Is monetary medicine enough to heal the market?

There is no quick cure for the disease of excessive debt that has brought the market to its knees. The Fed may have moved to prevent contagion, but it should be some time before markets return to normality.

A thank you to John Authers, who writes the Long View in the Financial Times, for his piece on Saturday 25th August when he quoted from Edward Everett's Mount Vernon Papers, cited in T.E. Burton's Crises and Depressions of 1917:

'If I mistake not, the distress of the year 1857 was produced by an enemy more formidable than hostile armies; by a pestilence more deadly than fever or plague; by a visitation more destructive than the frosts of Spring or the blights of Summer. I believe that it was caused by a mountain load of DEBT.'

1857 was a long time ago and most of the then fatal infectious diseases have since been cured. They would now have us believe that Central Banks have an instant cure for even the disease of excessive debt in the system and it now represents no more than a temporary problem that some optimists believe has already been consigned to history. However, they are overlooking one obvious point which is that the so-called healthy economies of the US, Europe, UK, etc., have largely come about as a result of the debt labyrinth. Financial engineering now lurks in every dark corner ready to morph into a demon and jump out! Even the Bank of China admits to holding $10 billion worth of CDOs it's everywhere!

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'Risk of recession greatest since aftermath of 9/11'

The former US Treasury Secretary, Larry Summers, recently said "It would be far too premature to judge this crisis over". [Like us, he seems to think the rules of the game have changed.] "I would say that the risks of recession are now greater than they have been at any time since the period in the aftermath of 9/11."

Bob Diamond, President of Barclays and Chief Executive of its Investment Banking and Investment Management Divisions, according to John Plender, told the Financial Times that this was not a credit crisis but one of liquidity and confidence clearly he believes the rules of the game have not changed. In John Plender's article, he mentioned Nouriel Roubini, Economics Editor at New York University's Stern School of Business (who we have quoted in this newsletter before). He says that there is a serious credit crunch where the problems of over-stretched homeowners, mortgage lenders, house-builders and highly leveraged financial institutions raise concerns about solvency.

Denis Gartman, a very well known American Money Manager, said this: "The decision to cut the discount rate and to open up collateral to mortgages and the like is not a shot of adrenalin to the economy but is instead a shot of penicillin. That is, the Fed is not moving to expand economic activity; it is a move to stem the spreading of the contagion. If anyone actually believed that the nation's intermediaries are going to go out and suddenly become expansive once again, extending more mortgages at anything other than onerous terms, they are sadly and badly mistaken. Having once been burned, the nation's banks et al shall be like Mark Twain's cat that having once sat on a very hot stove shall not sit on any stove again for they shall all look hot to him".

John Plender, in his article, explained that it is key to understand whether this is a crisis of liquidity or solvency because they require quite different remedies. The first will succumb to monetary medicine which is what everybody is calling for, so they think that is the problem; the second, and much more serious, would require a fiscal solution.

Those who are expecting a return to normality, John Plender says, will be disappointed because normality was actually a freakish bubble, only by recreating a similar bubble could that normality be regained.

Corporate sector not as healthy as it looks

The fact that stock markets have held up better than many would have expected, is largely because of enduring confidence in the corporate sector and falling share prices have triggered share buy-backs.

However, economist Andrew Smithers, argues that corporate balance sheets are not in such good shape, saying the opposite is probably true and this will become quite clear as asset prices continue to fall. Discrepancies, he says, are the difference between national and corporate accounts. National accounts are based on the convention that assets are worth their cost of production, adjusted for inflation and depreciation. Corporate accounts, however, increasingly respond to changes in financial market prices as these are "marked to market".

The world is plagued by use of presentational (selling) skills, "the glass half full or half empty concept". Everything is presented in its very best light to such an extent that it has become the normal thing to do. It is however, a kind of deception to always express matters only in their most favourable light. These clever psychological ways of providing information originated in the salesman's toolbox. A double glazing salesman will do nothing but accentuate the positive benefits of installing the double glazing which is fine because you should expect that and adjust for it, taking all that he says, with a pinch of salt. Your job, as a prospective customer, is to ask the penetrating questions that will unearth the truth of the proposition so that you can make a balanced judgment.

It is quite another thing however when a major company is doing the same thing. The point we think that Andrew Smithers makes is that it is now accepted accountancy practice to prepare financial information regarding the strength of a publicly quoted company businesses in which we might invest, based on the glass only ever being half full.

By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.

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