As I said on Oct. 13,the massive injections of liquidity by governments around the world are beginning to calm the markets. The credit markets, which is all I’ve been paying attention to, are beginning to ease, with three month LIBOR falling to around 4%. This is the first real sign that interbank lending is beginning to take place.
No one should mistake this for a sign that the real economy is out of the woods, but it does mean that the stock market can go back to functioning on real valuations of earnings, not panic and fear. Part of the reason there was such a consistent downdraft in the market for the last two weeks is that tomorrow is the settlement day for the billions of Lehman Bros. Credit Default Swaps. Many hedge funds that wrote swaps on Lehman debt had to raise cash in order to pay up to the mortgage bond holders. With that out of the way, maybe things will settle down for a while. However the task ahead of us is great. Vince Farrell notes the following.
In 1980, total household debt was equal to 50% of Gross Domestic Product (GDP). Today, household debt is about 100% of GDP. Looked at from a different angle, since 1983 debt has grown at a rate of 8.9% a year and GDP at 5.9% (from Jim Grant in the Wall Street Journal). From 1983, debt has grown a total of $55 trillion, while GDP grew by about $11 trillion.
Back in July, I wrote that we would inevitably have to “return to the mean”. To go back to the 1980 level of household debt will be incredibly painful for an economy that is 70% based on consumer spending.