The Fat Lady Hasn't Sung Yet

Yesterday, I flew from Angola to Brazil and had the plane ride to re-read a favorite economic book, John Kenneth Galbraith's A Short History of Financial Exuberance. For those who haven't read this short, mordant resume of financial mania and boom and bust cycles from Tulipomania in the 17th Century to the crash of 1987, read it. The book has only 110 pages, but it drives home its lesson quickly and sharply.
While in Angola, I was unable to keep up to the minute with financial data and news--partly my preoccupation with the course I was giving there and partly due to the as yet fully developed Internet infrastructure of the country. When I arrived home and began to catch up on the week's news, I was surprised at how similar were the descriptions of the qualities of the business cycles and the euphoria that Galbraith described and the current state of the markets and of economic commentary.
The entire world suffered a major financial shock in the third quarter of 2008 as stock markets lost an average of 40% of their value. Unemployment throughout the developed world has risen dangerously. The credit needed to keep industry and commerce ticking over has largely been absent from the market since last year. Defaults, bankruptcies, weakening demand have all characterized the economy in the six months.
Yet, as of the close of the market on Friday, the DJIA stood at 8,574.65, an increase of 30 percent over its low of March 9th. Likewise, the IBOVESPA index in Brazil had reached 51,396, an increase of 75% over its October 2008 low. As well, yesterday’s O Estado de São Paulo contained an editorial that asserts that the evidence is there that we have reached the bottom of the well and can now plan on recovery as early as next year. (“Fundo do Poço, o Bom Sinal”)
Are these values justified by underlying economic conditions? I don’t think so. We still have some episodes of the expansion of credit in which the losses have so far only been contained, but not yet recognized. I have already featured in this blog the risks to commercial mortgages and many commentators are periodically featuring the dangers in American credit card balances and rates of default. (See Robert Reich’s Blog – that’s its rather simple and direct title for more from one who remains skeptical.)
During the months in which the market was falling precipitously, market reforms were promised. New legislation was promised to control leverage and other sins of the Recovery plans were unveiled to both bails out the banks whose exuberance and folly led us into the crisis. In general, beyond a limited bank-refunding program (TARP and its European equivalents), there has been little stimulus money reaching the economy. There has been substantial use of the bully pulpit to promote the idea that the economy would begin its recovery soon. Confidence-building is a component on any sensible Keynesian style recovery program. Secretary Geithner and the rest of the Obama economic team regularly appear on Capital Hill to make positive “see the light at the end of the tunnel” remarks. In Brazil, Central Bank President Meirelles regularly does the same.
However, there has not been any attack against the underlying speculative urges that fueled the bubble that burst so spectacularly.
In the same issue of Estado, Pedro Malan, the conservative Finance Minister for ex-President Fernando Henrique Cardoso, wrote in an op-ed column that spoke of the complacency that government officials and market participants showed as the first signs of the effects of the American residential mortgage crisis began to stress both the markets and investors’ enthusiasm for more leverage. He is the first to adopt a tone that Galbraith would have respected – attacking the speculation itself and not some external factor.
In reality, the markets have little reason to go up other than the artificial optimism that politicians and “expert” investors are spreading. If we focus on the economic conditions we face, more restraint would be a better strategy. The boomlet we are enjoying ignores (and takes advantage of) the lack of regulation following the Fall crash. I believe the same types of pressures are feeding it as fed the original bubble. Speculators are trying to establish a price level that will enable them to close out their original positions at a profit. Other investors, industries and employees will have to live with the result once the market resumes its decline until some actual solutions are applied to the causes of the crash. We will be able to restore normal growth to the markets and to the economy only when our governments really attack the problems. They have not done so yet.