What Greenspan forgot to tell you...

Billmon goes into the details of what's bugging Wall Street. With hard data.

For the financial markets, last week had a ugly feel to it, both on Wall Street and globally. It wasn't a crash, certainly, but also more than just a garden-variety correction. It felt like the preliminary stages of a sea change in sentiment -- the kind that either accompanies the popping of a bubble, or causes it, depending on your economic point of view.

The Dow dropped 420 fast points in the final three days of the week, interrupted by nothing that could be called a significant countertrend rally. This despite positive earnings surprises from both GE and Citigroup.

When the market ignores good news from those two, it's essentially a storm flag for the entire economy, since between them you have a pretty good proxy for GDP -- particularly now that passing electrons with dollar signs attached to them has become such a big part of the U.S. economy. While first quarter earnings may yet be OK, the market is looking further ahead -- and seeing a sharp slowdown in both sales and profits...

...The standard bear case -- as expounded by Roach and others -- sees a creditors' strike as the end game for the current U.S. consumption binge. The bears generally advocate a hefty dose of "tough love" -- higher interest rates, tighter fiscal policy -- to ward off disaster.

I've no doubt that if left on autopilot the current system (i.e. "Bretton Woods II") would lead to a great big debt/dollar crisis -- eventually. At some point, the bubble would simply become too big and too absurd to protect, even for a cartel of Asian central banks. But, given the structural and institutional obstacles to change (both here and abroad) that point might not be reached for years.

Long before then, however, the weight of the global savings glut might bring the U.S. locomotive to a halt -- or even start pulling it backwards. And the "tough love" remedies proposed by the bears, while inevitable in the long run, could make things much worse in the short run, by further sapping global aggregate demand.

Read it all. Follow the links. And think about it.

Stirling Newberry also has a worthwhile post, analyzing why the "New Economy" boom fell short.

The investment deficit and budget deficit together create conditions in which real wages do not increase as quickly and there is less growth in the kind of upwardly mobile employment that people need. This situation also creates incentives for government to tax consumption, both because this reduces the trade deficit, and because the wealthy cannot be taxed. This creates a wages deficit. The wages deficit, in turn, gives people an incentive to borrow more, particularly against their homes. This creates a wealth deficit, with increasing inequality in assets. The solution to the wealth deficit is for people to use gasoline to shop around for better bargains, and to buy homes further from where they work, and in areas that do not have to pay the carrying costs of large metropolitan areas. This means they burn more energy, and this loops back around to the beginning of the cycle. The whole cycle then is:

1. Energy deficit creates trade deficit.
2. Trade deficit creates investment deficit.
3. Investment deficit creates budget deficit.
4. Investment deficit and budget deficit creates wages and wealth deficit.
5. Wages and wealth deficits create pressure to use energy to generate housing wealth, which starts the cycle over again.

Each stage pushes the next along, because at each stage there is a group of people that can benefit by pushing the problem to the next group of people.

It's also good to review Stirling Newberry's explanation why the situation benefits Bu$hCo.