If Puzzled, Play it Cold…

Alright, folks, I am going to be honest with you, I am puzzled… The stock market is going up and down: it had a strong summer since early July and fears of catastrophe (the DJ index hitting 6000 or even 5000) that went around in March have totally vanished, so it seems. However, the index took a hit last week and I have also read a number of comments to the effect that the stock market with its sharp rebound since March and a good performance in 2009 (about a 10% increase overall) is getting ahead of itself and is showing too much confidence in the soundness of our economic system and the strength and imminence of the economic recovery.

It almost felt good when I heard several folks on CNBC last week say that they had no idea where the stock market was heading… I still have a hard time reconciling the couple of apparently very solid explanations that I got in March about the possibility of the Dow hitting rock bottom (way below 7000) and the current seemingly widespread feeling that a Dow below 9000 seems rather unlikely. How did we get from one to the other so quickly?

Also, the question of the US public debt is an interesting one… Some numbers came out in the past 2 weeks, to the order of 7 to 10 trillion (depending on whether you count the free espressos in or out I guess…) as the US public debt total by the end of the next decade. Those are astounding numbers, aren’t they? But obviously, you have to look at what they represent relative to the US economy and to the country’s ability to sustain debt over the long run. On those two aspects, NYT columnist and Nobel Prize Winner R. Krugman says that we should not worry. In his blog entry The burden of debt, he mentions the examples of the Belgian and Italian economies as having taken on much more public debt as a % of their GDP than the US is currently and also draws a lesson from US history as the country had a huge debt after WWII that went down gradually as a % of GDP (despite the arm race with Russia) because the economy grew so much during those years. His point is that you don’t have to repay your debt as long as you stabilize it over time.

Warren Buffett in another NYT column, The Greenback Effect, argues that as long as there are folks out there who are willing to buy US Treasury bonds, the US economy is good to go. However, he does point out that this lifeline is the country’s very danger because once the Chinese and other sovereign funds stop buying those US Treasuries, guess who will be in major trouble. What that means is that the dollar should continue to be viewed as a currency of reference and the US economy has to be perceived as having reasonably strong prospects.

I find all of this a bit unnerving though - both Krugman and even Buffett seem quite optimistic to me. With the country having a huge amount of private debt ($13.8 trillion or 120% of the US annual income in 2008) as well - though the financial meltdown has prompted lots of folks to start to repay some of what they owe and to engage in saving, I am not sure I see how the “fundamentals of our economy are strong”, as McCain famously said amid the meltdown last year. The Obama administration is arguably not saying that exactly – nor is Krugman – but they are not that far.

I’d like someone to explain to me how a system can sustain itself and remain the anchor of the global economy over time with so much private and public debt – how about some serious systemic risk? Anyone?

PS. By the way, and let me go on a tangent here, I was just in San Francisco last week and on my way back I listened to Coldplay’s Viva la Vida album on the plane. I knew the main song only and I really liked Cemeteries of London and also Lovers in Japan. I’ve missed Coldplay a couple of times in concert in my area but good news - after my wife Anne and I saw a piece about Chris Martin on 60 Minutes some time ago, I think I finally convinced her to go and see them in concert… well, now they have to come back to the States…