The prevailing memes that justify the stock market rally seem to be :

  1. Greece, and hence the E.M.U., is “fixed.” That is, a default will be avoided. Well it can be, but really the only way to do it is for the rest of the E.U. to agree to assume Greece’s debts and fund its future deficits indefinitely. This is not unprecedented – for example, look at the transfers from the richer provinces to the poorer provinces of Canada. But it requires the transformation of the E.U. into some kind of a federal state. Greece may be giving up much of its sovereignty, but I don’t see many others states being willing to do so. And of course it is not just Greece that will need subsidies, the whole PIIGS group will be lining up with its hands out. Politicians are doing everything they can to avoid confronting this issue, but it won’t go away. Only a systemic solution will solve the problem of systemic over-borrowing.
  2. The U.S. economy is “recovering.” That is, it is on its way back to the typical postwar annual GDP growth rate in the 3-4% range and unemployment in the 4-6% range. The problem is that the U.S., like Greece, is no longer competitive except in a few areas (notably armaments) because debt-financed consumption has starved investment for decades now, while an overwhelming sense of entitlement has replaced the “American dream” of success, fame and wealth through thrift and hard work. Now it is the Chinese who have that dream, with a 40% savings rate and an investment-based economy. “Credit is the lifeblood of the economy,” said President Obama and he spoke the truth. But it is a devastating truth because it is unsustainable. The U.S. cannot forge a recovery by consuming more with borrowed money.

I’m still a bear. I think this stock market has lost its way in terms of price discovery, under the influence of the high-frequency traders, the Fed and a wide variety of other market abusers. It is no longer a discounting mechanism, at least for the time being. The disconnect between price and prospective value has become so large that the risk of a dislocation – Lehman-style – is once again very high. George Soros said that one should trade with the lie until it was about to be discovered. Unfortunately, it was left to the reader to develop some ESP mechanism akin to his “backache” to sense that magic moment.

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