A tumultuous week October 10, 2008 With all the excitement it’s easy to lose sight of what really matters. I will again repeat what I have been saying for a long time: this is not a liquidity crisis, it is a credit crisis. The reason why none of the bailouts and interventions has worked is because they were all focused on increasing liquidity. There is no lack of liquidity; there is a lack of confidence in the credit quality of banks and debt instruments.
Banks don’t need more loans, they need to fix their balance sheets by raising capital through the issuance of equity, and confidence in the banking sector will not return until the banks have raised new capital. In the current market nobody in his right mind will invest in banks (Buffett being the exception), which is why the UK government has announced that it will invest in banks. The UK plan partly nationalizes at least eight banks through a 50 billion pound equity infusion. Spain has done the same.
The United States government will follow, and I suspect will announce that it will buy equity stakes in US banks within weeks, if not by the end of the weekend. This will be the first step towards shoring up confidence in US and UK banks and it should bring some relief to the frozen credit markets.
Also within days I expect to hear that the United States government will guarantee all bank deposits, regardless of size. Several European governments have already done this and if the US doesn’t follow then money will start flowing to jurisdictions that do carry that guarantee.
These two abovementioned measures will go a long way towards shoring up confidence in the banking sector, but will not solve the problems in the credit markets. Interest rates are still much too low to compensate lenders for the risks they are taking and to cover the loss of buying power their money suffers through inflation. Monetary inflation has to come down very dramatically, or interest rates have to rise. Of the two, I think it is much more likely that interest rates will rise.
David Greenlaw, the Chief Economist of Morgan Stanley, thinks that the US Federal Budget Deficit will grow to approximately $2 trillion as a result of all the bailouts. This will undoubtedly put downward pressure on US Treasuries and upward pressure on US interest rates.
But don’t confuse an increase in US Federal debt with an increase in inflation – they are not the same thing. When the US government issues new debt they borrow money that already exists, which means there is no increase in the money supply. It is only the banks (including the Federal Reserve Bank) that can increase the money supply and create inflation.
Perhaps markets will rally next week. If they do, I suspect it will be no more than a relief rally. There is no reason to believe the stock market rout is at an end. I know for a fact that I’ll only be able to recognize when markets bottomed with hindsight, long after the bottom actually occurred. Markets are going to keep declining until they’re done, and then comes the long wait. How long? I don’t know, but I personally don’t expect the world, and certainly not the US, to come out of this economic downturn for many years. Perhaps five, if we’re lucky, but there is certainly historical precedent to believe it could be 15 years, or more.
Paul van Eeden
Disclaimer This letter/article is not intended to meet your specific individual investment needs and it is not tailored to your personal financial situation. Nothing contained herein constitutes, is intended, or deemed to be -- either implied or otherwise -- investment advice. This letter/article reflects the personal views and opinions of Paul van Eeden and that is all it purports to be. While the information herein is believed to be accurate and reliable it is not guaranteed or implied to be so. The information herein may not be complete or correct; it is provided in good faith but without any legal responsibility or obligation to provide future updates. Neither Paul van Eeden, nor anyone else, accepts any responsibility, or assumes any liability, whatsoever, for any direct, indirect or consequential loss arising from the use of the information in this letter/article. The information contained herein is subject to change without notice, may become outdated and will not be updated. Paul van Eeden, entities that he controls, family, friends, employees, associates, and others may have positions in securities mentioned, or discussed, in this letter/article. While every attempt is made to avoid conflicts of interest, such conflicts do arise from time to time. Whenever a conflict of interest arises, every attempt is made to resolve such conflict in the best possible interest of all parties, but you should not assume that your interest would be placed ahead of anyone else’s interest in the event of a conflict of interest. No part of this letter/article may be reproduced, copied, emailed, faxed, or distributed (in any form) without the express written permission of Paul van Eeden. Everything contained herein is subject to international copyright protection. |
|
