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By Rafil Kroll-Zaidi
Angel investor and iTulip.com founder Eric Janszen contributed to this month’s Forum, “How to Save Capitalism: Fundamental fixes for a collapsing system,” and wrote “The Next Bubble: Priming the markets for tomorrow’s big crash” in the February 2008 Harper’s. Rafil Kroll-Zaidi interviewed Janszen via email; answers have been edited for length and clarity.
1. Is the Dow still inflated?
It is. My Dow target since 2006 has been around 5,000. Here’s why: The impact on the stock market of the 2003–2007 monetary and fiscal reflation was similar to that of the 1933–1937 reflation–except that this most recent reflation was enhanced by real estate asset-price inflation. Sure, by 1937, the stock market had nominally recovered 80 percent of what it lost between 1929 to 1933. But in real, inflation-adjusted terms, it recovered only 50 percent of what it lost.
Today, all of the pricing power that was temporarily injected into the economy with the credit expansion is running in reverse, with across-the-board debt deflation. Soon the dollar will resume its decline relative to commodities (although not currencies) increasing food and energy inflation pressures in the United States, even as unemployment rises and wages deflate.
2. What can we expect from federal intervention?
The government has been trying to manage the debt deflation for over a year, to no avail. The markets are “pricing in” the structural problems of the banking system and financial markets–problems, as I said, that cannot be addressed with ad-hoc and marginal national policies. The entire global financial and monetary system has to be overhauled. This will require immediate and unprecedented cooperation among governments and institutions. But America lacks the global political leadership needed to drive the process.
Time is short. The financial-markets crisis is now spilling over into the real economy. Soon unemployment and other hardships will limit the ability of governments to sell a global bailout package. This is how the first great era of globalism degenerated into political chaos in the 1930s.
The nationalization of the U.S. banking system is a bold step. The markets are pleased, as has been the pattern for government interventions in years past: when interventions are promised, the markets crash up; when the interventions are not delivered, the markets crash down. When the interventions vastly exceed expectations, as with the agreement among governments in the U.S., the U.K., and Europe to purchase shares in leading banks–nationalization in all but name–the stock markets react with manic enthusiasm.
Certainly short-term risks to investors have declined. The markets correctly understand that a functioning credit system is a prerequisite for a modern economy. But getting the credit system working again is like restarting a heart-attack victim’s heart. The underlying cause still has to be addressed, and that takes years, and other organs may fail while the patient is out.
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3. It seems like the whole finance economy was Long-Term Capital Management writ large: basically no one, not even regulators, appreciated just how precarious it all was. How do we create a stable regulatory structure?
The decline in regulation is a symptom of FIRE economy interests (Finance, Insurance, and Real Estate) taking control of the political machinery to increase profitability. But the profitability of the credit industry was a side effect of interest rates falling (after the Volcker Fed raised them to 20 percent). The incursion of the credit industry into every aspect of American life–college tuition, health care–was the result. But it’s worse than that. Manufacturing was financialized. Take the auto industry–a finance manager at one of the Big Three automakers told me, “We used to be a car company that sold financing on the side. Now we are a bank that makes cars.” Look at GM stock in recent days. It’s gotten hammered worse than during the Great Depression, not only because of a coming loss in production profitability but also because of the loss in profits from credit operations that had become such a large part of their operating profits. The regulators have to start over.
4. There have been warnings about how precarious it is for the $63 trillion credit-derivatives market to be bigger than the “world economy.” What are people talking about when they bring up this figure? [MORE . . .]
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