What has the market told us over the past three months? Pretty much what it has been shouting for the past eleven years.
Without additional stimulus and government spending there’s just not enough economic growth to support prices at these levels and to meet current debt obligations.
Slow growth wouldn’t be so bad if it weren’t for the massive amount of debts piled up by individual households, corporations, municipalities and even sovereign governments themselves. The reality is that debt has to be repaid at some point, and for the past thirty years the assumption was that it would be funded out of the growth that the debt itself spawned. More debt equals more spending equals more growth. Whenever there was a bump in the road, the solution was the same: stimulate by increasing spending and lowering interest rates. Again, and again and again.
The reality is that since the early 1980s, much of the economic growth in the U.S. has been fueled by either inflation or debt. While there has been innovation and discovery and infrastructure developments along the way (most notably in the technology arena), overall growth has come at a terrific cost: we must continue to “feed the beast” or it will turn on us in most vicious fashion. Look at the effect in Europe, which has already begun their round of spending cuts with clearly negative outcomes.
Feed the beast. Look at the recent market (and policy) response when it appeared back in early August that there would be no more stimulus (the debt ceiling accord reached mandated $1.5 trillion in cuts and left no room for additional spending increases) – the market priced in a “no new stimulus” model and the results were clear: a 20% market correction in eight weeks time. But the pledge by Bernanke that the Fed stands ready to do more and the testimony from Timothy Geithner that “there’s no way we’re going to let our biggest banks fail” and European banks getting yet another bailout are tacit pledges to keep the game going.
That pledge is powerful, and it’s been enough to offer a sizable lift to the markets in October. The beast is satisfied, for now, but eventually it will get hungry again. When does it end?