Please, click here to read this article in pdf format: july-14-2009

Today is the 220th anniversary of the storming of the Bastille prison, in France. On a 14th of July in 1789, an angry crowd liberated what were mainly political prisoners in this fortress-prison, outside of Paris. The anger had brewed during previous years, as Louis XVI ran into massive deficits, which he sought to cover with rising taxes. People back then thought they had seen the worst crowding-out effect ever, by a careless government. But perhaps they were wrong. Perhaps, with yesterday’s announcement of the US 9-month fiscal deficit of $1.1 trillion, those courageous French seeking to end nonsense have been dwarfed by the American taxpayer. In any major crisis, new ideas are born. In the case of the French crisis of the eighteenth century, the new idea was that quantitative analysis could be useful. Yes, quantitative analysis (what follows is my view only; I invite anyone to check if I am right here) was born with the Tableau Economique, of the so-called physiocrats. This analysis sought to make the point that agriculture in France was important and that the government had to develop its potential (as you can see, the United Auto Workers are not original).

Equities rallied today. Maybe because Meredith Whitney was positive on Goldman, maybe because the market sold Treasuries, or Bank of America may not have to pay $4BN in fees to the US government, or perhaps the macroeconomic data is not as bad as it seems. As we have said in recent letters, endogenous factors alone do not guarantee new lows. This does not mean there cannot be new lows. All I have been saying is that, by itself, the macroeconomic fundamental situation should not push a panic sale, because governments have ensured there is liquidity going to the financial system (We will have more to say about this, in the case of Canada). If this flow of liquidity stopped, or if the market believes that it can stop, or if it is challenged by an exogenous effect, then the spiraling asset deflation could indeed be triggered.
How do I know I am right here? I don’t. I can only hope my own Tableau Economique is right. When stocks fell approx. 25% with the Lehman bankruptcy, between Sept. 15th and Oct 10th 2008, the Libor-OIS spread (= 3-mo Libor minus Overnight rate; www.sibileau.com/martin/2009/07/07 ) shot beyond 364bps. Today, the same spread keeps narrowing in the face of all the negative data. It is still above the 2bps pre-crisis, at approx. 31bps. With the chart below in mind (source: Bloomberg), I fail to see why investors should engage in an asset liquidation wave, realizing losses, seeking to preserve that which is currently not lacking. Unless again, exogenous, political, factors show up and break the status quo.