Beware The Cheerleaders

The search is on for a silver lining - see today's NYT (Jan 3, 2009), which managed to juxtapose "Stocks Rally, Will January Be An Omen?" and "Manufacturing Suffering In All Corners" in a feat of considerable irony, to name but one. We'd all do well to reread The Great Crash by JK Galbraith as a reminder of how the desire to see an upturn just around the corner blinded so many of the socalled experts and reporters (the book also has a fine Madoffian cast of crooks and criminals, speculating bankers - and accords leverage a prime role in the crash - a blueprint for the events of 2008...)

Let's not forget that without massive infusions of cash from the Fed and the government, there would be no markets at all for anything except U.S. government bonds. Mortgage rates are only so low because the Fed said it would buy this year's entire net new supply of mortgage-backed securities; I've given up trying to count the number of times a recovery in the commercial paper market - where only highly-rated companies can borrow anyway - has been forecast - it's been on life support for the past three months, and is likely to stay on life support from the Fed for the whole year. The Treasury announced a program Friday that implies it will guarantee any bank's bad debts - along the lines of the Citigroup rescue. The government bond market is wondering who on earth is going to buy $2 trillion of supply - there are already more than $5 trillion outstanding.

The world is coming off a massive debt binge - and yes, it is a global issue: the big export nations were just living off the U.S. consumers' reckless spending. Rebalancing the global economy is going to take much longer than six months - and any recovery in the economy, so necessary for a sound basis to any longer-term uptrend in stocks, is going to be a messy, volatile process. The big difference this time around lies in the interconnectedness of all markets across all regions, and the complete breakdown of the financial transmission mechanisms - trade finance has evaporated. How the wealthy Asian exporters and the large oil exporting nations weather the current storm matters a lot more than it did in the 1980s - they're the ones with current account surpluses that need to be reinvested, but some of them also face very fragile domestic outlooks. The euro doomsayers will be proven wrong, but that doesn't mean there won't be strains in the euro zone, the European Union and neighboring countries. Russia is walking a tightrope, yet again.

Rather than hunting around for silver linings on the basis of one day's trade, we might do better to seriously consider just how much it is going to take to resolve this mess - in terms of global political leadership, government spending and sheer luck.