Saturday, September 6, 2008

Newton's Third Law

I'm guessing everyone knows Newton's third law of motion. It states for every action there is an opposite and equal reaction. I think we can apply this law to investing and to economics.

Have you ever noticed that for almost every parabolic spike there is a parabolic collapse. Have you noticed that the longer a sector spends at the top of the market the further and harder it falls once it tops out. Take the energy sector for instance. Oil stocks were at the top of every one's list for most of 08. However for the last couple of months they have been one of the worst performing sectors. Commodities soared during the first half of the year. Now they are falling just as fast if not faster.

I've been saying for quite a while that the world is going to suffer through a very serious recession. The more I think about this the more I think I'm going to be wrong. I don't think we are going to fall into a recession, I think we are most likely going to fall into a depression.

Let me explain. First off history has shown that the world suffers a depression about every 70 years. It takes that long to work through a generation of investors so that we have time to forget the mistakes that led to the last one. They are of course massive credit expansion.

So let's take a look at recent history and see if we are heading down that same road. In 98 Greenspan flooded the world with liquidity to stop the bleeding in the financial system brought on by the collapse of LTCM. That gave birth to the largest stock market bubble the world had ever seen. Of course since there is always an equal reaction we then witnessed the total collapse of that bubble. Unfortunately Greenspan and the powers that be were not willing to accept the fact that we needed to take our medicine and let the excesses work their way out of the system. So the FED went on an even bigger liquidity binge in the process inflating the largest real estate and credit bubbles the world had ever seen. Now these bubbles are bursting. So what does Bernanke do? Of course he follows down the same path as Greenspan and floods more liquidity into the system. Since the real estate and credit markets are broken that liquidity went into commodities causing a parabolic spike in energy prices.

We are now on the reaction side of this whole mess. The historic rise will demand a historic fall before this is finally over. I don't see how we can possible cleanse the system of these incredible excesses without a global depression of similar magnitude.

There is no way that oil is going to stop at $100 after the move we just saw from the 07 bottom. There's no way the real estate market is going to bottom in 2 years from the stratospheric levels it reached during the bubble. The last time we witnessed a credit bubble even close to the magnitude of the recent levels was in the 20's. The reaction from that bubble was the Great Depression. There is no way in the world the financials have bottomed in only a little over a year and with only 10 banks so far going belly up.

In the real world there is no Goldilocks. The real world is going to demand full payment for creating the three largest bubbles in history. This is not something that is going to happen over night. It's also not something the government can stop by bailing out FNM & FRE. (The market has known this was coming for months now. It's already priced in). No there is no way to stop what's coming. All the FED can do at this point is continue to make it worse. So far that's exactly what they've done.

It could have stopped with the tech bubble bursting. If the Fed had just let the system work, the casualties would have been limited to stock market investors. Of course they didn't stop there. They created the real estate bubble and credit bubble. At it's high point this bubble affected almost 70% of the US population, not to mention a big part of the global population. When that collapsed they brought everyone on board by spiking commodity prices especially energy and food. Now we are all going to pay for the stupidity of a few people in power who think they can control the global economy. The same people who apparently think that monetary policy comes with no strings attached and that it really is possible to get something for nothing. I've got news for them it's not going to be different this time.

Not only have we come to an end of the fun part of monetary inflation but now we are entering the hangover stage of that party. It was one heck of a party and its going to be one hell of a hang over.