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Stephen Martin
Stephen Martin

Time To Start Up The Helicopter, Ben

September 30, 2008

It has been nearly two years since I submitted an article for publication. The primary reason for this is that I had basically said most of what I wanted to say. I was concerned that I was becoming “a broken record” and a purveyor of doom & gloom.

In more than 12 articles, I outlined my case for concern. I built a theme around four major risks facing the capital markets which I labelled “The Four Horsemen of the Capital Markets”. I was inspired to write these articles because of the growing complacency to risk that I had observed. The Four Horsemen were represented by War, Deflation, Plague and Nationalism. I have defined all of these in detail in previous articles so there is no need to expand on this. In particular, I was “counter-trend” on my views regarding inflation vs. deflation. At the time, my views were quite unpopular.

My deflation argument is unfolding as I anticipated. We now have declining real-estate prices, share prices and commodity prices. Wages and CPI will follow. We are in a classic Kondratieff debt-deflation cycle. The money supply has contracted massively as credit has virtually disappeared. Efforts to “re-liquify” the banking system through traditional methods are ineffective. Attempting to expand credit into the system does not work as long as fear reigns supreme. A bail-out of toxic debt raises moral hazard issues and is a political hot potato.

One solution is to issue a cheque to every man, woman and child that is underwritten by the Federal Reserve. This may be an effective way to “re-liquify” the system. It allows individuals to choose the bank they wish to cash their cheque with. It provides liquidity to banks via the Federal Reserve printing notes equal to the cashed cheques or as a demand deposit on the balance sheet of banks. This will help support the assets and presumably aid in the re-capitalisation of the banks that receive the cheques. It is politically correct as it “re-flates” the economy by putting the money directly into hands of individuals. Furthermore, there should be a capital-gains tax holiday for investment in bank shares held for more than 1 year. This encourages long-term investors in the banking system at the expense of traders and speculators. The banks will have to be regulated more strictly to ensure that the system itself is not put at risk from the unfettered actions of a few. Mark-to-market rules must be re-examined to ensure a rolling average valuation on balance sheets in order to reduce volatility. Banks should be boring and stable as they underpin the financial system on which the whole economy is dependent. The pendulum of de-regulation has swung too far “to the right” and must now swing back “to the left”. However, an over-regulated system will constrain growth and be inefficient. An intelligent balance must be struck. Finally, those large holders of U.S. Dollar foreign currency reserves should be encouraged to participate in the re-capitalization of the banking system.

There is little hope for any growth in the economy until the financial system is stabilised and trust comes back. The longer the policymakers and bureaucrats dither, the greater the depth and breadth of this depression. One particular casualty of a debt deflation in an open global system is a natural rise in nationalism and protectionist sentiment. In fact it has been argued by many that the Great Depression of the Thirties was exacerbated by the introduction of the Smoot-Hawley tariff which sparked a continuous contraction in world trade and ended in a world war. I offer a quote often attributed to Mark Twain: “History does not repeat itself, but it does rhyme”.

About the author:

Stephen Martin
Stephen L. Martin has published articles, studies and research on investments over 20 years and has appeared on national television and radio. He currently works for Fairfax I.S., a private U.K. based investment bank. The views expressed are his own and are not representative of his employer.

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