By Daniel M. Ryan
A week ago, I was mildly surprised to see the bear market continue despite there being indicators consistent with a near bottom. Instead of a slow-down in the bear's marauding, though, we saw intensification. To put it less detachedly, the Big Bear of '08 went from sacking the garbage bins to kitchen-raiding. There's still worry that the big bruin will exhaust the food and start nibbling on our legs.
The surprise chain continued clanking away on Friday, although Friday's link in this year's October Surprise was an unexpectedly happy one. Last Thursday was close to being a straight repeat of the Friday before October 19, 1987. I was invested in the market back then: like the typical investor, I had expected Friday the 14th to be followed by an exhaustion rally. My opinion changed when I met my father, who asked me to guess what the Dow had done that day. Seeing the look on his face, I guessed that it had dropped 100 points. He shook his head. I then proceeded to ease my foot in my mouth by shaving my guess down to 50 points. He shook his head again, and then told me the real figure: 508 points, a decline of 22.6%. I still remember how I had been told that the Dow had plummeted the equivalent of a mild bear market's worth of decline in one single day.
What surprised much of the world was the Crash of '87 becoming most of the entire bear market itself. The bear of '87 was around for a mere three months. When President Reagan had announced that the underlying economy was still sound, lots of sophisticated people assumed that he had fallen into Herbert Hoover mode: not all of them were liberal. The aftershock of October '87 was the slow, at-times-unbelievable realization that President Reagan had been right.
Thursday night had given the sign that Friday would have been another crash day. After the last-hour cascading drop on Thursday, briefly blocked by a minutes-long relief rally, the Asian markets opened horridly (with the exception of the Hang Seng.) The already-badly-pummeled Nikkei was down more than 10% in the first half-hour of trading. In sympathy, overnight U.S. index futures dropped smartly. A changing-times sign showed up in the commodities market that night, too. In the recent past, oil had been the "panic commodity" for speculators who didn't trust the greenback. Not on Thursday, though; oil kept dropping. That role was assumed by gold and silver. A certain confirmation of that role erupted on Friday afternoon.
Unsurprisingly, the U.S. averages opened with a huge gap-down. Shortly after about 9:40 AM, though, the Friday surprise did start. That fear-opening proved to be the low of the day – for all three averages. It was a close scrape as of about 2 PM, but the 9:40-or-so low proved to be the day's low.
There was a drop in the averages by the end of the day, but it was a pale reflection of last Thursday's ending plummet. As of 3:30 PM, all three averages were solidly up from Thursday's close. The last-minute drop on Friday, from the perspective of a full-day chart, looked more like a selling stampede interrupting an inter-day rally than a bear stampede continuing on its way. At about the time that the averages had turned from negative to positive, both gold and silver had been crushed.
Someone who uses a weekly gauge to measure stock performance isn't likely to be impressed by what, in full apparenthood, looked like yet another sucker rally. Someone who was expecting a flat reprise of October 1987, though, was mightily surprised on Friday.
Government officials in practically all of the OECD countries are still hard at work. The Friday G7 meeting ended with a five-point pledge to stiffen the string so as to make it pushable. Secretary Paulson added a specific by endorsing the U.S. government's use of some of the authorized bailout money to buy stocks in afflicted financial institutions. The Canadian government, in an unprecedented step, pledged to buy up to $25 billion worth of troubled mortgages from Canadian chartered banks.
The Federal Reserve has been far from idle too. As of September 29th's preliminary figure, the M1 money supply's 3-month annualized growth rate has hit double digits: 11.7%. M2's growth rate has also picked up, to 3.5% annualized over the same time period. According to the latest Fed money-supply report, the bulk of M1 growth took place in the demand-deposit category, as well as in checkable deposits held by commercial banks. One glaring, but unsurprising, exception to the checkable-deposit category was the thrift figure. The main category in M2 that grew in the last week of September was small-denomination time deposits. Also unsurprisingly, savings deposits in thrift institutions sank.
The monetary base, as reported by preliminary October 8th figures, has shot up even more. From Sept. 10th to Sept. 24th, the monetary base increased by about 8%. Taking Oct. 8th preliminary figure as accurate, the monetary base went up even more as September rolled over into October: 8.17%. In the last four weeks, the monetary base has shot up by more than 16.8%. For the 12-month period starting from August '07, the base increased by only 2.1%.
During that same September-October four-week period, total borrowings from the Federal Reserve almost doubled. Despite that enthusiasm, the amount of excess reserves almost doubled too. So, the Fed is pushing harder, but the string isn't stiff enough to fully translate a push into a move. There's little need to wonder why there's further credit-market-facilitating measures being contemplated, and implemented, in D.C. Although the money-supply figures do not show any hint of impending deflation – if anything, M2 hints and M1 flatly shows the opposite – the credit market has yet to be engaged in the same way that M1 has been. And, if the latest Fed balance-sheet figures are any indication, the Federal Reserve is beginning to take some of those excess reserves out of the reserve pool.
However, interbank lending rates are beginning to show some sign that the freeze may begin defreezing. The overnight LIBOR rate was an astonishing 5.2% Thursday night. Friday night's rate was a less unreasonable 2.5%, although the one-month and three-month rates have yet to follow suit. The capital market's desire for safety continued unabated as of Friday night: the 1-month U.S. T-bill rate was a miniscule 0.01%. The flight to Treasury-security safety did abate somewhat at the long end, though: instead of Thursday's 3.9%, 30-year T-bills on Friday night were well above 4.1%. These reeds are thin and sparse so far, but they do hint at swamp's end approaching.
Larry Kudlow ended up losing one on Friday. Strongly and repeatedly on CNBC's Thursday-night crash special, he insisted that it would be a bad move for the U.S. Treasury to buy shares in sunk-and-aided financial institutions.
Despite being overruled, his protest was still worthy…although not quite for the reasons that he gave. Although the planned buy-in seems like a step towards finance socialism, the assurance that the U.S. Treasury will only snap up preferred and non-voting common shares is likely to be followed through upon. To put it bluntly, the Treasury is not in it for the control; it's in it for the money.
What we're seeing in D.C. is a more flinty-eyed and less forgiving approach to bailouts. Mommy is slowly morphing into Daddy. Mommy didn't mind if the taxpayers got nothing out of a rescue; Daddy, though, wants the taxpayers to get a compensatory piece of the action. As Secretary Paulson's Friday announcement made clear, Daddy will indeed get a taste of the recovery.
This shift is, of course, motivated by a greater concern for the taxpayer in Washington. It has been decided that the prodigal son seems to rather like being prodigal, and so should pony up some vittles for his next welcome-home party.
This kind of arrangement really isn't socialism. Although it could be described by some as latent fascism, a more accurate term would be mercantilism – specifically, finance mercantilism. If the government has a stake in stricken financial institutions, then obviously government (and the taxpayers) have a mutual interest in seeing recovery take place. Instead of a disinterested favor, institutional interest will be the motivator for the U.S. government to get the credit market moving again. In a nutshell, this bond of mutual interest is the glue of mercantilism: if the government-favored companies succeed, then the public purse benefits alongside them. That's what we're seeing emanating from the U.S. capitol.
There's something to be said for it, as opposed to the "we'll eventually take it back in taxes" rationale. The American tax-paying goose, particularly the prudent goose, is in a pecking mood. In addition, a bailout that struck many U.S. citizens as rank favoritism will be easier to swallow if the Treasury gets more direct reciprocity through share buyouts. The reciprocity connection explains why a lot of plain favoritisms in the old mercantilist days tended to be tolerated by the publics of their time.
Few may know this, but the U.K government's debt-to-GDP ratio on the eve of the Industrial Revolution was much higher than the U.S government's current debt-to-GDP ratio. (I got this factoid from Niall Ferguson's The Cash Nexus.) At the time the Industrial Revolution got rolling, mercantilism was the norm and the mainstream: laissez-faire economic policy wasn't even experienced, let alone defended in print. The normality of mercantilism, plus the slow whittling down of U.K. debt-to-GDP levels through the 18th century, suggest that the Industrial Revolution was tolerated for mercantilistic reasons: "More wealth, more tax. More tax, more for the Treasury." In other words, the U.K. notables at the time had motives that were not dissimilar to Chinese notables' motives for encouraging Chinese growth over the last twenty-five years.
This comparison should indicate what the U.S. government has in its toolkit of the panic room. There are precedents…