Friday, June 20, 2003

Apparently Paul Krugman has been channeling The General's thoughts. On Wednesday I said
the equity market mini-boom since March is not really based on future expectations. It is based on future wishes but driven by massive amounts of liquidity shot into the system by the Fed and by foreign investors returning those still rather high-value dollars to the US in search of some kind of positive return.
Today Krugman says:
it's hard to find any real news to justify the market's leap. Instead, investors seem to be buying stocks because they are rising � which is pretty much the definition of a bubble.
One might think it stunning that investors learned no lessons from the 2000-03 stock market debacle, but as Ronald Reagan famously said, "there you go again". I think Krugman is being a bit unfair, however, tagging the cause of this latest bubble in investor fears of being left behind. The General points to massive amounts of liquidity in the system instead. Capital has to go somewhere, after all.

One helpful comment at the end of Krugman's piece today concerns the implications of an economic recovery and the record US budget deficit for the stock market:
If and when businesses start borrowing again, they'll have to compete for funds with the federal government, which will be running $400-billion-plus deficits as far as the eye can see. Meanwhile, foreigners won't keep lending us $500 billion each year; in fact, private investment inflows into the United States have already dried up. Oh, and the banana-republic policies now being followed in Washington won't just drive up interest rates; they'll probably generate a full-blown fiscal crisis one of these years. That can't be good for equity prices.
Interest rates can stay ultra-low not only because of Fed policy, but also because there isn't much competition for borrowing. Business just doesn't want to borrow no matter what the rates (unless to buy back their own stocks or speculate on those of others). But when the recovery does come and business does want to borrow, the 800-lb. gorilla called the United States Treasury will be there sucking up every spare dollar in sight and two or three hidden under rocks as well. These budget deficits will have to demand some blood sooner rather than later.

And while it certainly isn't fashionable these days to call the US a "banana republic," considering the financial status of the country, isn't the label apt? When the US was exercising global hegemony in the 1940s-1970s, the US was the world's creditor. Great power comes from being the fellow to whom everybody has to come to get the loans everybody needs. Today it's precisely the other way around. Now the US is the globe's capital vacuum, but can still threaten the world -- not with positive power but with negative power, i.e. the power to fail. This is essentially the power that workers in the former Soviet Union had. There were few rewards in fulfilling the five-year plan, but there were concessions made to those threatening to fail to fulfill it. This "power of the weak" is a dangerous one, however, more like Sampson threatening to pull down the temple upon everyone than any kind of rational quality of leadership or even blatant domination.


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