I really do not like to invest with my gut, but when I was predicting the credit crunch in 2007, it was my gut calling the shots. My portfolio was malfunctioning and that scared and depressed me. I got out and missed the crash.
This Monday I was very unhappy with the situation as I was writing my Sukuk piece. The question was, Depression at my end, or at the stock markets end. Two year olds think the world revolves around them and it’s a trap to imagine your mood is anyway coming from the outside, when it might be a piece of strong cheese you had for dinner interfering with your digestion.
So I went for a swim, deciding that if I still felt that bad about the markets afterward I would clear the desks. That was an expensive swim! However by Friday morning, having watched the Thursday rout, tick by tick, I was out. Singed but not toasted.
Selling a lovingly bought portfolio is like divorcing a wife for unreasonable behaviour. As you tramp down the road there is always regret, always the thought that perhaps if you held on for a little longer things might go right.
What a difference a few hours make. S&P has thrown a grenade into the bunker of the world economy.
The ramifications simply do not compute.
Occam the priestly mathematician said, when in doubt the simplest answer is the right one. In that case the roof is going to cave in next week. The S&P downgrade is a hammer blow to the ankles of the US and the world economy.
The technical implication for the intertwined world of finance of which the Treasury bond is a core architectural support is unknowable. Will the financial structure collapse or merely take the load with a creak or two?
One has to pray that this news was already known and that Friday’s prices were right, ahead of the announcement. Let’s hope that the deleveraging ahead of the reality of the downgrade means a wave of margin calls on Treasury backed collateral is already provided for.
We can hope that the market makes fools of all the pundits on Monday and is calm.
Yet this is the beginning of a new era in any event.
The economics of the recent era are dead. The first world’s economies have run out of financial road and a giant restructuring will get underway. Whether it is by coercion by the financial markets or ahead of the inevitable day of reckoning is only marginally relevant.
The era of ever growing government taking every increasing share of resources on the back of increasing debt levels has run its course. This is the end game.
There are two ways out. Both are similar.
Austerity and inflation. The right way is to cut government expenditure, down size public sector employment and monetize the debt with target of 7% inflation for 5 or so years. If you were a corporation you would be slashing your overheads and putting up your prices and no one would argue the logic.
The wrong way is Fake Austerity and inflation. Here you do not lay off government employees; you simply scare them into accepting no wage rises. You monetize the debt to make 7% inflation. Real debt shrinks. Budgets head towards balance as the notional income rises and costs stay flatish. However this is the road to long term stagnation. People in the public sector do not make wealth or jobs, they reallocate wealth made in the private sector. A person taken from the field and put into a department of agricultural turns a person from an asset creating income, into a liability generating costs. Growing the public sectors not only sucks financial resources from wealth creation sector, it drains productive people from the wealth creating part of the economy too.
The ‘Lafter curve’ shows how there is an equilibrium point for tax, where too much or two little tax lowers the amount of total tax collected. There is an optimal tax level to maximise tax income. The same type of curve applies to government and economic strength. To little or two much government spoils the economic picture. There is too much in the west and we have now experiencing the comeuppance of this.
Spot the winners in the world economy; they are the countries who are deregulating. Spot the losers. They are the countries piling on new chapters to the rule book.
To get back in balance, the developed countries need more people making wealth and less shuffling it around. They need to get their trade balances, balancing.
The downgrade is the dawn of a new era. The west will be restructured. Let’s hope there is the vision to get the job down actively, rather than passively where the market does it piece by piece.
If the market has to burn everything to the ground to get the west to create a sustainable economic model, it will. The market has no emotions like remorse, it cannot be beaten, it does not stop until there is equilibrium. If governments do not face up to reality that state downsizing is here, the process will be a long drawn out and excruciatingly painful one.
So it might seem ironic, that if it crashes in the weeks ahead, I will be buying back in. One thing is for sure, the market will go on and the game will re-commence.