No Time to Panic - This Is Not 2008 Again

At times of peril, when all around are panicking, the person who stays calm can see the facts, act prudently, and not merely survive, but prosper. No doubt, readers have heard that before, but this is a good time to remember it.

The markets are behaving like it is 2008 again, but it is simply is not.

The current situation does bare some considerable resemblance in two important ways. A recession is threatened by anemic growth-the man riding a bicycle too slowly-and a fundamental imbalance in demand between Asia and the West-caused by aggressive exchange rate misalignments a U.S. President and European leaders understand but lack the courage to confront.

And, a huge debt overhang-this time sovereign debt in Europe, not private mortgages-threatens the viability of critical financial institutions. European banks hold huge amounts of Italian, Spanish, Portuguese, Greek, and other European government bonds.

With the bond market pressuring Italy and restive about France, it is easy, but wrong, to polemic that Greece is Bear Stearns, Italy is Lehman Brothers and France potentially the next AIG. It is simply not the same.

In 2008, the problem was a massive overhang of poorly understood, faulty mortgage backed securities created and insured by U.S. financial institutions with virtually no reliable collateral. This time the principle debtors are sovereigns with the capacity to tax and restructure debt-if necessary by fiat. Those governments' problems are straightforward and understood, and enjoy the implicit guarantee of the European Central Bank.

Already, the ECB is purchasing the sovereign debt of the Mediterranean states and Portugal, and it will purchase more debt as necessary to supplement fiscal reform to ensure solvency. The ECB may not like it, but like the Fed, it is only as independent as its creators-the sovereigns-will permit.

As an economist, I am fully aware of the consequences for moral hazard and long term growth of socializing bank losses. Too much harm has already been done on this side of the pond by the bailout of GM, Chrysler and the Wall Street banks, and what the ECB will likely be compelled to do-buy bonds that it may never fully pay off-only compounds those harms.

In the near term, 2011 differs from 2008 in that that Rome, Lisbon and other profligate governments have access to the ECB printing press in a way that the abovementioned private firms did not to the Fed's money making machine, at least not until it was too late.

Inflation is less of a concern-bonds function as near money-and the ECB is merely swapping one form of liquidity for another on the books of the bank. Also, the iron rule that money causes inflation most applies when economies are at least near full employment-none of that is around at the moment. Austerity in the United States and Europe ensures underemployment of resources will persist.

In the West, democracy has gone too far-the majority consistently votes for politicians that promise more than societies are producing and borrow against the future in irresponsibly ways. The most irresponsible among us, under the banner of disadvantage and social justices, threaten civil collapse when disappointed-the riots in England are not a new phenomenon. Remember Watts, and just try to raise tuition in France.

Social Democrats on both sides of the pond have turned social responsibility through government into absolute fiscal irresponsibility.

Now as we unwind it all-bad private mortgages and bonds governments can't honor-the West is headed for another long period of slow growth. No longer will debt permit the West to churn paper and live high on Asia's productivity.

The West will have to accept a diminished place in the world for not limiting the powers of its banks and politicians to do too many foolish things, at the consent (demands) of the governed.

This said, markets are behaving irrationally-global financial markets are not headed for a second meltdown. But growth is going to be slow until western leaders correct the imbalance in demand between Asia and the West, and work off all the debt. Still, 2011 is simply not 2008.