I think it is high time that the pragmatists rule and the economists step aside. Now, certainly some economists are pragmatists, though they appear to be few and far between.
Self-interested commentators abound, particularly among Wall Street and hedge fund denizens, who are itching for the Federal Reserve and Congress to bail them out (or to provide the means by which they can make the U.S. taxpayer, kind of like those opportunists around the S&L bailout two decades ago). And all too many economists are making the same pronouncements, encouraging the continued reduction in short-term rates to "unlock" the credit markets.
Further, we continue to witness a U.S. citizenry that has little tolerance for pain, U.S. legislators who have little tolerance for declines in their popularity ratings, and an Executive branch that refuses to make the hard, long-term decisions that may be unpopular but would get the U.S. on the road to fiscal prudence. It is a sickening game to be watching from the sidelines and one which I am sure my fellow pragmatists can relate to.
If unlocking the credit markets were the only thing we had to worry about. There is plenty of liquidity out there; it is only that few are willing to part with it while market conditions are so uncertain. When can we expect to see the last of the portfolio write-downs (CDOs, CBOs, leveraged loans and loan commitments, residential and commercial real estate loans, and so on) held by our banks, investment banks and insurance companies? It was once $100 billion, then $200 billion, now $400-$600 billion. Let's call it a trillion. And the problem is that as these losses are announced quarter after quarter, it casts a pall over the entire market, delaying the healing process.
I guarantee you that more (sustainable) fortunes are made in times like these than in boom times, as it takes a certain inner strength and steely resolve to wait until maximum pain is being experienced and then to swoop in and pick up the assets at fire-sale prices. But we're not there yet. Many, if not most economists see a pick-up in the second half of 2008; I'll wager that 2009 is even worse than 2008 for the overall market. But again, I'm not an economist. Please pay no attention to me.
One economist who was vilified and then vindicated is Jan Hatzius, the gentleman from Goldman Sachs (NYSE:GS) who was so rudely taken to task by the twin geniuses, Messrs. Ben Stein and Charles Gasparino. Talking the book? Lacking independent thought? Yeah, right. The only problem with Mr. Hatzius' prognostications is that as negative as they were, they likely weren't negative enough. It is kind of like Nassim Taleb's discussion of black swans. People have a hard time thinking beyond their own experience, beyond their own frame of reference. Who could have predicted the credit bubble would pop as it has and with all the related repercussions? Precious few in the final analysis. And those that did made fortunes off their insight. And more great fortunes will be made in the next few years.
So what to do about today's climate? If I'm Mr. Bernanke I'm turning a deaf ear to all those looking for a bailout and to stop dropping short-term rates. Get some credibility. Defend the dollar. Lowering rates won't help anybody right now except for banks, who won't use the subsidy for credit creation but to slowly rebuild their balance sheets; they will hold term Treasuries and fund short, exactly as they did in the late 1980s/early 1990s. But if the Federal Reserve pursues such a path they'll further damage the dollar, further tarnish the U.S.'s reputation as a financial policy leader, fuel the rise of structural inflation and damage our growth prospects for the future.
But this is just a blip when it comes ot the larger policy issues at hand. That commodities inflation is a megatrend that shows no signs of abating for decades. China and India want their turn to enjoy the lifestyle and the growth we in the U.S. and Western Europe have been experiencing for a century. And they won't be stopped. And this places a huge burden on our supplies of clean water and energy, which have huge environmental implications that are hitting us today and will do so at an increasing rate over the next century.
That U.S. equities are at risk if we don't continue to innovate which means changing our backwards and damaging immigration policies. We are keeping out those whom we most need, the best and brightest that the world has to offer that want to make a home in the U.S. And then there are the mother of all entitlement programs, Social Security and Medicare, which no politician with any brains will take a legitimate crack at solving, preferring to punt the issue to the next generation and the next. Because once you've made it to Congress or the White House you kind of don't want to leave, right? Who cares that without major structural changes the U.S. will cement its role as debtor to the world with little chance of digging ourselves out? Certainly not those of capped teeth, slick talk and fancy Washington addresses.
We've got to get tough and we've got to work together. Everyone needs to sacrifice. This is how the Allies won World War II and this is what we'll need to beat the most insidious of opponents - complacency.