The economic outlook is still gloomy

Despite all the joyful prognostications of the optimists, I'm afraid I still don't see much light at the end of the economic tunnel - unless it's an oncoming train, of course! The various rescue packages passed by the US Government aren't addressing the real problems that caused our present mess: in fact, they're perpetuating many of those problems. A few articles in recent days make this point very clear.

Kevin Phillips sees inflation as a real danger in the short to medium term.

"The Democrats have replaced the Republicans as the big benefactors to the financial community," said Kevin Phillips, author of Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism.

"The financial community is donating more to Democrats than ever before and you've got more Democrats in the financial community, creating a very powerful pattern there. I don't think you're going to see the Obama administration and Congress willing to be tough enough in dealing with these things," he told Reuters.

. . .

A year ago, he warned of a the pending explosion of a 25-year "multibubble" that started in the 1980s, when the financial sector accounted for 10 percent to 12 percent of the U.S. economy had started metastasizing into an "arguably crippling" 20 percent to 21 percent by the middle of this decade.

Overleveraging and easy credit was bound to create disaster, he warned.

Phillips assigns much of the blame to former U.S. Treasury Secretary Henry Paulson, but perhaps even more on Federal Reserve Chairman Ben Bernanke, who he calls a "disaster," and his predecessor, Alan Greenspan.

Phillips calls Paulson a Wall Street insider who was looking out for his own, and Bernanke an academic misguidedly trying to refight the 1930s Great Depression. Together they formed the wrong team at the wrong time whose ad hoc approach threw away hundreds of billions of dollars and more than doubled the Fed's balance sheet, he says.

"What you're seeing Bernanke do is he's trying to create a bailout reflationary bubble, which he can't describe as a bubble, just as Greenspan couldn't describe the housing mortgage bubble as a bubble. What we're seeing by Bernanke is a covert attempt to rebubble," Phillips told Reuters.

Nouriel Roubini, the financial 'prophet' who predicted the present crisis years ago, seems to agree.

Nouriel Roubini, a professor at New York University's Stern School of Business and chairman of economic research firm RGE Monitor, said on Tuesday that he expected more dour macroeconomic data and problems in the banking and housing sectors, as well as pressures on consumers.

Big stimulus packages will eventually slow the rate at which economies contract, but that will take time, he added.

"There will be a light at the end of the tunnel somewhere down the line, later rather than sooner," he said at a Toronto news conference, which took place ahead of a Sprott Asset Management event entitled "A Night with the Bears."

Roubini, who made a name for himself by sounding early warning signs about housing bubbles and credit crises, earlier told Canada's BNN television that he still believed the recent market upturn represented a bear market rally, and not a change in sentiment.

. . .

"I am more a realist than a pessimist. I'll be the first one to call for the bottom of this economic contraction, recovery of the market when I see a sustained economic and therefore financial recovery," he said.

Nassim Taleb has listed ten points that, he claims, must be implemented to avoid another economic meltdown like the present crisis. In very abbreviated form, they are:

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks.

5. Counter-balance complexity with simplicity.

6. Do not give children sticks of dynamite, even if they come with a warning. Complex derivatives need to be banned because nobody understands them and few are rational enough to know it.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement.

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself.

Felix Salmon agrees with Taleb, but points out:

Yves Smith calls [Taleb] a must read, and one which she is “highly confident will never be implemented”; she’s right on both counts. But in many ways that’s the strength of this piece: it both must be implemented and can’t be implemented at the same time. Which constitutes a massive policy dilemma.

Taleb’s first principle is that “nothing should ever become too big to fail”. But all economies have too-big-to-fail institutions; they always have, and they always will. Looking at the rest of the list, how on earth do you stop the financial sector from awarding its employees bonuses, or creating complex products? Derivatives are, at heart, bilateral contracts: how can you ban two consenting adults from entering in to such a contract?

Taleb’s big idea, these days, is that we of necessity are moving into a world with vastly less debt than we’ve been used to. I’m not entirely clear on what his timeframe for this is. A quote from my (boss’s boss’s) boss, Tom Glocer, seems germane here: “I’ve met a lot of smart people in my life, and they’re the ones who are eventually always right and they always know where things are going [and] they always underestimate friction in the world and how long it takes to get there.”

Good articles all. I highly recommend clicking on the links and reading them in full, if you're interested in and/or concerned about our economy and where it's going.

Peter