My friend works at a big European bank. Last month, the government took it over.
My friend is in the funding department. Basically, his job is to bring in the money the bank uses to make its mortgage loans. But now the bank is nationalized and out of business. Obviously, there's nothing for his department to do.
He says they all sit around surfing the web all day.
(I spoke to him the other day. He was taking the day off to spend it on the couch, which is why we were able to have this conversation.)
My friend says the government wants to fire most of his bank's employees... but European law won't allow that until next spring. So until then, my friend will be paid for watching Seinfeld reruns on YouTube.
Recessions should be good for the economy. They fix the mistakes investors and businesspeople made in the boom. Consumers cut back on spending and build up savings again. Businesses lower prices to bring consumers back into the market. Liquidations release money from bad investments and make it available for new production. Employees work harder because they're afraid of losing their jobs. Companies strive to improve their products and their strategies... or they go out of business.
And above all, people who were prudent during the boom can now pick up bargains. Balance restores itself, and the economy can increase production.
But when government intervenes in the market, it denies the economy of these benefits. Waste results. The recession lasts longer.
We can see this clearly at my friend's firm...
For one thing, the government will keep paying my friend and his staff for the next six months, even though they aren't doing any work. My friend's not creating any wealth. And he won't look for a new job until the government fires him. Meanwhile, he delays cutting his living expenses and saving more money.
And what about all the loans the government took over when they nationalized his bank's portfolio? The bank shouldn't have made these mortgages and business loans in the first place. The market needs to liquidate these loans, but the government's intervention stops this. So house prices don't correct to their true levels.
In other words, the malinvestment lingers.
For the past 50 years, malinvestment hasn't mattered. That's because governments have cranked up inflation every time a recession came along. Essentially, governments produce a boom to escape from recession.
Artificial booms are bad for the economy. They saddle it with debt. They misdirect consumption and production. When later recessions hit, businesses find themselves stuck with even more redundant capacity, inventory, and workers. And inflationary booms destroy the value of money, so people favor consumption over saving.
Right now, governments all over the world are trying to create an artificial boom. They're pumping money into the system, propping up failed insurance, banking, and auto businesses. This weekend, China announced a $586 billion infrastructure spending package to reignite its economy.
The big question everyone's asking is, will world governments be able to reignite the credit bubble?
Here's the answer: The market's desire to liquidate investment mistakes is too strong this time. We've hit the wall. The credit bubble can't be inflated anymore. I expect prices to fall in all assets that were built on credit... And right now, that means everything.
So at this point, I'm focusing on investments that are popular in depressions. That's gold, short-term T-bills, cash, and the highest quality dividend-paying businesses. The next bubble will be in safe investments.
Good investing,
Tom
