a low-tax, entitlement-reform McCain presidency (the worst is over)?

Again, I dunno; we'll see. More important now, I think, is this: once we do find bottom, what do we do next? Here's what I think:

Credit market first:  Like I said before, somebody has to go first in the credit market. Tom Clancy's novel Debt of Honor had a situation like this, where the Japs had sabotaged the stock market's main computer system, and as a result nobody knew what anything was really worth. To fix it, they had a "do-over"- they changed the numbers back to what they were just before the sabotage, then restarted. At first, everybody hesitated, not wanting to to get burned by making a wrong move. Then one of the "good guys" in the plot made a big move, followed by some others, and soon everything was OK again.

If "somebody goes first" before the election, possibly early this week, and the rest follow suit, and the government stays out of the way except for providing liquidity, the the worst will be over. We'll be able to keep our core productive businesses running while we sort out the real estate asset values. 18 months from now we'll be back up to 11,000 with the LIBOR rates back on the historic (rational, asset-based) ratio trend line.

Real Estate assets second: The fix in the credit market will not work unless we let the bad risks go bankrupt. Unfortunately, neither the bail-out, nor McCain's latest plan, nor Obama's plan, will do that. All these plans are based on trying to avoid the pain of losses based on inflated asset values. And that means propping up "name" companies or "distressed homeowners" who should go bankrupt.

This is the wrong approach. Did the government prop up the tech companies that had hyperinflated market values in the dot com bust? No. And that approach worked out right in the long run, because we took the hits in the short run. We suffered a market crash, companies closed, people lost bundles on investments, stock options & retirement plans, and the housing market tanked. Then, on top of all that, 9/11 hit, killing commerece for 6 months and launching the US into war. 

But by 2004, the market had gained everything back. We need to the same thing again.  In fact, we were so confident that by 2005 we busily started to screw things up again by creating the new government-sponsored real-estate bubble. So this time, we must shrink government and cap its influence at all levels  so it can never again cause these problems.

If we don't let these bad risks go bust (which I think is likely under Obama, and even possible under McCain), then the credit market will freeze again, because the guys who "went first" will get hosed when their debtors start handing those debts over to the government, who will arbitrarily and capriciously re-value them down to near nothing. In effect, the government will be competing with them by inflating assets and sucking up capital into "can't fail" investments. Why take risks and try to make money if the government is going to take some of it from you and give it to people who lost money on previous bad risks?

Until that is settled, the market will continue to tank and stay tanked, ratcheting down with each prime rate decrease (already too low - look out for inflation), or bail-out deal, or stimulus package. Worst case, we keep creeping down until Spring of 2010 (yes, 18 months), after Obama and Congress have repeatedly bailed-out and stimulated and tried every New Deal public works scheme in the book, to no lasting effect. You can't eat carbon credits, or run container ships on wind power, or get volunteers to build cars or grow crops. All the do-gooder programs they try will add to and prolong  the misery, just like they did when FDR tried them.

I think that this is now a very real possibility, because the Social Security and public pension crisis is finally starting to get some ink, and there is no amount of Fed money available to fix that. Once that disaster is honestly priced into the mix, there will be a complete loss of faith in the public sector.  In effect, the public side of our economy will have to go bankrupt, and be rescued by the private side.

Because while all of this will be happening, smart guys like the Chief will work out side deals with other companies to keep their businesses going. That liquidity will get pulled out of the public system, un-taxed and unaccounted for, creating a giant black market. This is what happens in every command economy - the government elite takes what they can off the top, and everybody else sneaks around doing daily business under the radar.

The main difference between now and what happened in 1932 is that the infrastructure is in place for the private sector to rapidly replace everything the public sector has taken over. Our economy will have an unprecedented opportunity to go lean. Farmers will recalculate their crop values without subsidies, and the most profitable crops will get planted. Car makers will take orders direct from customers and carry their own paper. Shippers will participate in the value of the goods they deliver. Manufacturers will allow complete transparency into their production capabilities so users and distributors can coordinate their buys on a pull basis.

There is no way the public sector will be able to restrain or regulate this without a police state. Analogous to the internet, this "super black market' will be too big and too popular to manage centrally, and all attempts to do so will be met with immediate heavy resistance.  Oh, you say we can't build thousands of neighborhood nuke generators without an environmental impact statement for each one and 5 years worth of bureacracy between application and approval? Try and stop us.

In short order, this "super black market" - let's call it the Hayek Community - will have the strength to yank control away from the public sector, and voters will then restore private enterprise and open markets as the basis for a free and strong America.

Posted by: JBD at 03:51 PM | No Comments | Add Comment
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