Saturday, August 7, 2010

If you scare easy or have a weak stomach, don’t read this …

By John Sykes

I have had a sense of some impending disaster, of something really out of whack in this economy. This may be why.

John J. Xenakis in War and Peace and the Law of Mean Reversion:

As I always like to point out, mainstream economists didn’t predict or explain the tech bubble, or why it occurred in 1995 instead of 1985 or 2005. They didn’t predict and can’t explain the real estate bubble, the credit bubble, the credit freeze, the financial crisis, or the worldwide trade and transportation freeze. They can’t explain what’s happening today, and they have no idea what’s coming next year.

imageXenakis then uses one of the few reliable measures of stock values, the price/earnings ratio, to make the point that we are in a massive bubble that will have to end with a “reversion to the mean” of stock prices. Study this graph.

The mean is that blue line. To revert to that mean and make up for the time and distance we have spent above it can only happen with a bubble burst that will take many years and take PE ratios well below the blue line. Xenakis again:

Claiming “this time it’s different” is a fantasy. Just one look at that graph will tell you that we’re headed for the biggest crash in history, much larger than the 1930s crash. This is a mathematical certainty.

At the risk of oversimplifying what Xenakis says, we are going to have to pay for the booms we had by returning to the mean.

The poison that filled every corner of the economy, starting in 1995, was debt. Debt filled the business economy, debt filled the consumer economy, and debt filled the government economy — in America, in Europe, in China, and elsewhere. The poison created consumer products, created jobs, and created a risk-seeking population. It takes as many years to remove the poison as it did to create it.

One obvious sign of this is that trillions of dollars of “toxic assets” are still in financial portfolios around the world at nominal value — without having been “marked to market.” This “deleveraging” process has already taken several years and has hardly begun. It will take much longer than 200 days.

Some will argue that this is old thinking, that tested rules on market behavior can change. Nonsense. At some time you always revert to a mean. The only question is for how long and with how many years of pain.

Read the whole article. His ending isn’t pretty:

The same factors that led to the 2007 credit crunch still exist today, only they’re much worse. Banks that were too big to fail are much bigger. Banksters that screwed and defrauded their customers and clients, so they could pay themselves million dollar bonuses, are still doing so.

From the point of view of Generational Dynamics, the financial crisis has only begun. Once the real crisis occurs, and tens of millions of people lose their jobs and face starvation, a lot of the world will blame their neighbors and the United States. The result won’t be pretty.

This is truly scary ………

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