Last week in my Interest Rates Specialty Service I wrote – rather cynically, I might add – that Paulson's bailout plan was, at best, a misguided, misdirected attempt to bolster financial and economic confidence.
Then I was astonished to see that the House had voted the plan down – because I had no faith that our representatives would actually do the right thing. Alas, my newly found faith in Washington was quickly smashed on the rocks of reality after the bailout plan was signed last week. What's more, the Senate found a way to make a bad thing worse – to the tune of an additional $150 billion tucked on to the original $700.
And now, bonds are rocketing as equities are tanking. Bank-to-bank lending has evaporated, credit is drying up, and projections for consumer and business credit quality are dire. The Fed has few bullets left, and the U.S. dollar is forecast to become just a footnote in the history books. It’s all gloom and doom.
But before you fall for this line of reasoning, I would suggest that a bit of perspective is needed. Yes, we are in a deflationary recession (or worse) – something that EWI's CEO Robert Prechter has been warning about – but it’s not just a U.S. deflation. It's a global deflation – or, to put it differently, a global contraction in credit followed by falling asset prices.
And in such an environment, I would suggest that the U.S. is in a better position to weather the downturn.
Global deflation means global recession. Think about that: China and Europe will likely find out that the U.S. household and corporate demand for imports will fall far below the current estimates. That means a reduction in their exports. Also, Europe's financial system is extremely over-leveraged: The average leverage ratio of multinational European banks is, on average, 3 to 5 times greater than that of even the most highly leveraged U.S. commercial back – Citigroup, which stands at just above 19. That has already brought Iceland to the brink of bankruptcy.
All that makes me believe that the Maastricht Treaty, the European Central Bank and the Euro zone in general are structurally unprepared and incapable of coherently dealing with this financial crisis. And I would suggest that as the global decline digs deep, our financial markets could very well exhibit a relative strength surge.
The $700 billion dollar spending ticket is a U.S. taxpayer boondoggle for sure, but this number is just over 1% of the U.S. household net worth, and less than the annual amount the U.S. pays to import oil. That's why, come to think of it, as bad as it may get over here, our financial, service and industrial diversifications would probably make the U.S. dollar and equities a good bet, on a relative strength basis.
This story originally appeared on the October 3 Daily Forecast page for the U.S. 30-year Treasury Bonds in Bill Fox's Interest Rates Specialty Service. (See full menu for EWI's Specialty Services here.) Bill Fox is EWI's Senior Bonds Analyst. He has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional bond traders spread around the globe