Irrational Pessimism (The financial markets are healing)

SINCE 9/11, A PALL of pessimism covered the U.S. Polls show that between 60 and 85 percent of Americans have believed that the U.S. is in a recession or would go into one the following year. But from September 2001 through August 2008, those polls were wrong.

Nonetheless, the failure of Lehman Brothers, with its ripple effect on money market accounts and confidence in the U.S. banking system, finally made this prognostication a reality. Rather than a prolonged recession, however, or one that is worsening, we’re seeing a temporary “V”-shaped recession caused by a sharp, fear-driven slowdown in the turnover of money, or velocity.

But events are more likely to unfold in a much more positive way. With a “V”-shaped recovery on the way, and corporate earnings unlikely to drop by anywhere as much as the bears believe, it will be the shorts that must capitulate in the months ahead. As a result, a “melt up” in equity values is much more likely than a further “melt down.”

ESSENTIALLY, WHAT THE U.S. is experiencing is a crisis of confidence. The Conference Board’s Consumer Confidence Survey fell to an all-time low of 38 in September, lower than its level in 1980 when inflation rose above 14 percent and unemployment was surging.

This is irrational, but it is understandable because the survey accounts for the period immediately after the President of the United States went on national TV and said people could lose their pensions, jobs, and homes. This was hyperbole designed to gain support for the $700 billion bailout bill.

Financial markets are healing, in part because the government has finally put so much money into them that they can’t help but heal. Moreover, they are healing because the problems at hand were never as bad as many have thought

The culture of cheating is tanking everything. Just like with ENRON, no one is trusting anyone, it’s all corrupt.

The problem is that we are also dealing with a bipartisan culture of corruption. Enron had close business ties with the Bush administration and the Republican Party, just as Goldman Sachs and Fannie Mae were filled with Democrats. Most of Obama's incoming economic advisers are cut from the same cloth as those from the Bush Administration.

This author suffers from the same sort of misguided thinking that led to the attitude among many Republicans that deficits do not matter and that throwing a few trillion dollars at insolvent and mismanaged financial institutions and brokerage firms will cure the problem rather than merely postponing the inevitable. McCain's support for the $700 billion bailout may well have cost him the Presidency, as he went from a virtual dead heat with Obama to underdog status. The classic and Austrian schools of economics rightly teach that increasing the money supply will eventuate in the devaluation of the currency. They also eschew government intervention to thwart the business cycle.

The Obama Administration will be typically Keynesian, meaning that they will throw money at social and economic problems even more than the outgoing administration did, and increase taxes to boot. These measures will thwart recovery and prolong the downturn. However, unless the GOP returns to the free market principles of Goldwater, Taft, and Coolidge, a Republican restoration in 2012 will make little difference.

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