Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
INTEL (INTC) Stock Investing in AI Machine Intelligence Mega-trend 2020 and Beyond - 18th Jan 20
Gold Stocks Wavering - 18th Jan 20
Best Amazon iPhone Case Fits 6s, 7, 8 by Toovren Review - 18th Jan 20
1. GOOGLE (Alphabet) - Primary AI Tech Stock For Investing 2020 - 17th Jan 20
ERY Energy Bear Continues Basing Setup – Breakout Expected Near January 24th - 17th Jan 20
What Expiring Stock and Commodity Market Bubbles Look Like - 17th Jan 20
Platinum Breaks $1000 On Big Rally - What's Next Forecast - 17th Jan 20
Precious Metals Set to Keep Powering Ahead - 17th Jan 20
Stock Market and the US Presidential Election Cycle  - 16th Jan 20
Shifting Undercurrents In The US Stock Market - 16th Jan 20
America 2020 – YEAR OF LIVING DANGEROUSLY (PART TWO) - 16th Jan 20
Yes, China Is a Currency Manipulator – And the U.S. Banking System Is a Metals Manipulator - 16th Jan 20
MICROSOFT Stock Investing in AI Machine Intelligence Mega-trend 2020 and Beyond - 15th Jan 20
Silver Traders Big Trend Analysis – Part II - 15th Jan 20
Silver Short-Term Pullback Before Acceleration Higher - 15th Jan 20
Gold Overall Outlook Is 'Strongly Bullish' - 15th Jan 20
AMD is Killing Intel - Best CPU's For 2020! Ryzen 3900x, 3950x, 3960x Budget, to High End Systems - 15th Jan 20
The Importance Of Keeping Invoices Up To Date - 15th Jan 20
Stock Market Elliott Wave Analysis 2020 - 14th Jan 20
Walmart Has Made a Genius Move to Beat Amazon - 14th Jan 20
Deep State 2020 – A Year Of Living Dangerously! - 14th Jan 20
The End of College Is Near - 14th Jan 20
AI Stocks Investing 2020 to Profit from the Machine Intelligence Mega-trend - Video - 14th Jan 20
Stock Market Final Thrust - 14th Jan 20
British Pound GBP Trend Forecast Review - 13th Jan 20
Trumpism Stock Market and the crisis in American social equality - 13th Jan 20
Silver Investors Big Trend Analysis for – Part I - 13th Jan 20
Craig Hemke Gold & Silver 2020 Prediction, Slams Biased Gold Naysayers - 13th Jan 20
AMAZON Stock Investing in AI Machine Intelligence Mega-trend 2020 and Beyond - 11th Jan 20
Gold Price Reacting to Global Flash Points - 11th Jan 20
Land Rover Discovery Sport 2020 - What You Need to Know Before Buying - 11th Jan 20
Gold Buying Precarious - 11th Jan 20
The Crazy Stock Market Train to Bull Eternity - 11th Jan 20
Gold Gann Angle Update - 10th Jan 20
Gold In Rally Mode Suggests Commitment of Traders (COT) Data - 10th Jan 20
Disney Could Mount Its Biggest Rally in 2020 - 10th Jan 20
How on Earth Can Gold Decline During the U.S. – Iran Crisis? - 10th Jan 20
Getting Your HR Budget in Line - 10th Jan 20
The Fed Protects Gamblers at the Expense of the Economy - 9th Jan 20
Last Chance to Get Microsoft Windows 10 for FREE! - 9th Jan 20
The Stock Market is the Opiate of the Masses - 9th Jan 20
Is The Energy Sector Setting Up Another Great Entry? - 9th Jan 20
The Fed Is Creating a Monster Bubble - 9th Jan 20
If History Repeats, Video Game Stocks Could Soar 600%+ - 9th Jan 20
What to Know Before Buying a Land Rover Discovery Sport in 2020 - 8th Jan 20
Stock Market Forecast 2020 Trend Analysis - 8th Jan 20
Gold Price at Resistance - 8th Jan 20
The Fed Has Quietly Started QE4 - 8th Jan 20
NASDAQ Set to Fall 1000pts Early 2020, and What it Means for Gold Price - 8th Jan 20
Gold 2020 - Financial Analysts and Major Financial Institutions Outlook - 8th Jan 20
Stock Market Trend Review - 8th Jan 20

Market Oracle FREE Newsletter

Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

The Current Financial Crisis- Causes and Consequences

Stock-Markets / Credit Crisis 2008 Oct 17, 2008 - 04:26 PM GMT

By: The_Gold_Report

Stock-Markets Best Financial Markets Analysis ArticleAdrian Day's reputation for discovering big winners adds credibility to the global investing pioneer's insights, which he is sharing with The Gold Report subscribers via excerpts from recent articles in Adrian Day's Global Analyst . Acknowledging what trying times these are for investors, in this first segment of a five-part series, Day discusses what led to the current economic crisis and how he sees Washington's $700 billion (and counting) bailout playing out.


The Current Crisis—Causes and Consequences

The house of cards built on easy credit has finally come tumbling down, triggered by the failure of one of the most flimsy of the cards, subprime mortgages. We'll look at the causes—it's important to understand causes if one has any reasonable chance of analyzing the present and assessing the outlook—and weigh the likely outcome of the government's actions.

Not to keep you in suspense any longer, we believe the bailout and associated actions, adding yet more credit to an economy already over-ripe with easy credit, far from solving the problem (i.e., getting banks to lend again), will make matters ultimately worse, by postponing the necessary adjustments, building up inflation, and destroying the dollar and its purchasing power, devastating savers and undermining the foundations of the economy.

This will be a protracted slowdown as corporations and households de-lever and attempt to restore some health to broken balance sheets. Nevertheless—to jump ahead to the critical conclusion for investors we'll discuss next time—we are far beyond the time for wholesale liquidation, if it means selling quality companies well below their intrinsic values. It may be too early for aggressive across-the-board buying, but remember the words of the late, great John Templeton, who advised us to “buy at the point of maximum pessimism.”

What Brought Us Here?
It is critical to start by analyzing the causes of the problem, and assessing the likely outcome. Only by understanding that, can we hope to know what to do. So what brought us here, and what's next? The root cause of our current problems is clear: excess credit creation over these many years. Too much money and artificially low interest rates always and inevitably lead to speculation and mal-investment. Whatever excesses there have been on Wall Street—and there have been many, as well as the abject ignoring of any sense of fiduciary responsibility—nonetheless, blaming “Wall Street speculators” for the mess is a little like blaming a drunk child when the parent left the open bottle in the playpen.

Critical to understand is that this is not a normal cyclical downturn. Such is triggered by tightening money and higher rates in a deliberate attempt to cool an “overheated” economy and restrain inflation. The resulting recession can be sharp but is typically short. Similarly, it is relatively easy to get out of a cyclical recession: do the opposite of what triggered it, that is, ease money and lower rates. But this is not a cyclical downturn; it is, rather, a secular de-leveraging contraction. Tighter money and higher rates did not trigger it, and easing money and lowering rates will not get us out of it. Au contraire. We currently have easy money and low rates, rates that are actually negative at the short end. And easier money and even lower rates, such as we've seen over the past year, have not helped. (Indeed, despite the Fed slashing the overnight loan rate from 5¼% to 2% in the seven months to April, rates in the real market—mortgage rates, credit card rates, etc.—actually increased and, of course, available credit contracted.) This is important to recognize.

Selling Begets Selling
Thus, this de-leveraging process is likely to be a protracted process as banks, other firms, and households restore health to their balance sheets. But such a process feeds on itself, as we have all-too-painfully seen this year. Companies sell assets to raise capital, which pushes down prices, which forces others to raise capital, pushing prices down further, which causes banks to contract credit. And as banks contract, small businesses have difficulties, reducing purchases, and so on. So much of the selling in the market has been forced (by financial companies needing to raise capital to meet ratios; by investor receiving margin calls, and funds getting redemptions). The waves of forced selling then cause panic among investors, leading to the very worst kind of selling, blind liquidation of thinly traded securities into down markets. This can, and has, driven prices down sharply and suddenly.

Will the Bailout Work?
The banks have no capacity or appetite for lending, which is why lower rates haven't helped. And why, given that for investment banks to reduce their average leverage from 30 times to 20 times would require that $6 trillion of assets be sold, the government's $700 billion bailout won't change the picture either. (Another question: Do they buy bad assets at prevailing prices, in which case it won't improve banks' capital ratios at all, or do they defraud the taxpayer and buy back at above-market prices, as Paulson seemingly wanted to do?) It may plug a hole short term, but it doesn't mean the banks open up and start lending again.

Washington is attempting to solve the problem by doing more of what caused the problem in the first place (and—greatest irony and travesty of all—with the very same people in charge who caused the problem in the first place, who encouraged the excesses, and who didn't see the problem until too late). By trying to keep asset prices up, Washington is repeating the error of the 1930s and ensuring that the downturn lasts longer.

No parallel is precise, but we might look at what happened when Japan's stock market and real estate bubbles burst at the beginning of the 1990s. The Bank of Japan slashed rates, down to ½% on long-term government bonds, and bought up bad assets from the bankrupt banks. (They didn't open the monetary spigots, as has Washington.) Neither high interest rates of shaky banks have been a problem in Japan for many years.

But that didn't cause banks to resume lending. Japan also increased deposit insurance (covering accounts in full until 2006.) That simply slowed the needed restructuring, and caused the banks to withdraw, as The Wall Street Journa l put it, “led to the establishment of zombie banks.” There has been essentially zero net capital investment in Japan in the last 15 years. Despite near-invisible interest rates and strong banks, Japan has been in either recession of deflation (or both) for most of the past 18 years. And Japan had one huge advantage over the U.S. today, namely that households had low debt and high savings.

It's Not Pretty Ahead
Not only will current policies not solve the problem, they protract the downturn and delay the needed resolution. But they make matters worse by ensuring more inflation, already at a 17-year high in the U.S., adding another disincentive to save. Taxes will go up, further suppressing economic growth or chances of a recovery. The likely result is a severe case of stagflation

So the economy is likely to enter a recession soon, but it will be a long and painful experience coming out of it, a protracted period of sluggishness, with other economic problems. And the market, likewise, is likely to be sluggish for some time, though once we see some stability return, specific sectors and individual companies will recover sooner, while we will see short-term rallies.

Next time, we'll look at the outlook for various markets, including, most importantly, the dollar, and then discuss how investors should act in the current crisis (clue: don't dump quality companies below their intrinsic value into a declining market).

Adrian Day is President of Adrian Day Asset Management, which manages portfolios in resource and global equities. Contact him at Adrian Day Asset Management, 801 Compass Way, Suite 207, Box 6643, Annapolis, MD 21401; Tel: 410-224-2037; Fax: 410-224-8229; Email Adrian Day

Visit The GOLD Report - a unique, free site featuring summaries of articles from major publications, specific recommendations from top worldwide analysts and portfolio managers covering gold stocks, and a directory, with samples, of precious metals newsletters. To subscribe, please complete our online form ( http://app.streamsend.com/public/ORh0/y92/subscribe )

The GOLD Report is Copyright © 2008 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material only in whole (and always including this disclaimer), but never in part. The GOLD Report does not render investment advice and does not endorse or recommend the business, products, services or securities of any company mentioned in this report. From time to time, Streetwise Inc. directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

The Gold Report Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules