Enzio's Clock

Background

1. Where we are in the current crisis

We remain addicted to Prof. Kindleberger's fantastic anatomy of a crisis, something that we shared with you on in June 2007 and again on 21st January 2008. For your convenience, I am re-printing this here:

"We are so thrilled with Prof. Kindleberger's clarity that we want to show you his cycle yet again. Here is our summary first given you on 8th June, 2007:

"Prof. Kindleberger wrote a marvelous anatomy of a crisis:

o Displacement happens when the economic outlook is altered by changing profit opportunities. (currently: China and India’s emergence is propelling commodities markets as well as corporate profits thanks to improvement in lifestyles)

o A boom ensues. Bank credit and personal credit expands significantly. This results in Adam Smith’s “over trading”: pure speculation, overestimation of profits and excessive gearing step forward. (currently: sub prime lending, exchange traded funds (ETFs) that are based on air). Bubbles occur. Economists define bubbles as “deviations from fundamentals”. Back to my Economic Clock: the only big markets that have such deviations from fundamentals are the USA and Japan. However, the current mania (Mr. Greenspan’s "irrational exuberance") will keep feeding on itself. We are in the latter stage this boom phase now and, excluding America and Japan, there is no bubble – markets are in line with fundamentals, with their respective Economic Time.

o Distress sets in. The smart money starts selling. One event is the tripwire; Prof. Kindleberger calls it a "causa proxima". More recently, for instance, I thought that the sub prime mortgage matter might be such a tripwire to crisis, but I was wrong, alas! He also says that "causa remota" is due to an excess demand for money (ESM). “Revulsion” rears its ugly head: revulsion against commodities or securities leads banks to stop lending on the collateral of such assets.

o Panic sets in. Everyone bolts for the exits. Then, one of three things happens. Either prices fall so lowly that people load back up (currently: that is what February was about), market “circuit breakers” are established, i.e. trading is stopped if certain price limits are reached, or a lender of last resort stabilizes confidence,"

We wrote on 8th June 2007 that "...we are in the latter phases of the boom phase".

Here is what we have been writing of late (we cite bits below in italics and, for your convenience, double-click on the italicized part to read article). Below, we juxtaposition our blathering to Prof. Kindleberger's marvelous framework:

In part III of our recently-concluded mini-series, Stock Markets & Inflation, we suggested that the market will peak this October and then slump for a good year, i.e. "panic" sets in this October and stays stuck throughout 2009. That pattern prediction is based on our analysis of what happened during the past four stagflations.

2. Finance and The Economic Clock™

Hitherto, it seems as if markets have focused on banks' avarice connected to their own assets - that since have morphed into liabilities. So we read about sub-prime and all that, whose price tag we have valued at about $1 trillion in overall losses.

What the market has yet to realize is that the current bout of an excess demand for money is driven by banks: they have flipped from greed(during Kindleberger's "boom" phase) to fear (ever since "distress" set in, and all the more once "panic" embeds itself in peoples' psychology.

The Economist of 17th May 2008 published a useful supplement on banks, "Paradise Lost". Read it if you can! The journalist rhetorically asks why banks are so special? Having provided two reasons (their business model is inherently fragile: losing confidence, people can withdraw their deposits immediately; also, they do so much business with each other that if one -e.g. Bear Stearns - wobbles, so does every other bank), he writes that "The third and most important reason is the role that banks play as the wheel-greasers of the economy...That process has now gone into reverse"...For most (banks), it has meant reducing the size of their balance sheets by selling-off assets or cutting back their lending...if American financial institutions were to end up losing $200 billion, credit to households and companies would contract by a whopping $910 billion. That equates to a drop in real GDP growth of 1.3 percentage points in the following year. If the banks suffer, we all do."

3. What about non-US banks?

Here we have serious worries. With the American banks, the market knows what it does not know; not so in Asia, Europe, Latin America and indeed, Africa! There, regulators have not put guns to the heads of banks and made them come clean, so they have not. Expect ricochets from non-American banks, too.

4. The Economic Time™ in 2009+

All of which spells market gloom as of October and through a large chunk of 2009, and possibly into early 2010. This is because bank lending will intensify America's excess demand for money, and less lending begets an excess supply of goods. In short, expect hefty downward revisions to corporate profits for the next six quarters. That will make markets panic, as Prof. Kindleberger mapped-out so many years ago.

Indeed, Bloomberg reports as follows on yesterday's Wall Street blues as follows:

"May 23 (Bloomberg) -- U.S. stocks fell, extending the market's biggest weekly retreat since February, on concern a worsening housing recession and rising energy costs will prolong the slump in corporate profits."

5. How to Save Money Off This Idea

1. Always ask your financial adviser first.
2. Avoid America's stock market, and particularly its financial sector, including banks, insurers and brokers.