Back on the Ledge

On May 6, around 2:30 p.m., Western stock markets went kind of nuts. About a quarter of an hour later, most major indices lost almost 10% of their value, obliterating about one trillion dollars of investors’ wealth in the process. Then, miraculously, stocks bounced back as if nothing had happened. Now referred to as the “flash crash,” it seemed like a super short aberration. Someone’s “fat fingers” sending a massive and erroneous sell order that could have sank the Titanic or a technical glitch that inadvertently converted huge block trades from buys into sells.
Whatever it was, it seemed like a fluke, still warranting the regulators to investigate and impose more stringent market rules to keep them from being unruly. And it would have remained a fluke if only the markets did not fall off the ledge again just two weeks later. “Fat fingers” may have been one factor on May 6, but another factor could have also been a great many investors realizing at the same time that stocks are spectacularly overvalued.Somehow, we ended up on that ledge again, driven by fear and anxiety. Canada’s senior stock market lost seven percent last month, while stock markets in Europe and the U.S. fared even worse, losing 11% in May. Of course, investors are panicked. They painstakingly watched their portfolios crawl out of various depth holes since 2008, only to see them shed value again.Not only equities are losing significant ground. Commodities like oil and copper are also sharply declining, as fears that the weak economic rebound will go in reverse are resurfacing, perhaps even stronger than before. Even the massive European bailouts do not impress anyone nor have they convinced investors around the globe that the Great Recession, Part 2, can be contained, let alone avoided.How could we be back at that dark place again? And so soon? After all, we have been hearing from respectable economists, minus the doctors of doom, that the worst is behind us. Better yet, the classification of the Second Great Depression has been merrily abandoned a few months ago, not even declaring the events that led to the 2008 credit crisis as the Great Recession, but merely as just another downturn.

I wonder what new classifications will have been given to this so-called recovery. I have a few names for it, but I don’t think they would pass my editor’s cutting board. For this recovery has been neither robust nor genuine. In the U.S., jobless claims are on the rise again. The U.S. Conference Board’s index of leading indicators, which estimates future economic trends, has been on the decline again. Deflation is suffocating all life out of prices, threatening a rerun of Japan’s “lost decade” in North America.

To address the question of how we could have ended up back on the ledge, the answer potentially lies in the simple realization that whatever little recovery we may have seen so far has been facilitated by cheap money in the form of the global economic stimuli. It seems that rallies in equity and credit markets could have been artificial and nothing more than a mirage. If that indeed proves to be the case, we could find ourselves hoping for the double-dip “recovery,” not dreading it.

I really don’t believe there is an upside here, so let’s work with the worse-case and the absolutely awful case scenarios. The lesser evil would be the double-dip recovery, or a W-shaped recovery, painful and exhausting, but at least it would have the word “recovery” in its


The worst-case scenario, unfortunately, seems more and more likely to me. When the credit crisis first struck, I still believe it was a mistake to fight mountains of debt with more debt. Instead of bailing out car companies, Wall Street, the housing sector and consumers,
politicians, policymakers and economists should have put their heads together and figured out a way to reduce the massive amounts of debt, not add to them. If only the past couple of years were not election years in a number of developed countries, because that is obviously not the time to sell difficult solutions. As a result, taking on more debt has led to the creation of the new debt crisis.

At the very least, what needs to be done now is to cut government spending radically and to increase taxes. What we could be avoiding, hopefully, are massive sovereign debt defaults around the globe. However, the price is very high, potentially the highest, involving years, perhaps even decades of stagnating economic growth.