Is the GFC over? And what about the recession?

August 2nd, 2009

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In our previous article, we wrote about the coming looming disaster that will eclipse the Global Financial Crisis (GFC). This prompted one of our readers to ask,

Editor, you believe that the GFC is over?

What about the recession?

We realise that there’s plenty of room for misunderstanding regarding our stand on the GFC. So, we are writing this article in the hope that all misunderstandings will be clarified and also provide a road map to help you understand the big picture.

First, we believe that 2007 will be the year of peak prosperity in the real economy. The decade leading to 2007 was indeed a time of euphoria for many. It is a time of low price inflation, thanks to the massive ramp up of China’s industrial productive capacity, flooding the world with cheaper and cheaper Chinese made products. It is also a time of low interest rates (thanks to Alan Greenspan) and cheap credit (thanks to the advances in ‘innovation’ from Wall Street). Consequently, through the current account deficit of the US, the world was flooded with liquidity to send a high tide of ever-rising asset prices. As we wrote back in June 2007 at Epic, unprecedented inflation,

Today, the world is experiencing an unparalleled inflation of asset prices. This is the first time ever that the world is experiencing asset price inflation in all asset classes (e.g. property, bonds, commodities, stocks and even art!) and in all major nations (e.g. US, China, Japan, Australia, UK, Russia, etc). We will repeat this point again: never before had such a universal scale of asset price inflation ever happened in the entire history of humanity! Today, even artwork is also in a ?bull? market (if you consider artwork as an asset class)!

All these confluence of factors made the world go merry in drunken excesses. But unbeknown to most except the contrarians, the rot was already setting in (see our guide, What causes economic booms and busts?).

Then, as we all know, the GFC struck. Our long-time readers are certainly not caught by that- they’ve been warned as early as January 2007 at Spectre of deflation. The panic culminated in the Panic of 2008 (which ended with a final low in March 2009).

Currently, emboldened by the ‘green shoots’ of recovery, there is another powerful rally in stocks and commodity prices all over the world. Optimism returned, speculations returned and confidence turned up again.

So, is the GFC over?

It depends on what you mean by GFC and which part of the world.

If by “GFC” you mean another panic in scale and intensity as the Panic of 2008, then we believe it is ‘over’ (notice the quotation marks). Statically, the Panic of 2008 resulted in a more oversold condition than the 1987 and 1929 crash. That is, the selling pressure was worse than 1929 and 1987. Therefore, based on statistical probability, another panic that is worse than the Panic of 2008 is unlikely to return for quite a while yet.

Does that mean stock prices will never revisit the March 2009 lows? That depends on how successful the Keynesian reflation attempts (government stimulus, printing of money, bailouts, etc). If deflationary pressures gains the upper hand against governments’ reflationary efforts, then stocks can still drift lower to below the March 2009 low in say, a couple of years time. In such a scenario, this current “green shoots” rally will certainly meet with a major correction- currently, prices are at extremely overbought territory. After that major correction, then can be a counter-rally, than correction than counter-counter-rally (i.e. a saw tooth movement) until the ultimate low. If March 2009 turns out to be the ultimate low, we may end up with indecisive whipsaw movement for quite a while. The stock market may end up hyperinflating if governments are too ‘successful’ (see Can we have a booming stock market with economic calamity?).

So far, we are focusing on the financial markets. The real economy, on the other hand, will continue to grind down slowly, thanks to never-ending government stimulus (see Are governments mad with ?stimulating?? and Preserving jobs at all costs leads to economic stagnation). It is unlikely to fall off the cliff in the same manner as during the Panic of 2008. We remembered someone saying that had the real economy continue to deteriorate that way (i.e. fell off a cliff), the world will return to the stone-age in a few decades time. As the real economy grinds down, we expect price inflation on the street will continue to make life more difficult.

Now, can you see that asset prices in the financial markets and the real economy are walking on two different independent tracks? This observation has yet to be noticed by the mainstream. Many investors still think that rising asset prices imply a recovering economy and falling asset prices imply a deteriorating economy. As we have taken great pains to point out to our readers, asset prices and conditions in the real economy can go in opposite direction (as they are doing right now) for an extended period of time. We are more certain of what will happen to the real economy than what will happen to asset prices.

So, what follows next? We will continue this story in the next article. Keep in tune!

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