We've run out of bubbles

Booms and busts are natural to capitalism, but for years now an irresponsible Fed has interfered with the down cycle. The only choice now may be to let nature take its course.

msn money 1/14/2008
By Bill Fleckenstein

Are the bulls in hibernation?

I'll begin the new year with this comment: There are no bullish interpretations for the stock market's action thus far. This tells us that 2008 will be the year when reality finally overtakes the Goldilocks crowd.

Of course, we should expect the bulls to regale us with stories about a proverbial second-half rebound -- the possibility of which is approximately zero, in my opinion. We should also expect believers in that hypothesis to spark a rally from time to time, based on hopes of surprise interest-rate cuts and on actual cuts.

But their efforts will become progressively less effective. (Anyone seeking a road map to how that might evolve can look at the market's responses to the rate cuts from 2000 through 2002.)

Irresponsible liquidity originally emanating from the Federal Reserve and then-chief Alan Greenspan (a subject I cover thoroughly in my soon-to-be-published book), coupled with reckless acts of deregulation, have created the problem we now face. The country has gone "all in" via the credit-bubble-inspired housing bubble, which is now unwinding.

I do not believe there is a potential bubble left that could bail us out, nor do I believe a bailout should be attempted. Likewise, I do not believe any quick fix exists.

What I do see as the real solution is to let the creative destruction of capitalism finally run its course, after having been held back for a couple of decades.

I know I've said it before, but it bears repeating: Capitalism involves booms and busts. There is a phenomenon known as the business cycle that loosely revolves around those booms and busts. The policies of Greenspan and the Fed suppressed those busts, and "risk" was more or less struck from the lexicon of the English language (while linguists have pronounced "subprime" their word of the year).

If we stop attempting to bypass the creative destruction of capitalism, we will finally be able to bring about a recovery built on a solid foundation instead of the quicksand underlying the 2003-07 "recovery" that was built on the housing mania. Though I would like to think the politicians and the Fed get the message and will let the process play out, I am not going to hold my breath.

Memo to those who would meddle

Indeed, as Stephen Roach wrote in last week's Financial Times (read "America's inflated asset prices must fall"): "The U.S. body politic is . . . underwriting massive liquidity injections that produce another asset bubble and proposing fiscal pump-priming that would depress domestic saving even further. Such actions can only compound the problems that got America into this mess in the first place."

Noting how those actions had suppressed the savings process in this country, Roach commented: "America's aversion toward saving did not appear out of thin air. Waves of asset appreciation -- first equities and, more recently, residential property -- convinced citizens that a new era was at hand. Reinforced by a monstrous bubble of cheap credit, there was little perceived need to save the old-fashioned way -- out of income. Assets became the preferred vehicle of choice. With one bubble begetting another, America's imbalances rose to epic proportions.