Slowly Turning the Ship of State (of mind)

This morning we awoke to the news that the U.S. Senate had rejected the automotive industry's pleas for a rescue package. It is difficult to imagine a more definitive and negative headline that is yet to come than "General Motors Files for Bankruptcy." Afterall, what is good for General Bullmoose is good for the USA. I think such a headline must come and should come.

Clearly the failure of the TARP package to banks has colored the attitude of enough senators that carte blanche is not in the cards this time. Who can blame them? The money provided to financial institutions as a quick fix has certainly shored up their balance sheets but as of yet done nothing to goose economic activity. Banks are not lending. Per Federal Reserve data on September 10th, banks held $2 Billion in reserves excess to requirements, essentially nothing. Two months later, November 19th data shows they have $600 Billion in excess reserves. In other words not much is moving. At least one of the two basic conditions of lending is missing apparently.

Banks must feel strong enough to lend, and they must feel their customers are strong enough to pay back the loan. Earlier this week fully one half of the issued debt of U.S. corporations is rated lower than investment grade, junk. It would seem that confidence to let much of that $600 Billion stroll out the door assured that it, plus interest, will come back is lacking still.

I have until this year been in the camp of those who felt money supply was the font of all inflation. Clearly that is only half of the picture and is the combination of money supply AND credit. Currently as money supply soars courtesy of the Fed, destruction of credit is happening even faster. Until credit flows once again we are in a net deflationary environment. The question is for investors, for how long and what do we do in the meantime.

The nation has little option now but to provide, in the public sector, fiscal stimulus. But in a note of optimism, not my generally view, if we as a nation can embrace the idea that it is not a government imposed action, but a public, national call to action we will prevail. The United States has had a history of rising to its greatest challenges. This will be one of them.

A few months ago my son said to me, "its not often I can say I've seen you be too optimistic about the market. This time you weren't pessimistic enough." Ouch! But like the ship of state, I think it is time to begin slowly turning the state of mind.
It won't be easy and the strategies slightly different but we should be looking at beginning to buy into moments of fear.

John Barnyak
President