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Tuesday, 18 March 2008

Bearing the Bad News

by Ben Stein

Let me be the first to agree: The finance news lately is bad.

The collapse of venerable firm Bear Stearns in the past few days has been dazzling. The company was supposed to be worth a bare minimum of $80 per share. It turns out to have been worth one-fortieth of that -- a catastrophe for its employees, whose fortunes lay largely in Bear's stock (a super-good lesson in diversification for everyone).

That a business with a stellar reputation for measuring risk got it so wrong is a bad augury for other Wall Street firms. It turns out that the Street has been run largely as a gigantic casino, only a casino in which the house could lose big.

Waiting for the Other Shoe

Obviously, we're all wondering when the next shoe will drop, or if there will be another one at all.
In this environment, bank lending is curtailed and the legitimate work of Wall Street -- financing business investment -- slows down drastically. This, and not the collapse of Bear, is what will hurt the economy, and affect stock prices in the long run (or the medium run).
There's also an endless torrent of bad news about the falling dollar. Seven years of wild mismanagement of the federal budget by the Bush administration are coming home to roost. Bush, for whom I voted twice, inherited a giant surplus, and turned it into a giant deficit by his greatly excessive tax cuts. The need to finance the deficit has made the United States into the world's beggar, going from door to door with a tin cup.

A Perfect Storm

The need to finance the staggering trade deficit is even more horrific. We borrow close to $1.6 billion a day to feed our cars and air conditioners. These two deficits have simply demolished the value of the dollar. This has led to a self-reinforcing cycle in which oil states demand more dollars to offset the falling dollar and we need to borrow more to pay for those higher prices; this in turn leads to a still lower dollar, higher oil, and on and on.

Then there's the housing correction. Housing prices are falling in every part of the nation except Manhattan, and you can be sure Manhattan will join the ranks as soon as bankers lose their jobs. Homeowners get a bit discouraged when their homes fall in value, and this keeps them from buying at the local department store, which slows down the economy, too.

In other words, there is what some might cal la "perfect storm" of bad news on the economy.

Anti-Depression Tactics

However, as your oldest columnist, let me give you a few words of encouragement:

First, when recessions are building and when economic activity slows, the landscape always looks uniquely bleak. Commentators always say, "This time it's different and this time it's going to be another Great Depression." It isn't going to be another Great Depression, not by a long shot.

The Great Depression was caused by a Federal Reserve deliberately trying to slow down the economy and drastically overshooting its mark over and over again. This time, the Fed is actively stimulating the economy and flooding it with liquidity. To be sure, this effect is damped by the dim mood on Wall Street, but it always eventually gets traction and money starts to spread throughout society.

Unless the Fed is actively seeking to crimp economic activity -- as it did in the late 1970s and early 1980s, when we had the worst postwar recession -- there will not be a genuine depression. There could be a recession and there probably will be, but a real depression, with long-term unemployment over 15 percent, is a most unlikely prospect with a pro-expansion Fed.

Expansion on the Horizon

True, there are those immense federal budget deficits, which undeniably create havoc with our long-term dollar valuation and also create inflation. But in the short-run they're stimulative. They basically borrow from our grandchildren to buy goods and services today, and this is good for us right now.

So to have a serious downturn with a super-stimulative Fed and stimulative fiscal policy would be extremely rare.

Wall Street will suffer, and it will drag down the innocent as well as the guilty for a time. But eventually, the Fed moves will ease the pain for everyone, and people will once again start making money by lending money. Commodities will be a problem, too, but they always move in cycles. This one will come down, too, although it may take a very long time.

Finally, the immense surpluses that the far Eastern states and the petro states generate have to be invested here. There's simply no other market large enough to absorb them, and that, too, will be expansive.

Buy Now, Reap Later

In a word, this is going to be a rocky time for a while. Good people will suffer. But we'll get through it, and there will be no Great Depression in the foreseeable future.

If you have a good, long time horizon, it's time to buy European stocks, emerging markets, even our own market. But don't let yourself get short of liquidity. If you have a few years of cash and bonds on hand, get some stock now while there's blood in the streets. The good times will come back when you least expect them.

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