The American Spectator : Irrational Pessimism

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Irrational Pessimism

By Brian Wesbury on 11.3.08 @ 6:08AM

The recession we've entered into wil be short-lived, unless those who've been predicting doom these last eight years continue to go unchallenged.

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Don't misunderstand: mark-to-market accounting should still be suspended; but that would be gravy at this point. Within the artificial accounting restraints the government has created, enough money has finally been injected to contain the problem.

STILL, IT IS CLEAR that many do not share this optimism. And why should they? Short-sellers have made a bundle in recent months. But we are now at a point of over-confidence on the short side. Irrational pessimism has set in, and just like a bubble to the upside, this downside bubble must eventually burst.

The short-sellers and pessimists were right about a recession and large stock market declines, but for the wrong reasons. The markets fell apart because of accounting rules and ham-handed government intervention, and this is what undermined confidence and led to a drop in consumer spending.

The key thing to remember is that while the U.S. financial system may have taken a beating, it has not completely broken down. The Great Depression was caused by a massive deflation and the destruction of money as thousands of banks failed. Today, the Federal Reserve has more than doubled its balance sheet to a whopping $2 trillion and the Treasury has drawn a line in the sand, essentially taking any more large bank failures (for accounting reasons alone) off the table.

And every time the Fed injects money into the system, the economy reacts. The money will find its way into the economy and a sharp recovery in spending will begin quite quickly. And when the velocity of money actually increases, the injection of money into the system will be like gasoline on a fire.

When that happens, short-sellers will have nowhere to run. But because they have grown overconfident, it will take some time before they fully capitulate. In the process, the markets could have a spectacular run to the upside. Already, we have seen this in Japan, where the Nikkei rose 26 percent in just three days. Look for a "melt up" in the months ahead as irrational pessimism finally must give way to reality.

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About the Author

Brian Wesbury is chief economist for First Trust Portfolios, L.P.

Letter to the Editor View all comments (9) | Leave a comment

Agent Orange Peel| 11.3.08 @ 6:47AM

'Look for a "melt up" in the months ahead as irrational pessimism finally must give way to reality.' The preceding sentence is your concluding sentence based on your preceding analysis. The preceding analysis to the ending fact of the Titanic's sinking was the analysis that the ship was "unsinkable".

Tejas calling| 11.3.08 @ 7:53AM

The Ponzi scheme of fiat paper money is nearing the end of its cycle as confidence in it is starting to wane. The Fed injects more money in the system and yes, the market reacts.... Prices go up as the dollar gets diluted once again...

The markets have turned into this corrupted entity where the insiders are making money hand over fist to the detriment of others who think it is still a great deal. Poor bastards. Even rigged roulette wheels eventually get found out...

Andy| 11.3.08 @ 8:48AM

The news of economic recovery will depend on the election. If the democrats win, the economy will be doing great (no matter the numbers). If the republicans win, no amount of stimulus will stave off the inevitable recession.

M. Tobias| 11.3.08 @ 10:26AM

Mr. Wesbury makes the point that the steep drop in stock prices is largely due to consumer fear. I agree. The, he goes on to completely ignore his analysis. The markets will rise. The speed of their rise will depend upon the confidence of the individual investor. This is tied to many things, including; media hype, business retrenchment and the outcome of the current federal elections.
This could be a fast recovery, or a prolonged one. There is smply no way of gauging that the moment.

Sherman McCoy| 11.3.08 @ 12:25PM

we had a 46% decline in the great depression and a 48% rise, before a subsequent fall. This year, we witnessed a 46% decline, and even if the world eventually comes to an end, we will get a rally that will make your head spin. Nothing ever changes in the markets.

Ed| 11.3.08 @ 3:08PM

Andy,
You've got it right, only backwards. Obama just said he's going to bankrupt coal fired power plants. They provide almost all of our electricity. Democrat legislation was behind the financial meltdown. Democrats are economically illiterate.

Stephen Lins| 11.3.08 @ 4:33PM

Mr. Westbury seems to think that the "money" injected into the financial system by the Fed is the same as new capital. If only things were so simple. We would have solved the economic problem long ago and spent most of our time tending our unicorn herds.