A rally that is both rational and crazy

November 10, 2009

(Jjamessaft1ames Saft is a Reuters columnist. The opinions expressed are his own)

Stocks and other risky assets are rallying around the world this week because the Group of 20 nations said on the weekend they would keep the economic stimulus flowing, a state of events which illustrates where we are and what a very strange place it is.

The G20, the only group of big hitters that matters because it is the only group which includes the Chinese, met in Scotland over the weekend and, as is the way of these things, did very little with immediate consequences for anybody.

In the communique they issued, the Group of 20 finance ministers, after congratulating themselves on the recovery, more or less admitted that the measures we once thought of as heroic are in the process of becoming commonplace.

“However, the recovery is uneven and remains dependent on policy support, and high unemployment is a major concern,” the statement said. “To restore the global economy and financial system to health, we agreed to maintain support for the recovery until it is assured.”

Let me put that in human terms for you:

“We’ve spent untold trillions saving the economy, but, er, we’ve really only saved the financial system and that only to the extent that we keep on saving it. Jobs, well, not so much. We therefore pledge to continue doing this thing that may or may not be working until we are sure that it is.”

Global stock markets then went off on a stonking rally on Monday, which major media attributed to the pledge of continued stimulus. I suppose we shouldn’t dismiss the possibility that the financial media was, as we often do, mistaking coincidence for causation, but professionals were citing it too.

So, what are they promising to do? Will they be able to do it? And why do the risk markets like it so much?

There are at least two aspects to the stimulus – continued easy money from central banks and actual government spending.

The easy money part – low interest rates and unconventional measures – clearly will continue. It will be politically very difficult to raise interest rates while unemployment is still so high, and given the wan nature of the recovery, unemployment will take a long time to fall.

The actual government spending part is a lot harder to bank on, as it were. One reading of the Japanese experience in the 1990s is that their stimulative measures worked but they lost heart and withdrew them for mostly political reasons, thereby bringing on a relapse from which they never really properly recovered.

The politics of another stimulative spending binge will not be easy, especially in the U.S. and especially given populist backlash. That’s not to say more stimulus won’t be needed, it very likely will, but you can’t count on it arriving. Deleveraging takes a long time and we very likely would have been better off just writing the debt down in the first place.


Investors have decided, and I think they are probably right, that so long as the authorities are hell bent on reflation it is foolish to get in the way.

As analyst David Merkel has pointed out, the statement of the Federal Reserve meeting, released last week, characterized financial markets as “roughly unchanged” since they last met in September, revealing that they pay far more attention to equity markets than debt markets.

Because of course equity markets were going more or less sideways in October but many of the riskier parts of the debt markets were rallying strongly. Wasn’t this whole crisis, and its expensive fix, supposed to be about “unfreezing credit markets”? Not anymore, apparently.

That is because the Fed realize that they have got to keep equity markets up, indeed have got to force them to rise. It is the only way to float the equity above the debt, make the banks and the holders of debt whole, and allow the financial system to weather the crisis.

There were other options – default, temporary nationalization – but that is not the route we went down. So, within this context the rally makes great sense.

Notice how equity markets have been on a huge tear since last week, going up on news that implied that the Fed would remain on hold for a long time, going up on unemployment rising through 10 percent in the U.S. and, funnily enough, going up on faith that the G20 would stick with stimulus measures.

This brings us to the crazy part. While it may be individually rational for everyone to hitch a ride on the policy train and follow asset prices higher, I would argue that the project is collective folly.

The risks are inflation and a rapidly falling U.S. dollar which leave banks and debtors solvent in nominal terms but not better off. Those risks are best observed now through the dollar, which is falling, and gold, which is at record highs.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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Property taxes, utility bills (you call them rates I think) haven’t changed and the towns and cities haven’t noticed that the bubble burst. In fact the property taxes and utility bills still creep upward due to their own COLA logic. This does not help the consumer who is supposed to be stimulating the economy through big consumer spending. None of this local taxation does anything to stimulate economic activity. It just sucks up income on more or less unproductive efforts. All town projects are really on hold. But it must be nice to work for the local schools or town hall. Talks with my dear old Dad remind me that this is what the Depression was like. You were well off if you worked for the Town or State government – but those days almost sound humane because town or state employees didn’t have contractual cost of living adjustments.

All the towns and cities may be doing is waiting until the dollar has inflated to levels where the assessments seem like they match and make sense again. Our houses won’t be more valuable, they will only sound like they are. But nothing much is selling so I can’t understand how that will ever work. Since the property in towns and cities has dropped appreciably in price and still aren’t selling, how can it ever get back, even with inflation, to the levels before the prices collapsed? There is some increase in the employment here but the wages haven’t risen. A very few more people can now pay their bills but those bills are getting larger. They have invisibly risen dramatically actually, because they are being based on assessments made at the peak of the bubble. But in visible terms they are still also rising.

It’s a little like living in an expanding universe and actually feeling the phenomenon.

Posted by Paul Rosa | Report as abusive

I have often critizied Saft in the past as Mr. Gloom and doom and too negative. Alas, he was correct in the past and I was over optomistic.
This article however is dead on!
Way to go Jim. This makes more sense than anything I’ve read in months!
Your sometimes critical friend in Alaska.
Very nice job,

Posted by Greg | Report as abusive

In the words of Forrest Gump, “stupid is as stupid does.” The equity markets are indeed doing the irrational, and their stupidity will become apparent in the first quarter of ’10 when they realize that holiday sales were a bust due to excessive global unemployment. We will see a slide of at least 15%. But for now, enjoy the stupid ride!

Posted by Steve | Report as abusive

Equity markets may be rising, but if you look at volumn on the Dow it is falling as the market rises!

I am not quite sure of your comment ‘It is the only way to float the equity above the debt, make the banks and the holders of debt whole, and allow the financial system to weather the crisis.’ I assume you are saying that if the banks can have a market value greater than their debt then that is what is being sought. It would make the banks solvent. However, since the banks are allegedly stating unrealistic valuations on their mark to market holdings this makes the whole thing a nonsense as these would be heavily over valued in their balance sheets.It means that investors will be buying into a bank stock which is unrepresentative of the facts: is this really what free markets have come to?

The whole thing is a pack of cards. Many countries will soon have debt levels of over 100% of GDP.This will be unfundable unless they all resort to endless printing, massive inflation or simply default. Of course there is always war. All will be revealled within 18months.

Posted by D Rumsfeld | Report as abusive

From 1900 to now, dollar has lost 97-98% of its value. 1 dollar in 2000 is now worth 75 cents. so the last para is very poignant because nominally we might be better off but our net worth is actually down and people do not realize that.

Posted by spaul | Report as abusive

There’s another way to look at the way the G20 and the new one world economy (ie China and all the rest) are handling this…put a bottom on the free fall from last year and put pretend dollars back into the economy, refueling people’s 401ks and then getting them to spend again ON REAL THINGS, maybe things we make right here in the USA. REAL jobs follow, albeit lower paying ones with peso American $s. It’s La La Land, James. Even in this feeble scenario, it looks a lot better than all the banks defaulting, auto manufactureres folding at once, and unemployment at 30-40%.

Posted by Dave55 | Report as abusive

it looks like there is competition in money printing across the globe. how to stop it ? maybe we should cut the supplies of ink or paper. why is the dollar sliding against the euro when EU is artificial union of countries with very weak or almost bankrupt economies and alll they do is what US does past 40 years ,print and devaluation. At the end its all paper.

Posted by marjan | Report as abusive

A solid piece. Thanks. I think it exceedingly unfortunate that the courage was not found to write off bad debts, force bankruptcies, nationalize if necessary.

The price of cowardice is, as a rule, pretty steep, and likely to prove so in this case.

I agree with your analysis: Having gone down this unfortunate path we are witnessing a classic instance of rational individual behavior manifest as collective folly.

In the immortal words of that great economist, Howard the Duck, ‘This does not bode well.’

Posted by atomikweasel | Report as abusive

Great commentary James, I couldn’t agree more as many of my peers and I have discussed the scenario you have painted for us. It is challenging to the person who calls the emperor on the fact he is not wearing any clothes and I congratulate you on being so bold.

It is challenging to sit by and watch the folly unfold and run to participate in the market as it moves through wave after wave of movement based on irrational reaction to mixed news at best (eg. unemployment still climbing).

I hope that at some time governments move down the path of stopping to prop-up financial institutions with essentially free money and allow a few to be nationalize if only until an orderly restructuring can take place.

Currently I see no incentive for the financial giants who are “too big” fail to change their structure or their behavior.


Posted by Derek Small | Report as abusive

ok dear James, I know all this from march-april this year, but now you and me are not much happy of this original rally, the fats cats that all we know are smiling as usual as they use to be in the past, present and future. Try to arrange some hair inserts like my president Berlusconi on your head just to be more latin lover

Posted by john terrone | Report as abusive

Notice how with all these PROFITS and BONUSES, none of these banking/commodity/financial monstrosities are even thinking of paying off the TRILLIONS in toxic debt that THEY foolishly created.

And NO GOVERNMENT on this earth is even THINKING of making these economic terrorists and thieves to take responsibility for their own actions!


pretty obvious isn’t it? Finance has taken over the Governments of the G20.

Posted by C.D. Walker | Report as abusive

James: I love your column, but haven’t you ever heard of “the trend is your friend” and “don’t fight the tape”.
What the stock market is telling us, is that in 6 months the economy including unemployment will be better than they are today. Case closed.

If I were the Republicans (the Party of No) I wouldn’t be counting my votes in the 2010 mid-term elections just yet.

Posted by judd m. mills | Report as abusive

There is just too much money being ‘printed’ and provided at virtually no interest to large institutions. That money chases all sorts of assets, from stocks to gold, that is why all classes of investments move higher (when the money supply is in balance, the gold price usually moves in the opposite direction of stock prices).
Very little of the ‘stimulus’ money is seen by the small businesses and the working people.
Inflation is already taking its course, the official statistics are clearly inaccurate – conveniently excluding prices that would negatively affect the rosy picture.
If we continue down this path, we might become a third-world country, a nation with a weak currency, an ultra-rich upper class, and a bankrupt middle class.

Posted by Joe Brown | Report as abusive

James, the few big players have a huge pile of money on the side. They either eye the devaluation of the whole pile seating idle in a hostile environment or try safeguarding the value by having chunks played in hopes of attracting new money with the promise of better returns. Overall, the big players hold their part of the bargain, lifting the market quite a bit. Small players know that the game is rigged, but this time, in their favour. Nevertheless, they are nervous no less, since nobody expects an announcement when the game is over. Consequently, they amass whatever gains in liquid assets with low or no return, depriving of capital the end target, the main street. This is a blow to the scope of the whole exercise. Big or small, we all stand to lose.

Posted by M | Report as abusive

No, allow me to put that in humans terms : “We, fellow G20 bankers all, have salvaged at great taxpayer expense the financial system we’ve been sordidly mismanaging [applause!] The taxpayers are getting absolutely nothing in return, which is exactly how our system is designed to function. Should the rabble happen to notice this and protest that There Is No Upturn, we can always argue that they are too stupid to understand the financial system as we have redefined it to the point of uttermost obscurity, for the sake of rescuing our noble economic system. In other words, everything is going as planned. Now, fellow bankers, let’s all have a nice game of golf – remember, it’s deductable!”

Posted by The Bell | Report as abusive

Mr. Saft: Since you posted my first comment I have been able to talk to some of those who have been recently re-hired at the only large employer in town (no names).

The plant fired about 70 people last year who were full time workers with some limited benefits. Health insurance was always an option at the expense of the employee. There was no employer contribution to health insurance at the non unionized plant even before the layoffs. They recently hired back about 69 of those people but as temporary workers (at least according to one person I talked to). No benefits and no increase in pay apparently. Other mills – a paper mill in particular – has been rearranging workers hours where they have longer shifts using fewer people. It did not appear that they are giving overtime pay when three – eight hour shifts are combined to make two, twelve hour shifts.

This is a very graphic portrait of what a shrinking standard of living means. The ground of being for all manufacturing in this country is and will be for the indefinite future, the low wage of workers in the developing countries.

I occurs to me that China could let it’s Yuan appreciate quite a lot and still not loose its ability to undercut global competition. In fact, the stronger yuan will give it more clout to get what it wants cheaper. Mr. Buffet must appreciate this fact. But his purchase of Burlington Northern may only mean that he does not expect the US to experience a revival of manufacturing but to become a third world type of economy where the basic commodities like lumber, coal and food stuffs are harvested to be processed into higher value goods overseas.

The Chinese may eat the coal totally,, and the food imports (in part) but you can be almost certain that the lumber will be coming back here in the form of furniture, dimensional lumber and other components for the building industry – if it ever revives. They don’t build with lumber – they use masonry for most residential and commercial construction. Most of the world uses masonry – reinforced concrete or concrete masonry units, brick and structural tile – for everything.

I suppose, eventually, we will loose the argument about preserving federal forests lands to the lumber industry and they will be raped as well. It will appear to be a luxury and anyone still worried about the health of the natural landscape will be seen as hopelessly out of touch with reality.

A shrinking standard of living is not going to be pretty.
It is not just standards of living as defined by material well being – but quality of life as defined by issues of civil liberties and equal protection under the law that will also be at risk. People who cannot maintain the first will very likely sacrifice the second merely to stay alive. It is conditions like this that can feed the fascist (that is the power of “the people” to bully the population into blind conformity) instincts of so many. China does not offer a heart warming portrait of human rights.

And although I am not an economist – it does not appear that protectionism will offer much support to a falling standard of living. The only large employer in town is owned by a European company. We all wonder how long it will survive if the dollar continues to loose value? Our untrained instincts tell us – not long.

I can’t say that I couldn’t imagine how quickly -The tables could be turned – and with a “made in China” stamp on the bottom at that. But what bothers me most about the discussion in most media here, is the lack of emphasis on maintaining standards of living in anything more than the material sense.

Posted by Paul Rosa | Report as abusive

You are more prolific than Salvador Dali, James. Stonking meaning an artillery stonk ? Let’s forget about interest, with reflation the Fisher Effect nullifies it. What is worrying though, is that individuals and entities are borrowing to deal in equities. Maybe it was not such a bad thing that the banks were made custodians of the stimuli packages after all, rather them than reckless speculators.

Posted by Casper | Report as abusive

As long as the positive sentiment is powerful enough to move the economy, the stock market rally can sustain.
Hopefully the politicians keep their mouths shut. You just need one stupid sentence from them to send the DJIA below 10,000!

Posted by scheng1 | Report as abusive