What Dangers Are Still Lurking Ahead

The Financial World According to Inya” Column
by Inya Ivkovic, MA

I know, I don’t need to beat this “we-are-not-out-of-the-woods-yet” dead horse. Yet, what makes me pick up that bat repeatedly is irrational optimism, too much of it and too often. Don’t get me wrong, I’m basically more of an optimist than a pessimist, but irrational optimism really ups my “worry factor.”

Now, I’m not saying there is no reason for optimism. In the midterm, the U.S. outlook should be fairly optimistic. We went through a financial crisis, we survived credit drying up and we experienced investor exodus towards safety and quality.

However, this rudimentary “cash parking” ended about six months ago. It seems that, these days, the market has found its new equilibrium and its pendulum has stopped swinging violently. Toxic assets seem to have been flushed out and, typically, after such panics as the one we lived through in 2008/2009, the economy tends to make up lost ground relatively quickly. The only wrench thrown into worldwide economies’ wheels — and it is quite a wrench — would be trillions of dollars in budget deficits left in the wake of unprecedented and concerted worldwide economic stimuli that had essentially flooded the global financial systems.

Advertisement

There are other wrenches, too, such as stagflation. With so much debt on the table, there may come a moment when the U.S. Federal Reserve, for example, won’t be able to keep inflation under control. The only way for any central bank to impact inflation is to have a financially healthy government to back it up. But when a government is technically insolvent, inflation is going to happen and there is nothing its central bank can do about it. The worst case scenario would be getting stuck at high price levels with no recourse against them. Unfortunately, that is also quite a plausible scenario.

Making matters worse are potential new defaults happening elsewhere in our globally interconnected economies. Like Iceland before it, Greece appears to be de facto bankrupt, if not de jure. Most governments around the world are suffocating under monstrous amounts of debt, which cannot be easily herded and is likely to lead towards high and distorted taxes, potentially causing unbearable deadweight on the society.

Then there are government tendencies to micromanage and hide behind aggressive policy-making. Proponents of the free market believe that the economy should be left to its own devices. Perhaps there are arguments to be made supporting this thesis, but I cannot shake the possibility that the market being free of any reins is what got us into this mess in the first place. I also don’t have an answer for this one, other than to acknowledge that the U.S. government and the Fed are really stuck between the proverbial rock and a hard place.

If there was any advice to be given to Obama Administration, it would be to stop making reactionary decisions in a panic. Every single thing that has gone wrong with our world most likely cannot be fixed and certainly not within a year. Sometimes being patient and giving time for the dust to settle and raw wounds to heal is the right way to go. Policymakers should also become better listeners, focusing on what economy is trying to “say,” and devising policy that is evidence-based, not panic-based.

I know, I don’t need to beat this “we-are-not-out-of-the-woods-yet” dead horse. Yet, what makes me pick up that bat repeatedly is irrational optimism, too much of it and too often. Don’t get me wrong, I’m basically more of an optimist than a pessimist, but irrational optimism really ups my “worry factor.”

Now, I’m not saying there is no reason for optimism. In the midterm, the U.S. outlook should be fairly optimistic. We went through a financial crisis, we survived credit drying up and we experienced investor exodus towards safety and quality.

However, this rudimentary “cash parking” ended about six months ago. It seems that, these days, the market has found its new equilibrium and its pendulum has stopped swinging violently. Toxic assets seem to have been flushed out and, typically, after such panics as the one we lived through in 2008/2009, the economy tends to make up lost ground relatively quickly. The only wrench thrown into worldwide economies’ wheels — and it is quite a wrench — would be trillions of dollars in budget deficits left in the wake of unprecedented and concerted worldwide economic stimuli that had essentially flooded the global financial systems.

There are other wrenches, too, such as stagflation. With so much debt on the table, there may come a moment when the U.S. Federal Reserve, for example, won’t be able to keep inflation under control. The only way for any central bank to impact inflation is to have a financially healthy government to back it up. But when a
government is technically insolvent, inflation is going to happen and there is nothing its central bank can do about it. The worst case scenario would be getting stuck at high price levels with no recourse against them. Unfortunately, that is also quite a plausible scenario.

Making matters worse are potential new defaults happening elsewhere in our globally interconnected economies. Like Iceland before it, Greece appears to be de facto bankrupt, if not de jure. Most governments around the world are suffocating under monstrous amounts of debt, which cannot be easily herded and is likely to lead towards high and distorted taxes, potentially causing unbearable deadweight on the society.

Then there are government tendencies to micromanage and hide behind aggressive policy-making. Proponents of the free market believe that the economy should be left to its own devices. Perhaps there are arguments to be made supporting this thesis, but I cannot shake the possibility that the market being free of any reins is what got us into this mess in the first place. I also don’t have an answer for this one, other than to acknowledge that the U.S. government and the Fed are really stuck between the proverbial rock and a hard place.

If there was any advice to be given to Obama Administration, it would be to stop making reactionary decisions in a panic. Every single thing that has gone wrong with our world most likely cannot be fixed and certainly not within a year. Sometimes being patient and giving time for the dust to settle and raw wounds to heal is the right way to go. Policymakers should also become better listeners, focusing on what economy is trying to “say,” and devising policy that is evidence-based, not panic-based.