Merrill's Contra-Bear Argument

Tyler Durden's picture

Merrill Lynch (excuse me, BofA/ML as they like to put on the lead left side of REIT prospectuses), presents its case for why optimism dominates and all theories voices by perma-bears "have little founding in economic theory or history." What is notable from the below multi-pronged perspective on the definition of the term "recession" is that BofA/ML's entire argument rests on the premise of a fiat currency as taken for granted. Eliminate that, and the construct of imminent recovery from any and every economic cataclysm becomes immediately flawed. Ironically, the only reason there is no mass violence and civil uprisings right now (which would have been the case had RBS and HBOS gone under, an event which according to Bloomberg was mere hours away), is because printing presses the world over went into overdrive with wanton monopoly money (or nightcrawlers as they have been penned elsewhere in the blogosphere) creation (or destruction, depending on your perspective). From BofA/ML, on why permabears are fools:

All you gotta do is act naturally

It is important to realize that in the absence of negative shocks, the economy has a natural tendency to (eventually) return to full employment. After all, the modern, activist anti-recession policies generally didn’t exist before the 1950s. The economy recovered from many recessions in the past without the help of the Fed or fiscal authorities. Economists do not fully agree on the mechanisms (or the speed) of a natural recovery. However, we think the following theories all have some validity:

  • Keynesian: Recessions occur due to a “coordination problem”: a shock hits and causes everyone to pull back on activity for fear that others will be cutting back as well. Recoveries are a reversal of these pullbacks. This is akin to the “feedback loops” view of the cycle.
  • Classical: Recessions cause wages and prices to weaken to the point where demand for workers and products rebounds.
  • Austrian school: A recession is a period of cleansing or “creative destruction,” where less productive industries die but it takes time for more productive industries to be born. Once resources start moving to the more productive sectors, a boom sets in.
  • Financial accelerator model: This is another feedback loop theory. When the economy weakens, lenders tighten lending standards causing further economic weakness, and that in turn causes even tighter lending standards. The opposite happens during recoveries: a better economy makes more people creditworthy, causing more credit and more spending. This is a favorite of Ben Bernanke.
  • Accelerator models: Recessions occur when firms react to weak sales by cutting production even more dramatically, driving inventories lower. The opposite occurs in the recovery: as sales pick up, firms try to boost production to match sales and stop the collapse in inventories.
  • Pent-up demand: A related view is that by the end of recessions, companies and households have delayed many essential purchases—the car is getting rusty, the house needs a new roof, the computer needs updating, the machine tool becomes outdated. This pent-up demand drives spending once a semblance of confidence returns.

The one notable exception to this view is Marxism. In Marxist theory the capitalist world is doomed to ever worsening cycles of boom and bust, culminating in its collapse and the assent of communism. Needless to say, we do not ascribe to this view.

The bottom line: the economy can grow without ever-increasing government stimulus. While policy actions play an important role in many theories of economic recovery, and most economists believe active policy helps the economy recover faster, there are many reasons to expect a natural normalization in economic activity. Extreme perma-bear stories have little founding in economic theory or history.

It needs no pointing out that the current recovery has no analog in history, as it is so much more than a manufacturing recession. To get educated on that, we recommend the BofA/ML gentlemen read the work of their former colleague David Rosenberg. 1950s was not known for a time where several hundred billion in securitizations were rolled out each and every year to profit from the stupidity of the subprime investors (and of Iceland). Our credit recession strikes at the core of the fiat currency system. Ironically, the Marxist view, the one slighted by BofA/ML, is precisely the one that would have been most appropriate if the Fed had not decided to interfere with the biggest wealth transfer in recorded history (from middle to upper class). And the most ironic outcome, is that we may have well skipped the recession part altogether: numerous pundits will attest that America exists in a state of Corporate Communism at this point. So just why again is a Marxist view irrelevant? Oh yes, it is so far below tenured economists (of the BofA/ML cadre) to even consider the alternative that their entire worldview has been flawed from the beginning.

The truth is much simpler: after Lehman fell, the financial system, which relies exclusively on two taken for granted concepts: confidence and trust (which at their core are one), saw itself in an unprecedented $26 trillion hole, as the two core precepts for a functioning fiat economy were pulled, very much like the proverbial rug under the house of cards. The tally of the damage was done by both SIGTARP and former Goldman banker Nomi Prins (attached).



What is the conclusion: the collapse of the liquidity pyramid, the disappearance of securitization, and the near-death experience of a fiat system has had an opportunity cost of $26 trillion, which had to be funded, backstopped and guaranteed by the heart (but not soul cynics would add, as that has already been sold to Satan or Wall Street, whichever comes first) of the currency devaluation system itself: the US Federal Reserve. An opportunity for what? Simply to perpetuate a current broken system which rewards only entities such as the aforementioned BofA/ML (the firm would have been bankrupted 100 times over if it had not been for the relevant parties stepping in at the right time), affording Messrs Harris and Matus (whom we have lots of respect for otherwise) the luxury of spewing such unsubstantiated optimistic drivel even though their paychecks are still guaranteed by the US taxpayer (perhaps they could take their optimistic cheerleader role with a little more humility in this light). And what is the flipside? A global reset: where the debts of every man, woman and child in the US could have been wiped clean (several times over). Of course, that would mean the end of the current banking system as we know it, as all those bank balance sheets have loans as assets, either securitized or in whole, that are intricately tied with the current broken iteration of capitalism (that and waging wars, but that is a topic for another day). This would also include mortgages, which at last count were about $12 trillion in notional. If Obama is so focused on making the home ownership dream a reality, he could have easily accomplished that, and at less than half the cost to the US middle class. After all the latter will be the only one left picking up the pieces when this latest ponzi scheme blows up. Which, like any bubble, it will, sooner or later. However this time the fate of the Fed (in other words America itself) is tied in with that of the bubble. Its burst, when it comes, will be the end of the current paradigm, call it what you will. And what is most unfortunate, is that the BofA/ML Messrs. Harris, Matus, Hanson, Helwing, Bigg and Dutta, are all too well aware of this.