Archive for March 11th, 2009

As I mentioned last week, I expect the market to find a temporary bottom at some point this year and to stage a significant rally. However, I expect that this rally will prove to be a bear trap, as the market will then fall far more to find its true bottom a couple of years from now.

I don’t base this prediction on any sort of economic theory, but rather on history. Prior to the Federal Reserve Act of 1913, economic contractions were short and violent affairs. The Panic of 1907, for instance, was over and done with in a single year. The panic spelled the end of the Knickerbocker Trust Corporation, and many small regional banks failed and wiped out their depositors. This kind of “liquidation” of struggling companies was viewed as a necessary evil back then. No one likes liquidation, but it does its work quickly.

Things are different these days. John Maynard Keynes came along and theorized that all economic downturns were caused by “insufficient demand.” He argued that politicians needed to juice the economy with easy money to get consumers spending again. The fact that Keynes’s theory is nothing more than math piled on top of a foundation that’s part conjecture, and part shaky definitions, did not stop it from becoming popular. Similarly, the fact that Keynes’s prescription of juicing the economy with easy money does not seem to actually prevent recession — but, rather, prolong it, until it becomes far larger and more devastating — has not caused it to since fall from grace. Politicians get elected on promises to give money to their supporters and Keynes’s theory makes it their primary mission to do so.

This is why Keynesianism never goes out of style. Read the rest of this entry »