Quote from scriabinop23:
Markets can be all terribly wrong.
The credit markets were wrong before this blowup, and they are likely wrong now.
This video makes one good point: markets are great at being wrong. Furthermore, Taleb is contradicting himself by saying with certainty what is going to happen.
Lets look how markets were wrong:
1) Buying subprime for 100c on the dollar.
2) Buying oil at 147 (inflation and supply fear), then 6 months later selling at 42.
3) Shipping rates. Why was everyone so wrong signing drybulk ship leases 1 year ago at 230k/day that now are practically free in comparison?
4) Credit markets are priced to MORE defaults than the great depression right now (yes, this is true). Is this true?
I don't buy that since credit guys are more sophisticated because they are 'professionals', that pricing that results is necessarily the reflection of the truth vs the stock market. Giant mispricings in their markets led to this mess.
My chips are on the reflation bet through increased money supply to offset this credit-induced deflation. Those who still have credit and assets will be rewarded, since a return of economic activity spurred by int. rate policy and fiscal stimulus multiplied * increased money supply = elevated GDP as well as obviously higher prices.
Sorry about double posting.
I always find it sort of funny when people say "markets are wrong". Market participants take into consideration information available at the time they are making decisions. When the information changes, market participants change their decisions. This doesn't mean the market is "wrong". The market is not wrong. The information changes.
Let's see your list:
1.) Subprime loans were mispriced for a myriad of reasons including mistakes by the government sanctioned credit rating agencies, government guarantees on certain mortgages, lack of capital gains tax on houses vs. other assets, and an overly loose monetary policy by the Fed and other central banks around the world.
The unintended consequences of these mostly government attempts to create an outcome it desired, is too many people were lent too much money that will never be paid back.
2.) the $147 oil price reflected demand and supply information at the time and the $42 price reflects supply and demand information now.
3.) Shipping rates. So, you're saying that the market is wrong because it's not clairvoyant? Future shipping rates, like future oil prices, are a best guess by the market based on information known at the time the contract was signed. How is "why was the market wrong about how things will be in the future?" even a valid question?
4.) There may be more defaults than the Great Depression. The GD did not result from an a popping of a bubble and certainly not one that was caused by government meddling in the economy and an overly loose money supply.
An economic fact is that you can only consume as much as you produce. Credit changes the timing of consumption, but it doesn't change the fact that consumption must be paid for with production at some point. The bubble burst because we suddenly realized that even without a recession, we couldn't possibly produce enough to repay the loans we have already taken. Thus, you don't even need a recession for defaults to rise. Add a recession to the mix, and defaults could very well top the number during the GD. Or not. I'm not clairvoyant either, but that is market participants' best guess based on the information available to it now.
The only way to reflate this entire mess is for government to step in and lend money in place of private lenders. But government will be borrowing from foreigners to do it and it will be borrowing against future production. Remember - the bubble burst because we suddenly realized we couldn't produce enough to pay for the consumption that has already occurred. While government doesn't actually create wealth, it is following the pattern of the Great Depression by directly competing with private industry as well as lending to mostly zombie businesses which clearly know how to do only one thing well - destroy wealth. Where do you suppose the money to repay lenders to the U.S. government will come from?
As the borrows too much (the price of CDS on Treasuries is already rising) and more people become reliant on government instead of private industry, creditors will demand a higher interest rate - which the U.S. can't afford. Nervous creditors will pull their money out of Treasuries. That's when we will have a currency crisis characterized by hyper-inflation and asset confiscation by government to pay off creditors. Currency crises happen very fast and without warning.
Except for the "sterilization" policies of the Fed in 1930, which decreased the money supply and precipitated the depression, all of Hoover's and FDR's policies were inflationary. Yet, we didn't recover from the GD in real terms until after WWII. Also, reflating is going to be harder now than then. In the GD, the problem was liquidity. Today, the problem is solvency.
Thus, I'm not betting on reflation. I think we're going to be in a period of deflation and stagnation and the market will bounce around like a maniac - as it does in the bear markets of the 70s's and the 30's.
