Opinion Archive

What to Make of the Panic of 2008

October 29, 2008

In the course of a few weeks, it has become 30% cheaper to live in Mexico (in dollar terms). Wall Street's former "Masters of the Universe" have collapsed, Greek tragedy-style, into the bewildered arms of government. Mexico's multi-national CEMEX is now worth less than 1/3 what it was at the beginning of the year, despite the fact that countries plan to build ever more cement-laden infrastructure to counter the downturn.

It is a sign of the bizarre nature of these types of financial panics that people are dumping ownership of companies with hard assets (via stocks) in favor of currency, which has no tangible underpinnings. What is even more counterintuitive, the US dollar, which is being "printed" in record amounts (through US government debt and ultra-low interest rates) has actually seen its value rise. Despite the inherently inflationary actions that have constituted the response to this crisis, the US government was offering you a mere $3.87 dollars per year for every $100 you invested in Treasuries with a 2038 maturity last week. It is an incredibly brave assumption that inflation will average less than 4% over the next 30 years, but panic-stricken investors will take anything that gives them a little peace of mind. These days, it seems, tranquility comes at a high price.

Some conspiracy theorists say that there is a political motive behind this latest chapter of the sub-prime mess. They suggest that there are hidden "powers" who have engineered the panic in order to clinch a Democratic victory next week. But weren't menacing financial conspirators supposed to be Republican, according to traditional conspiracy theorist lore? Consistency, as well as reason, seem to be early victims of panics.

As pretty much everything (except Treasury bills and the yen, which is rising for other reasons) loses value, the consumer is being affected in a quick and direct way. For example, those of us who fill our tanks on this side of the border will see the gasoline tax, called "IEPS" according to its acronym in Spanish, get a boost upwards. Just a few months ago, many editorialists were criticizing the Mexican government for keeping the price of motor fuel too low via subsidies. Few pointed out that the IEPS also works the other way. In times of high oil prices, the Mexican government makes more money, so the Mexican consumer benefits. In times of low oil prices, the domestic sales tax on gasoline rises to cover the shortfall. That is what we're starting to see today, with prices in the US and Mexico finally converging (about $2.22 dollars per gallon in Mexico and $2.45 in the US, at $13 pesos to the dollar).

So, what's in store for the peso, in particular, and our two economies, in general? This particular crisis seems to be different from previous panics in both origin and scope, so no one really knows. China still has enormous amounts of resources to maintain growth, which should limit the collapse in commodity prices, for example. In terms of the peso, if it stabilizes at around 12, inflation won't be too high and the depreciation will probably help exporters. But if the currency's swings remain erratic, it will add damaging uncertainty to millions of transactions, causing people and companies to reduce their activity, thereby exacerbating the downturn in this country. Similarly, if the flood of money coming from world governments takes too long in "greasing" the wheels of commerce and industry, the downturn everywhere else will be more severe than if the funds flow quickly.

Curiously, given the way that the terms "recession" and "depression" are so overused, there is no exact definition of either. Journalists use a "rule of thumb" for recessions, defining them as two consecutive quarters of negative growth. As the word "depression" starts to be freely bandied about, a consensus definition seems to be gaining traction, pointing at a 10%, or more, decline in economic activity during any given quarter. That hasn't happened in the US since the 1930's.

It is important to note that official American figures are not currently negative, with the latest being a healthy +2.8% for the second quarter of this year. But, given the fact that markets are mechanisms that "discount" future scenarios, they have already factored in a long and painful recession. Advanced estimates for third quarter US GDP will be published by the Commerce Department tomorrow at 8:30am EDT, so expect another volatile day.

Of course, here has never been a successful investor who did not follow the cardinal rule to "buy low" and "sell high". In case you were wondering, this is what they meant when they said "low". Just remember, don't panic... and caveat emptor.

For the latest thought-provoking article by Agustin Barrios Gomez please go to our Opinion Column page

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