Thursday, August 30, 2007

Localized financial tumor or macroeconomic metastasis?

It seems to me that both, Bernanke's critics (e.g. FT's Martin Wolf) and his advocates (e.g. WSJ's Greg Ip), write as if it were self evident where exactly the line dividing a few fools who made the wrong bets and the innocent "real economy" lies.

One will say that Bernanke has been swayed by the fools crying for a bail out while the other will says he hasn't. But before we decide on whether a clean surgical cut is in effect or nowhere to be seen in the latest monetary policy moves, one needs to see that the problem has not metastasized to a point in which bad and good financial cells are hard to tell apart.

The fact is that the central bankers do not know for sure. If the touted deepening and globalization of finance that media, academia, and think tanks have advertised in the last few years have advanced half as much as they say they have, then the distinction between the "few" fools and the "real economy" may be much murkier than the financial pundits would want us believe.

In a recent NYT's column, Paul Krugman suggested that the uninsured creditors that got the ABS's ball rolling behaved as unregulated bank substitutes. Not only how much, but also how specifically, have they substituted the banks in business, personal, and public financing in the last few years? What's the state of the respective balance sheets? How are those balance sheets interlinked?

The pundits seem to think that the corporate balance sheets are in good shape. Apparently, they hold a lot of cash. Not so fast! -- says Andrew Smithers in today's FT. In any case, parsing the data and doing the guess work to determine where this line (or something like a line) may lay must be a key item in the Jackson Hole agenda.

Is finance -- or beauty for that matter -- skin deep? This reminds me of the proverbial beautiful person (any gender is fine here) who wanted to be loved not for her/his looks, but only for her/his brains. Nobody could prove true love to her/his satisfaction and she/he always felt unloved.