Barton Biggs Turns Bearish

I don't believe that an even more dramatic economic or stock-market apocalypse is nigh, but many, many wise people do, and I must admit I am more worried now than I was a few weeks ago. I have attended two large conferences of global investors in the last few weeks, and it was clear that at both more than half of the participants believed that the Obama administration has stumbled badly, that its programs are too little and too late and that the president's halo is disappearing.

Since late last week, confidence indexes in the U.S., Europe and Japan that had seemed to level out were once again showing growing consumer concern about the economy. The most highly regarded economists and strategists now expect a long, deep, global recession, with stock markets falling another 20 to 30 percent. A vocal hard core warns of years of hard times comparable to the Great Depression at worst or the Japanese lost decade at best.

Here is their argument. The world's governments and central banks are implementing stimulus programs that have fatal flaws. The synchronized collapse in global financial demand was caused by the reckless, speculative expansion of money and credit, and now we are in a vicious supercycle of liquidating debt such as the world has never known. Throwing money at the problem and propping up the greedy banks that created the speculation is, as Jim Walker of Asianomics says, like trying to put out a fire by pouring gasoline on it. The result will be an even bigger, more searing fire. Walker argues that the stimulus programs will only prolong and worsen the credit excesses, and that the massive deficits and reckless expansion of the money supply will unleash hyperinflation, a more painful and socially dangerous threat. Think of Germany's hyperinflation experience in the 1920s or more recently of Brazil's or Zimbabwe's. He is predicting a long, deep, global depression with soaring, paralyzing inflation.

Walker is an economist of the so-called Austrian School. Hayek, Hegel and Schumpeter are its forebears, and they disdain Keynes. The Austrians believe that debt supercycles can only be cured by allowing the world economy to fall into a short but very steep and severe depression, which liquidates the debt, bankrupts the sick banks and companies, and causes soaring unemployment, but also lays the foundations for a new era of healthy growth. They call this process "creative destruction," and they concede the pain will be intense but maintain it will be concentrated over a short period of time. Booms can only be corrected by busts.

George Soros points out that the history of financial panics is that the authorities must move quickly and risk overkill. To do too little means that a crisis develops a momentum of its own, which can result in a death spiral that takes decades to reverse, à la the 1930s. By this logic, Obama's stimulus program does not get enough fiscal adrenalin into the economy's bloodstream fast enough. Soros and others maintain it should have been north, not south, of a trillion dollars and that too much of it won't hit until 2010 and 2011.

In his philosophical moments, Soros says that for several millennia in different civilizations, great cycles of wealth creation have usually lasted about two generations, or 60 years. Inevitably, unequal riches corrupt and create envy, and they are always followed by a generation of enormous wealth destruction. The greatest cycle of wealth creation of all time began after World War II in the late 1940s. He believes it peaked in 2007 and that now the world is in for a generation of wealth destruction that will be very painful. Not a cheery thought.

As for the remedies for the banking system, many wise strategists believe the solution is to be found in the so-called Swedish model. In the early 1990s, Sweden had a huge speculative housing bubble. The Swedes moved aggressively, forcing banks to transfer their toxic loans to a "good bad bank," thus bankrupting most of them. The government then nationalized the remaining banks, installed new managements and cut taxes. The Swedish economy recovered and some years later the nationalized banks were sold back to the public, with the government making a profit. Many were hoping Secretary Timothy Geithner and the Treasury would adopt this model. Instead the Treasury labored with much fanfare and then produced a mouse. Geithner's presentations have been vague and uninspiring.

The bears argue that the Great Depression and the Japanese lost decade were deepened and prolonged by policy errors by the authorities. President Hoover raised taxes; the Bank of Japan raised interest rates and then dillydallied for years. The lesson of Japan is that fiscal stimulus programs alone are not enough. The bank-rescue program will determine the fate of the economy. Bad banks must be nationalized, and the U.S. and Europe should get on with it promptly or we will have our own lost decade and a stock market that falls yet another 25 percent.

These are some of the bear scenarios that are plaguing investors and leading them to believe new lows and a depression lie ahead.