Friday, August 19, 2011

Why This Economic Dip Will Be Even Worse

Many financial commentators are assuring me that despite all the bad economic news, the US economy should not double-dip, and that we will not see a replay of 2008. I agree that it won't be a replay, because I think it is going to be worse.

A few reasons:

Last time the crisis was in the banks, who ultimately wound up getting backstopped by governments. Now those government "safe havens" are the cause of the crisis. Who is going to backstop the backstops?

Going into 2008, the decoupling story was still a bright spot for the bulls. Many thought that while the developed world might slow down, emerging markets like India, China, and Brazil were going to boom enough to keep the rest of the world sputtering along. Now India and China are dealing with serious inflation hazards, and EM stock markets like Brazil's are performing much worse than those in the developed world. Unless "To the moon, Alice" suddenly becomes a viable export model, there aren't going to be any markets frothy enough to tug the rest of the world into prosperity.

In 2008 there was still room for interest rate cuts, and central banks all sliced with abandon. Have you seen today's interest rates? There ain't much to cut.

What about "quantitative easing?" There may be less appetite for it now, but that doesn't mean central bankers are suddenly going to abandon their diet of counterproductive actions. We probably will see more QE measures, but all they will do is further stoke the corosive inflation that already has people wincing. That extra inflation will leave folks with even less money to spend on, well, anything.

And let's not ignore the psychological component. In 2008, many were caught flat-footed because events they had previously thought to be impossible (US home prices falling, major banks going under) happened again and again. 2008 wasn't that long ago, so those "impossible" shocks are still fresh in people's minds. Consequently, they will act much more urgently to avoid getting buried in the collateral damage of the impossible. This means capital will flee more rapidly at early signs of trouble, making the shockwaves even worse. This might explain why European stock markets have sold off so brutally at every fresh bearish peep out of Greece, Spain, and the like.

Perhaps it is time to coin a new investment phrase: The end is your friend!

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