Aug 11, 2011

Stiglitz and 'Fear Index' See Trouble; Recovery v. Crazies

Five-year Vix Fear Chart - Now up near 50
Substantial changes to the banking system forcing banks to make loans to small business could be the answer to stagnation. But this is unlikely to make it through the current GOP Congress, says a depressed Joseph Stiglitz

Today, the world looks to see if 2011 will offer a repeat of the nightmare of 2008, following plummeting stocks yesterday, capping a bad 10 days.

Adding to fear about Europe, [Europe Considers Ban on Short Selling], is the emergence of a potent political force, the American Tea Party, that is literally cheering for an economic melt-down as the GOP in a somewhat more muted fashion attempts to talk the economy down for political ends.

But talk down not just into another recession that runs in a somewhat predictable cycle, but rather the more awful condition of an unpredictable financial collapse, a global economic crisis.

So, the general public will get a crash education in the VIX fear index.

VIX fear index

Fear breeds fear; Crazy breeds the unknown.

The VIX index measures fear and resulting volatility of investors, offering an educated guess on the next 30-day period of the CBOE Futures Exchange (CFE) and S and P 500 Index.

Market psychology and pathology impact ultimately the performance of one's 401-K, and the VIX functions as a red flag and early warning.

The higher the VIX, the more the volatility and fear.

The VIX is at trading at $41.76 (down from the opening; -1.23(-2.86%))  at 10:22 this morning, and the Dow is up 185 points at 10:22 A.M.

On October 24, 2008, the nightmare of 2008, the VIX reached a day-high record of 89.53.

An investment manager told the Financial Times that the last few days' trajectory of the VIX occurs only "during systematically important shock events such as the 2008 financial crash, Bear Stearns bankruptcy, 2010 flash crash, and the 2007 credit market meltdown."

Joseph Stiglitz spoke with Jeff Macke at TechTicker yesterday, and the Nobel Prize-winning economist looks an appropriate representative of the economy that a major American political party is desperate to oppress: Stiglitz looked like a Zombie. Check out the video.
Professor Joseph Stiglitz

From Jeff Macke at TechTicker:

Professor Joseph Stiglitz has won two Nobel Prizes, taught at the finest schools in the world, and is one of the most highly regarded economic minds in the world. Perhaps it is exactly this intellectual firepower causing his "very depressed state of mind" when he considers the state of the American economy.

The professor joined me and my Daily Ticker colleague Aaron Task, simultaneously honoring us with his presence, bumming us out with his forecast, and giving us hope for a solution; even though his best-case scenario is the United States flat-lining like the Japanese "Lost Generation." How could he not be glum these days?

For starters, we can't get out if we don't know how we got into this mess. Stiglitz says the matter started at the top. "The problem was the economic downturn, the crisis, was much worse than the Obama Administration wanted to own up to." And in his view the stimulus was too small, too brief, had too many tax cuts, and too few drivers of economic growth. I would've pointed out that the Administration was passionate about the sorry state of affairs to the extent the President could blame his predecessor, but that would seem argumentative.

Fiscal policy didn't cure our economic woes, so Aaron and I inquired about the role of Ben Bernanke and his merry crew, which was meeting at the time of our conversation. Can the Fed help break the economic slump?

An emphatic "no," responded the normally loquacious Stiglitz. Failed monetary policy of the past was one of the causes of our current problems and stimulus from the Fed has done what it can. Short-term rates are de minimis and real interest rates are negative, a stance which isn't going to change until at least 2013.

Big corporations are awash with cash, notes the Noble Laureate, but small companies, the real drivers of employment, can't get loans. Substantial changes to the banking system which would force banks to make loans by in effect, penalizing them for keeping cash on the books, could be the answer. But this is unlikely to make it through the current Congress.

The subsequent statement from the Fed represents an effort to do exactly that at the monetary level. Real interest rates are even more negative than they were yesterday morning. Holding cash comes with a cost. Will this lead banks to get cash off their books by lending it to the small businesses that need it? That's up to the elected officials. The Fed has done what it can, their "hands are tied," as our esteemed guest said.

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