Et Tu, Davos?

In the early 1930’s John Maynard Keynes was asked by a reporter if there were any precedent for what had happened to the world's economy. He replied yes, it lasted four hundred years and was called the Dark Ages.

If there is a difference between the current crisis and that of the 1930’s, a leading candidate is the level of denial by the professional class. Perhaps too many of today’s generation of leaders and pretenders still believe their economics 101 professors who told them a depression could never happen again.

In a trivial sense that may be true. There may not yet be twenty-five percent unemployment and a one third decline in output. But, there are other possibilities just as dire, if not more so. Fear and panic play on many tracks in the global village. No one is ready to throw in the towel quite yet on the free markets and democracy. But still, civil unrest comes easy in a sensitive age. And besides, we are still in the early stages.

Consider Davos, where the intelligentsia of globalism and trade just met. For the true believers of Davos, a gut wrenching crisis like the present is not supposed to happen. They still cannot contemplate worst-case scenarios that could yield one of the great upheavals in human history.

“There’s a ‘Great Gatsby’ quality to Davos,” said Niall Ferguson, a professor of history at Harvard University in Cambridge, Massachusetts, referring to the novel by F. Scott Fitzgerald. “When people look back at this gilded age, I’m sure there will be images of the investment bank parties at Davos, just as people looked back at flappers after the 1920s. People are still in denial.”

Ferguson, author of “The Ascent of Money: A Financial History of the World,” and a first-time Davos delegate, said “There’s a sense of ‘let’s have the party anyway,’ and ‘let’s talk about the post-crisis world,’ as though that could be soon.” (http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=abAA1ieh6wTk )

Perhaps the Davos crowd would do well to recall the words of Aleksandr Herzen, speaking a century ago to a group of anarchist about how to overthrow the czar, “We think we are the doctors. We are the disease.”

Roadmap, what roadmap?

As we travel the winding path of the financial and economic crisis, a recent blog on Seeking Alpha asks: Where are we on the Roadmap? Cam Hui then proceeds to answer:

If history is any guide, given that the U.S. recession began in early 2008, then on average the recession will end in late 2009/early 2010. Reinhart & Rogoff showed that equity prices had an average decline of 55% and the S&P 500 has neared that mark on a peak to trough basis.

This environment suggests that equity markets are in a bottoming, base-building process. We should be prepared for a test or even small breakdown from the lows seen late last year, but the downside is limited. If the average recession ends in late 2009/early 2010, then the timing of the final bottom should occur sometime in 2Q or 3Q 2009.

I’m sorry Cam, but here is a more interesting question: Is there a roadmap? This is not an average decline. It is not even an average nasty recession.

With apologies to Tolstoy, all bull markets resemble one another, each bear market creates misery in its own way.

In terms of timeline, Hugh Hendry from Eclectica suggests a longer period of adjustment. He told CNBC,

Debt of all forms went from a generational low of 110% of GDP in 1974 to 360% of GDP recently. We have supersized everything. In 25 years it will be back at 110% of GDP. That has profound implications on valuations and asset classes. It puts a downward damper on everything.

Closer to the mark is Martin Wolf who opines in a recent blog in the Financial Times that choices made in 2009 will shape the globe’s destiny.

Welcome to 2009. This is a year in which the fate of the world economy will be determined, maybe for generations.

Some entertain hopes that we can restore the globally unbalanced economic growth of the middle years of this decade. They are wrong.

Our choice is only over what will replace it. It is between a better balanced world economy and disintegration. That choice cannot be postponed. It must be made this year.

For those still in denial, this is a sobering trade-off. There is no John Maynard Keynes in the wings, there is no agreed upon strategy that beckons. Myopia and self interest will rule among nations as they always have. Interestingly Wolf does not allow for the most likely outcome, a muddling-through process that will permit extensive disintegration before we achieve a better balanced world economy.

The real question is, can the world and its leaders muddle-through without running the risk of civic unrest in all major countries? Commentators are worried about the risk of civic unrest in China. The real risk is civic unrest in the USA and Europe.
The US in particular is a populace with a low pain threshold. It can no longer fight wars if it means spilling its own blood. Similarly, it is a populace born to spend, it’s own money and that of others. How readily can it learn to save. How long will it tolerate an underperforming economy? Unemployment reached 25 percent in the Great Depression and the country survived. What is the tipping point for the unemployment rate in US and other Western economies? Is it 25 percent or possibly lower, perhaps 10 percent before extremists of left and right, populists and demagogues, emerge on our political doorstep. The real question then is will they be welcomed?