Tuesday Could Be Brutal on U.S. & World Markets
On January 2nd I wrote a post:”Entering Financial Hell?” in which I quoted Warren Buffett talking about “derivatives”, like those that have caused the Sub Prime credit crisis: “They are like hell… easy to enter and almost impossible to exit”.
Tomorrow morning might be the morning we find out the answer to my question about financial hell. The selling pressure at the New York Stock Exchange opening bell may be very intense. Especially if there is another day of World panic selling like today before New York opens. Bill Gross’s figure of $500 trillion of derivatives (most of that in borrowed money) gives you an idea of the scale of leverage now being applied like a ton of bricks in a falling elevator. The senior bond holder will get the underlying asset and everyone else will be pounding sand. Those of you who know my work understand that I have been worried about the “cut taxes, borrow and spend” notions put forward by the supply siders in the first Reagan administration for a couple of years publicly. These wacky guys like Larry Kudlow have brought us to this point. From Mike Milken (who financed the Supply Side Revolution) on, this whole notion that borrowed money was more efficient than invested money has poisoned our country’s balance sheet.
Credit is finally a confidence game. And now we have a loss of confidence at the highest levels, because no one really knows how much of the toxic waste leverage really exists. With many of the bond insurers ready to file bankruptcy the default rates could skyrocket. Even with the big public banks, much of it is parked off balance sheet in Enron like “special purpose entities”. As for the Hedge Funds, the size of the derivative holdings is one of the primary reasons they have fought efforts to make their large holdings more transparent (like Mutual Funds).
Buckle your seat belts. Tomorrow could be the start of choppy weather.
The Spanish stock market suffered a “Black Monday” with the 3rd worst day in its history and is leading the falls among the European countries with a -7.54%. The situation is being compared by the Spanish economists to 1987 (the effects of the New York’s crack) and 1991 (the URSS political crisis). The Spanish stock market (IBEX-35) has lost a 16,8% during this month.
I agree that this is a very serious situation. However, I would disagree that tax cuts themselves are to blame. (As one example, I might cite Trabandt and Uhlig’s study that shows that tax results do result in increased governmnet revenue:
http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2006-023.pdf
)
I admit, I didn’t completely understand how you can tie “supply side economics” with deficit spending, something that one tends to equate to demand-side economics. And I think any economist would agree that demand-side is worse (I’m willing to be corrected).
There are many issues at play, most prominently the astounding and gross fiscal negligence of the Bush administration; a senseless and very expensive war; pumping way too much money into the economy, too fast (a major contributor); banking deregulation; and, most importantly, a completely non-existent oversight of lending practices.
Payback’s a bitch.
Alex-I think we are in agreement. The general notion that tax cuts lead automatically to increased government revenues has been pretty much debunked. That is not to say that in good times, revenues can rise even after tax cuts.
We both agree the big problem is fiscal negligience as you so fittingly called it.