By Neil Reynolds
Harry Koza figured that the market crash of 2008 was coming when U.S. banks started to write 110 per cent loan-to-value mortgages. This, he said, was the financial equivalent of “running with scissors.” He figured the crash was imminent when California licensed 500,000 new real estate agents in a single year. In other words, he read the signs. When the housing bubble burst, he surveyed “the wreckage of the worst credit mania in history” and figured that the next mania was already taking shape: the great stimulus mania.
Mr. Koza, senior market analyst for Thomson Reuters in Toronto, concedes that he can sound a bit pessimistic. (He once said that he regarded economist Nouriel Roubini – the celebrated “Dr. Doom” – as “kind of a Pollyanna.”) But if so, Mr. Koza says, that’s where the signs directed him. And he is a serious student of signs. It was early in 2009, in a paper he wrote for the Halifax-based Atlantic Institute for Market Studies (AIMS), that he anticipated the next mania.
To understand the future, Mr. Koza wrote, you need to appreciate the fact that people relive the same Master Mania – “like Bill Murray in Groundhog Day” – over and over again, though, perhaps, with progressively darker consequences. This mania rests on the assumption that governments can reverse the business cycle. “They can’t,” Mr. Koza wrote. “[Yet] each crisis is met with the same policy prescriptions that begat the last bubble and that will beget the next one.”
“The same folk that helped create the mess are now vowing to cure it,” he said, “by doing even more of the stuff that created the problem in the first place.” In other words, the solution to excessive debt is more debt.
Mr. Koza enumerated the easy-money credit bubbles of the last generation, each one coming fast on the heels of the one before. Since 1980, he said, nine credit bubbles had burst: (1) the LDC (less-developed country) crisis of 1983; (2) the crash of 1987; (3) the S&L crisis of 1989; (4) the Japanese bubble of 1990; (5) the Mexican bubble of 1994; (6) the “Asian contagion” of 1997; (7) the LTCM (Long-Term Capital Management) crisis of 1998; (8) the “tech wreck” of 2000; and finally (9) The great debt bubble of 2006 – and beyond.
Were these crises the product of market failure? Mr. Koza thought not. He cited one sign that strongly suggested otherwise: the ratio of private sector income (wages, earnings, dividends) compared with public sector income. Before the Great Depression, the ratio was 12:1. During the New Deal, the ratio was 5:1. During the debt bubble, the ratio was 3:1. What would the ratio be in the days ahead? Would it be 2:1? Or 1:1? Or worse? Mr. Koza speculated that it would soon be 1:3 – the reverse of the ratio only five years earlier. One day soon, he said, the public sector would dwarf the private sector.
“Governments seem to view a recession as a pause in a never-ending pattern of economic growth, a pause which they are compelled to attempt to shorten,” Mr. Koza wrote. “But a recession is, in fact, a time when excess debt is wrung out of an oversaturated economy. Bailouts, subsidies and government fiscal stimulus programs retard this process.”
By consensus now, the U.S. Federal Reserve has done almost as much damage as it can do. In 2008-09, it injected $1.7-trillion (U.S.) in quantitative easing (euphemistically designated Monopoly money, really) into the global economy. This was QE1. In 2010-11, it injected another $600-billion: QE2. Now Fed chairman Ben Bernanke is apparently contemplating another round, QE3. This time, the markets are more skeptical. Morgan Stanley’s Stephen Roach neatly expressed this sober consensus the other day: “QE1 didn’t work,” he told CNBC. “QE2 didn’t work. QE3 will not work. And QE12 will not work.”
Even The Economist, an advocate of stimulus spending and QE manipulation, agrees: “Governments in the rich world,” the magazine said, “have painted themselves into a corner.” Harry Koza read the signs perfectly two years ago. He was right: The world didn’t need more money. It needed less debt. Mr. Koza, master semiotician, gave good advice: Stop. Let it be.