Elements of Speleology
Posted by Harry Stotle on October 25, 2008
How deep? That is the question. Stock markets have now lost 25 to 30% globally in less than a month, which represents a destruction of nominal wealth of approximately $25 trillion.
Announced bailout packages amount globally to about $3 trillion. The largest portion of such packages is made of temporary loans from central banks and guaranties, as opposed to long term transfers of liquid assets from national treasuries. A significant part has already been used to cover the losses from subprime loans, as well as the immediate consequences of Lehman’s failure under the double form of defaulting receivables and defaulting Credit default swaps. Assuming the packages can be doubled in size (which is probably the upper limit before entering into stormy monetary waters), they cannot cover the reasonably expected defaults within remaining CDS net positions ($ 37 billion). If we add to theses amounts the destruction of nominal wealth in real estate to be expected over the next 6 months (perhaps 30 % globally) and in other real assets such as mineral reserves, it is hard to imagine how governments could reflate the system at the appropriate level fast enough to avoid a depression.
If stock markets are rational they should drop further. More likely, some cash-holders will start believing they are soon reaching the levels of new opportunities for a reentry into the market, triggering volatile rallies, yet unable to steadily reverse the trend at least for a while.
Obviously the world economy will be craving for a recovery and there is little limit to what can be invented in terms of money creation to soothe social injuries and calm down unrest. Risky times, by all means.
This is how the world goes
nntaleb said
Hi there
It was great meeting you last week in Paris. I like the comment “it is not going to be very tough… just 80% lower for a start”.
Ciao,
Nassim of Amioun
sonofbatuta said
Excellent and sobering series of posts by Harry Stotle. We are seeing the begining of social unrest globally as the ‘average’ person begins to realize that there is less in their pension, their stock option plan and in the value of their homes. In the US a looming problem of unfunded pension funds is looming and pensioners will become increasingly agitated and vocal that this hole in their supposedly safe retirement plans are funded. The buck will be passed around with increased tensions created between states, federal authorites and the pension plans play out as to where and from whom such money can come from. Even in oil rich kuwait people have taken to demonstrating to demand government intervention to shore up local stock markets. democratic countries western countries will face bigger problems as they cannot resort to repression, cannot appease everyone and simply do not have the required reserves to through money at these social problems.
I am curious to what Harry Stotle in saying ‘there is little limit to what can be invented in terms of money creation to soothe social injuries and calm down unres’?
harristotle said
Sonofobatuta is tackling the most painful issue.
Before the end of the deflationary process, and after having exhausted the current resources of national as well as international treasuries (IMF), after central banks have lowered interests rates to zero or even to negative, we’ll start recreating public deficits and printing money to fill the huge remaining gap between existing public means and the amount of wealth taken out of the economy over the crash.
It is not possible to simply adjust the monetary mass to the new amount of lower priced assets, and limit oneself to moderate monetary injections aiming at fostering a natural growth, for certain categories of assets (e.g. labor) cannot be lowered as much as others.
Theoretically, in a global world with advanced communications and therefore little regional specialization, salaries and pensions should even out. This cannot happen however without the most dire political repercussions: people in the developed world are simply not ready to be paid like the Chinese.
Inflation comes as a necessary consequence.
Inflation, as we are too well aware, is dirty business: each economic zone is tempted by competitive devaluations, trade wars start afresh , pensions get wiped out.
The remedy is another illness, but no one to this day has had a better solution to offer.