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Politics : Welcome to Slider's Dugout

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From: jim_p	4/21/2009 1:46:28 PM
	24 Recommendations Read Replies (2) of 50105

I'd give the markets a 1/3 chance that we test new lows, a 1/3 chance that we re-test the old lows and a 1/3 chance that we have seen the lows and we retrace 1/2-2/3 of the current rally before we go higher. The current downturn will last at least 8-12 years despite any action taken by the Fed and we are in year two of the deleverage process. In a more macro picture, growth/GDP is a function of both energy supply and money supply/growth. Money is cash plus credit which is also increased or decreased by the money multiplier and the velocity of money. Cash in the system is around $2 trillion and credit is around $50 trillion. In other words if you increased the supply of money by 100% or $2 trillion it would only take a 4% reduction in credit to wipe out the effect of printing $2 trillion. In addition this assumes that by printing $2 trillion you can place this money into the system (make new loans to credit worth people). It also assumes that the money multiplier and the velocity of money stay constant. Nothing could be further from the truth on all of these factors. You now have a whole generation of bankers who will never be willing to accept the risks or the leverage that allowed the system to get here in the first place. The opposite conditions will exist for at least the next generation. Banks will only make loans that that they are certain will get repaid and only to the highest credit worthy entities. In addition, the highest credit worthy entities don’t need or want credit. We also have a whole generation of consumers who will never be willing to accept the risks or the leverage of the past due to the shock from the loss of wealth they have just incurred. In addition, credit was 60% banks and 40% commercial paper and CDO's. The CDO market is history and will not come back. What little increase in credit expansion we are seeing in banking is due to the collapse of the other 40% of the credit system. The money multiplier has already fallen by 50% and will stay low for a generation to come. The velocity of money has already fallen from a high of 2.32 to 1.8 and will most like continue to fall closer to 1.25 over the next decade. The increase in the velocity of money over the past decade took place because of increased leverage, the shadow banking system and financial innovations such as the MBS's and CDO's. These trends are on a permanent reversal which will reduce the velocity of money for many years if not decades to come. Another way to look at it is if the Fed could increase its balance sheet by $10 trillion and it would not make any difference to the outcome of the current downturn. The Fed has no control over the velocity of money, the money multiplier, the saving rate or the banks willingness to expand credit or the shell shocked consumer to borrow/consume. Once debt deflation starts from extreme levels the only cure is time and incredible pain on the way down from extreme over leverage to extreme under leverage and there is nothing anyone can do to stop the process. The Fed by its aggressive actions to date has averted a collapse in the system and they can help by keeping interest rates low, but that's about it. I'm back to all cash and plan to day trade the markets until we see another bottoming process most likely this fall. Good luck, Jim

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