Nouriel Roubini and Marc Faber are well known bears, but that fact has not prevented them from being largely right of late. And since the events of the last few weeks have been particularly nerve-wracking, the US media has taken to focusing on the more soothing aspects of news developments, to the extent they can be found (by contrast, the Financial Times assumes its readers have stronger constitutions).
Both saw the Fed’s moves of last Friday, its discount rate cut and the announcement that it stood ready to make a Fed funds rate cut if markets did not stabilize, as putting a band-aid on gangrene.
First, from Roubini, who sees the problems affecting the financial markets as deep-seated and in many ways beyond the Fed’s reach:
Will the Fed be able to rescue the economy and avoid the hard landing? This is quite unlikely in my view.
First, as argued here before we are facing an insolvency crisis for many agents in the economy, not just a liquidity crunch. Given the serious insolvency – rather than just illiquidity- among many economic agents (many mortgage-burdened households, dozens of mortgage lenders, many homebuilders, some hedge funds and financial institutions, some distressed corporates) a modest Fed easing in the fall – even a likely 75bps cumulative cut by December – will not make much of the difference as you cannot solve an insolvency problem by throwing liquidity at it. The de-leveraging of a massive Minskian credit bubble has barely started and easy money will not be able to reverse this credit downturn. This is a much more serious credit crisis and crunch than the liquidity crunch around the LTCM near collapse in 1998.
Second, even the currently prices Fed rate cuts will not be able to restore normal conditions in credit and financial markets given the widespread uncertainty about the losses from subprime and other mortgages and given the uncertainty about which institutions are at risk. Equity markets have moderately rallied today but the credit crunch in highly illiquid instruments will remain and keep markets and investors on the hedge. And news of further downgrades, delinquencies, insolvencies and stresses in pockets of markets and in financial institutions will keep investors highly nervous and risk averse.
Third, the economic slowdown is already underway and given the glut of housing, autos and durable goods in the economy the demand for these goods will be relatively insensitive to interest rates. In 2001 and on the Fed aggressively cut the Fed Funds rate, from 6.5% to 1% by 2004; and long rates fell by 200bps in that period; still the 2001 recession was not avoided given the then glut of tech capital goods and real investment fell by 4% of GDP between 2000 and 2004. Once there is a glut of capital goods – then tech good, today housing, autos and consumer durables – Fed easing is like pushing on a string and becomes less effective as it takes time to work out such a glut.
Faber, as reported in Bloomberg, has a simpler thesis: the Fed is trying to validate asset prices, and that effort will fail, leaving a legacy of inflation:
The Federal Reserve’s cut of the interest rate it charges banks was “unjustified” and will create more problems, investor Marc Faber said….
“I think it’s an intervention into the marketplace that is not justified,” said Faber, in an interview from Danang, Vietnam. Injecting more money into the system will “create an additional set of problems at a later date.”….
“They’re driven by asset markets their policies, which is a mistake in the first place,” said Faber, publisher of the monthly newsletter the Gloom, Boom & Doom Report. The housing problems arose in the first place “because of easy monetary policies.”
U.S. stocks are at the beginning of a bear market in which benchmark indexes may fall more than 30 percent, he said in an Aug. 10 interview.
“I’m very critical of central banks,” Faber said in the Aug. 10 interview from Vancouver. “They may bail out the system, but there will be a cost, and the cost will be inflation.”
Faber said today that the dollar isn’t likely to “collapse” as money flows to U.S. currency and yen assets.
“I believe that U.S assets, while they will not make a new high, they will outperform assets in emerging markets for a while,” he said. “There’s a capital outflow from emerging markets into the U.S. and into the yen.”
Faber told investors to bail out of U.S. shares a week before the 1987 Black Monday crash. He correctly predicted in May 2005 that stocks would make little headway that year.