The rush and the rout.
Tuesday’s market rout, when the Dow Jones went below the psychological 12 000 barrier and the SP500 lost all the gains for the year was, to paraphrase the always wily Winston Churchill, not the end of partisan drama, or even the beginning of the end of the US fiscal troubles. By all accounts, it is the end of the beginning of a slowly unfolding recession.
Simply put, the drop in personal spending and the anemic performance of manufacturing indexes in the past few days were not a surprise – the latest US GDP numbers indicated that the bulk of the 1.5% savage cut to first quarter growth came from a downward revision to inventory investment, which only meant that retailers took longer to run through their stock of goods. The accounting gimmicks which allow for value creation in financial services, given the differentials between interest paid and earned amidst the Fed’s easy money policy, keeps the current bits of growth in the green. Without a doubt, the real economy is already experiencing a downturn and market guile knows it.
Policymakers in Washington thought the debt deal would unfurl only the sweetest intentions around the world. They were wrong. Financial markets are a beast which leaves little crumbs of deceit… never huge signs of distress. Panic ensues only as the great equaliser, when the sham shines its own naked ugliness upon gentiles and believers alike.
There was not panic on Tuesday but calculation: the real driver was not fear of an apocalyptic US default, until very recently markets were unusually tame. Indeed, they were right: the US bond market comprises more than half of all sovereign debt in circulation, so large market actors were not going to dump a 14 trillion market in one single swoop. To the chagrin of the gullible, if it came to the bare wire and despite Bernanke’s un-assurances, the Fed would have sustained the market. Sure, repos would have gotten more expensive, and some money-market funds would have been rattled by the volatility, but policymakers had options – they just chose to look the other way.
Vexation hung on finer subtleties – the case in point? July 27th, coincidentally one day before the titans of the financial industry sent their letter pleading for a higher debt-ceiling. That day, everything but cash experienced relentless gravity – the risk-on / risk-off dynamics of markets, where investors shift back and forth between “safe” US debt and equities, just broke. Ever since the Great Recession, the correlations between assets have undergone an interesting transformation; you find more assets and classes either strongly correlated positively or negatively and less in between. As good hedges are harder to find, this mindless tug-of-war keeps markets today (somewhat) coordinated against an increasingly bleak and divided backdrop – when an economic downturn in the US is all but certain and with Europe playing a very skilled game of kicking (and juggling) multiple debt cans along the road, un-freezing this mechanism was the real worry.
Investors were not looking for the US government to save itself. This was a manufactured crisis, nothing was going to change in the short-run. Given the current economic malaise, investors only wanted a way out; with a recession coming, solace was needed at any cost. But as we will see in the coming months, the letter of the current agreement as it stands will be just that – filler that will not bring durable solutions. Only a fool will follow such provisions to their natural outcome (namely, a deeper recession). The supposed last-minute bargain will only garnish more fodder for similar battles to be confirmed. Away from flyover country, the real winners are investors who quietly are beginning to unwind and re-think their US positions into new, vantage investments.
Good old Keynes said that in the long run we are all dead – today, given the current circumstances, that awfully rings true in a not-so-distant future about the hapless and the unemployed, all amidst what seems to be fast approaching double-dip recession. But then again, some others will remain rich in the short run, and survive to be rich over the long haul – with new, and perhaps improved, safe-haven assets other than the full faith and credit of the US government.
Eloy Fisher is Research Fellow for the Council for Hemispheric Affairs, a think-tank based in Washington D.C., and a PhD student at The New School for Social Research.