Commentary: The biggest bear trap in history

We don't have a problem listening to the optimist tunes that "worst part is behind us"- we just don't think it would be wise to actually believe them.

dollar graf 88 224 (photo credit: Bloomberg chart)
dollar graf 88 224
(photo credit: Bloomberg chart)
After almost three months of strong rallying in the world's stock markets, there seems to be some change in the air. More and more experts, including some of the most bearish, are claiming now that the "worst part is behind us." Top regulators, including the chairmen of the Fed and the IMF, sound confident that global economies will start growing again by the end of the year. Politicians in Washington, London and Tokyo are pumping more and more money into the banks, major industries and even to individuals, hoping to revive dead credit markets and crippled economies. The orchestrated effort to convince the public that everything is under control is understandable. There is no doubt that psychology plays a major role in times like these, and that calming the public is a legitimate goal. So we don't have a problem listening to these optimist tunes - we just don't think it would be wise to actually believe them. True, the massive capital injections to the banks - trillions of dollars pumped by central banks and governments - have stabilized the system for the time being. The banks' free fall is showing signs of hitting some kind of bottom. The question is whether they could survive the crash - and even if they could, whether another one is about to occur. Bear in mind that the vast majority of the losses recorded so far by banks are related to the residential housing markets, with all the subprime garbage loans, poisonous financial derivatives and even loans to "prime" borrowers. But that is only one part, not even the biggest, of the huge credit sums the banks so happily pumped in the last few years. What happened to the loans given to the business sector? Commercial real estate? Credit cards? Foreign governments? There are many more trillions of dollars in the banks' balance sheets that are at serious risk. The banks are reluctant to acknowledge them, since they already suffer from a severe capital shortage. The regulators, terrified by the horrible truth hiding in the financial institutions' books, are playing their part by letting the banks overlook the time bomb and by allowing shameful accounting practices, such as the outrageous decision to let the banks write down the value of their own debt without actually buying it from creditors. The politicians are acting like a child playing hide and seek, closing his eyes and believing that no one can see him now. They think that by painting the situation with brighter colors through speeches and faked accounting practices, they can avoid the unavoidable. Instead of using this unique opportunity to enforce new, tough rules on the corrupt financial system, instead of fighting the disease of over-leveraging and basing the entire financial and industrial world on more healthy foundations, the leaders of the world decided to choose the soft and easy solution of inflating economies by printing more money. But brilliant speeches and virtual reports cannot change reality. Neither can money-printing. Ask the Romans - they could tell us a lot about how inflation can kill empires. The reality is that banks in the US are practically ruined. Things are so bad that banks have even stopped foreclosing houses, since they already own millions of homes taken from defaulting borrowers, and they cannot get rid of them. In some cases the bank is willing to settle the debt and leave the property in the owner's hands for 15 cents to the dollar, and most of the borrowers can't pay even that. The reality is that more than half a million people lose their jobs every month. The reality is that businesses are totally halting their purchases and are defaulting on their obligations in staggering numbers. Even the lucky ones who still have jobs are seeing their wages shrink and their net worth collapse, so they have stopped buying. The reality is that what we are seeing now is just the painful reaction to the bursting of the phony credit bubble that enabled us to consume and produce much more than we should have. Take GM as an example. Last week the government took control of the company after pouring in more than $50 billion in cash, just enough for a few more months. But the problem with GM is so much bigger than just a shortage of funds. The problem is that they build big, expensive cars, using a big and expensive labor force, and then try to sell them to customers who suffer from big and expansive debts. The only viable solution to these acute problems is a long and painful process of adjustment to a lower standard of living. The Americans will have to get used to smaller meals, smaller houses and smaller cars - and much smaller levels of debt. So believing that all this could be over after a year and a half seems naive to us. The current rally of the markets, ignited by the government's massive interventions and bailout plans, recalls in many ways the false recovery the US economy recorded in the first half of 1930, right after the market crash in the autumn of '29 and right before the harsh truth revealed itself by the summer of that year. There is a good chance that we are looking at the biggest bear trap in history. This is not to say we can predict the future. What we do know is that in life, there are no miracles and no free meals You don't have to be a genius to understand that if the Fed has tripled its balance in less than a year, meaning it printed two new dollars for every single dollar in notes that existed a year ago - the value of the greenback will plunge. That might ignite a new wave of rising commodity prices and a slide in all US financial assets denominated in dollars. Currency market will be shaken, gold will soar to unimaginable new records, bond and equity markets will collapse and the world will find itself in an even more terrifying spiral of panic. Murphy's Law never seemed as relevant as it does now. So many things can go wrong in today's environment that the best move is to assume they will, rather than hope they won't. Hope is a very powerful thing. We hate to live our lives believing they are only about to get worse. Irrational optimism, wishful thinking and repression are not only common human behaviors, but possibly even define us as species. But don't fall for that. Sometimes you eat the bear, the old saying goes, and sometimes the bear eats you. Right now it seems the odds are in favor of the bear, so stay away from the forest.