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Sunday, March 29, 2009

Greenspan: Equities Show Us the Way to Recovery

Alan Greenspan says that once stocks start to recover, all will be well with the world:

Equities show us the way to recovery, by Alan Greenspan, Commentary, Financial Times: Global economic policymakers are currently confronted with their most daunting challenge since the 1930s. ... Counterfactual scenarios are highly problematic to say the least. But there are intriguing possibilities that offer comfort that, if all else fails, the global economy is not on a track towards years of stagnation or worse.

In one credible scenario ... lie the seeds of recovery. Stock markets across the globe have to be close to a turning point. Even if a stock market recovery is quite modest, as I suspect it will be, the turnround may well have large (and positive) economic consequences. ...

Global losses in publicly traded corporate equities [are]... almost $35,000bn, a decline in stock market value of more than 50 per cent and an effective doubling of the degree of corporate leverage. Added to that are thousands of billions of dollars of losses of equity in homes and losses of non-listed corporate and unincorporated businesses that could easily bring the aggregate equity loss to well over $40,000bn, a staggering two-thirds of last year’s global gross domestic product.

This combined loss has been critically important in the disabling of global finance because equity capital serves as the fundamental support for all corporate and mortgage debt and their derivatives. These assets are the collateral that powers global intermediation, the process that directs a nation’s saving into the types of productive investment that fosters growth. ...

A rise in global private sector equity will tend to raise the net worth (at market prices) of virtually all business entities. ... In the current environment, new equity will open up frozen markets and provide capital across the globe to companies in general, and banks in particular. Greater equity, after addressing the shortage of bank net worth, will support more bank lending than currently available, enhance the market value of collateral (debt as well as equity), and could reopen moribund debt markets. In short, liquidity should re-emerge and solvency fears recede. ...

The substitution of sovereign credit for private credit has helped to fend off some of the extremes of the solvency crisis. However, when we look back on this period, I very much suspect that the force that will be seen to have been most instrumental to global economic recovery will be a partial reversal of the $35,000bn global loss in corporate equity values that has so devastated financial intermediation. A recovery of the equity market, driven largely by a receding of fear, may well be a seminal turning point of the crisis.

The key issue is when. Certainly by any historical measure, world stock prices are cheap... The pace of economic deterioration cannot persist indefinitely. ... The current pace of deterioration is bound to slow and with it there should come a lessening of the level of fear. ...

As the level of fear recedes, stock market values will rise. Even if we recover only half of the $35,000bn global equity losses, the quantity of newly created equity value and the additional debt it can support are important sources of funding for banks. As almost everyone is beginning to recognise, restoring a viable degree of financial intermediation is the key to recovery. Failure to do so will significantly reduce any positive impact from a fiscal stimulus.

Maybe there was a Greenspan put after all?

    Posted by on Sunday, March 29, 2009 at 02:52 PM in Economics, Financial System | Permalink  TrackBack (0)  Comments (52)

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