Post-Bailout Blues

First, allow me to apologize for the long silence, but there was serious mulling to be done, and spewing half-baked thoughts during the mulling process is not recommended. There was just too much static to get a good sense of what was going on. When you want to get a sense of the Big Picture, think Taoism.  Tao is usually translated as "the Way", which it is. But Tao as an active force, manifested in our own reality, is better understood as "the Rhythm" of life which, in turn, reveals "the Way". In this context, daily events, often lost in the cacophony of life, are but individual notes of the underlying rhythm. Accordingly, it's sometimes best just to sit tight and listen for the rhythms of life.

So, what the hell happened last week? Is the world going to hell in a hand basket? (No.) Will Urkel convince the nation to validate his narcissism? (Probably.) Recent events have changed our perception of the political and economic landscape. It's probably best to start with the economic scene. Two questions are pertinent: Whither the global economy? And, why is the market still in free-fall after the passage of the bail-out?

The global economic outlook is clouded, at best (which contributes much to the market's volatility). The bears are in the driver's seat at this juncture. Panic in the financial markets is the result. There are strong cases to be made for a short and shallow recession, or a long and brutal global malaise. Heck, two of my favorite economists (Don Luskin and Wayne Angell) can't even agree on whether we're facing an inflationary or deflationary monetary outlook. I'm leaning towards the short-and-shallow scenario, but that's just a hunch, one that no prudent investor would risk his capital on. The fact is that Europe is probably headed for a bumpy ride; their delusions that the financial problems are purely American will soon be tested (indeed, the excesses of some European housing markets make the US look tame). That said, a decline in the euro would be helpfully to the less-competitive, export-driven economies in the euro zone (especially France and Italy). China is slowing down, but that's not a bad thing. The Middle Kingdom's growth rate remains white-hot, and a slow-down reduces the danger of over-heating. India has got some structural issues, but is still growing. Moreover, both nations will be helped by the decline in global commodity prices. Japan is as anemic as ever, but what else is new?

If the bail-out has passed, why is the market still falling? The bail-out was never a panacea for the market ills, merely sand-bags on the regulatory levee. Moreover, the struggle over its passage was merely the most prominent concern of market concerns, but by no means the only one. In brief, the passage of the bill meant that the markets could move on to new subjects of worry and hand-wringing. Fears of how far the financial contagion will spread now dominate. It must be recalled that the financial system is the economic equivalent of both the circulatory and nervous systems rolled into one. When it goes out of whack, the whole body suffers terribly. Fear itself can do a lot of damage, as it infects the decision-making process, starving otherwise healthy industries of financial life-blood.

At this point, the panic has to run its course, and policy-makers have to do their best to limit the damage. Markets tend to lurch between fear and greed (evinced by the fat-tailed distribution of annual market returns). The one bit of good news is that there is a ton of capital sitting on the investment sidelines in the form of cash. The trick will be to convince that capital to return to the markets. That will only happen when we hit bottom.

Speaking of hitting bottom, Obama has profited mightily from the chaos. His economic plan would only make matters worse (assuming he could even implement it), but politics is about perception. People blame the GOP for their economic ills and believe that Obama will improve the situation. McCain's economic illiteracy makes it much worse.