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January 31, 2007

A New Understanding
by Michael Panzner

It looks like David Lereah, the buffoonish and pathologically optimistic chief economist of the National Association of Realtors, now faces stiff competition in his quest to win this year's "Baghdad Bob" award.

His rival's name is John Lipsky, and in contrast to others' recent warnings about an explosive build-up of risk in the global financial system, this policymaker apparently believes things aren't necessarily all that bad, reports the Financial Times, in "Big Risks To Global Economy 'Receding'."

Lower energy prices and a more stable US housing market have diminished risks in the global economy to the point where the world now has the "luxury" of worrying about mispriced financial markets, according to the new first deputy managing director of the International Monetary Fund.

Excuse me, but did he say something about a more "stable" housing market, or has surrealist painter Salvador Dali been reborn as a new age economist? Last time I looked, the only thing holding steady in the residential real estate market is a sense of foreboding.

John Lipsky told the Financial Times that financial market risks including general high asset prices, an explosion of structured finance or unwise trading in the yen - were "less pressing than those we worried about a few months ago".

Hmm, "less pressing." Is he actually suggesting that a bursting property bubble, an imploding subprime finance sector, an orgy of leveraged speculation, and extremes in risk-taking that make dot-com exuberance seem almost rational really give little cause for concern, or did I miss something?

"Now, we have the luxury of worrying about these other issues," he said.

Interesting choice of words, though I suppose in a totally upside-down world where value is only measured in relative terms, and where prices and spreads on the riskiest sorts of financial detritus are at manic extremes, than the phrase is wholly appropriate.

Mr Lipsky, former vice-chairman of JP Morgan investment bank and a long-standing optimist on financial markets, is now the most senior US official at the IMF. He is radically reshaping the fund's thinking on financial market issues, something that has come as quite a culture shock for the more cautious IMF staff.

Oh, I see. A "longstanding optimist" and ex-industry insider formerly employed at a firm that may be most exposed to mispriced markets, shaky counterparties, dubious derivatives and catastrophic "model failure" is the person responsible for revealing the so-called truth about the invariable good times ahead?

At the World Economic Forum in Davos last week he expressed far less concern about financial market risk than the consensus.

Here we go again: another pseudo-contrarian, like all those Wall Street talking heads, mainstream reporters, and uninformed commentators who reckon the popular vision of a U.S. ensconsed in Goldilocks-like economic utopia is an illusory façade overlaying a murky sea of bearishness.

"Dramatic changes in global financial markets continue to be supportive of the global economy," he said, adding that the explosion of lending to emerging economies provided a strong discipline on borrowing governments to perform: "Good policies get rewarded."

I wonder if that apparently welcome "explosion" Mr. Lipsky refers to is anything like the less-than-benign explosion of lending to subprime borrowers in recent years--many of whom are now hitting the wall or have been dragged into foreclosure with not so much as a handshake and a "how are you"?

Mr Lipsky was not concerned about the weakness of the Japanese yen, which could be caused by the "carry trade", heavy borrowing in Japan to buy higher yielding assets elsewhere.

"This is a subject, like asset bubbles, that is easy to talk about, but there is something structural in the net outflow of Japanese saving," he said.

"Over the period of deflation, Japanese savers did not invest abroad. Accumulation of reserves was then a proxy for unusual savings. Now, interestingly, savers have shifted their preferences to non-yen assets. If so, [perceptions of a carry trade] must be a transition."

Wow, the words of a visionary who really knows how to stand back from the madness -- as he tumbles feet over head into a world of Alice-in-Wonderland-like Pollyanaism. Please, sir, get a grip on yourself, before it is too late.

Mr Lipsky is also changing the tone of the fund's comments on global trade imbalances. Far from being an imminent danger to the world economy, the imbalances should be thought of as the corollary of remarkable strength in the global economy over the past five years, he said, and policies were moving in the right direction.

Bad is good and skies are not blue -- did this man drink one too many Kool-Aid-laced cocktails on the evening party circuit in Davos, or has the thin mountain air deprived his brain of much-needed oxygen? Otherwise, how can one seriously rationalize away the fact that such imbalances have historically been the prelude to sudden and sizeable "adjustments," as policymakers like to put it.

The US fiscal deficit was falling more rapidly than expected, Europe had enjoyed greater economic strength, some oil exporters were investing in production capacity and beginning to spend oil revenues, Japanese consumption was growing and the clear strategy of the Chinese authorities was to boost domestic demand, Mr Lipsky said.

With everything looking much more positive, Mr Lipsky is confident that reform of the IMF can proceed.

"The mindset has shifted somewhat," he said. "The challenge is not to stave off imminent risks but to take advantage of the benign environment in terms of institutions, policies and results."

I can see mindsets shifting all right. Listening to Mr. Lipsky expound on his bizarre and Panglossian visions of an alternative reality is like smoking a powerful mind-altering vapor that will no doubt evolve into the bad trip of a lifetime for those who believe it.

One of the reforms particularly close to his heart is to improve the fund's analysis of financial markets and their interaction with the wider economies of countries the fund monitors.

This would involve "forging a new understanding of financial markets and their role in the global economy and making financial analysis an integral part of fund analysis".

All I can say is, if his "new understanding" is any reflection of what most policymakers around the globe believe nowadays, then God help us when the time comes for clear-headed thinking and decisive action.

In the longer term, Mr Lipsky wants to ensure financial markets are put at the centre of all the fund's work, including crisis prevention and resolution.

"We need to think of techniques that work with the grain of financial markets to limit the scope of crises that do occur," he said. "To accomplish that, it can't be business as usual."

Unfortunately, Mr. Lipsky, the odds are great that with delusional, head-in-the-sand perspectives like these, frequent and large-scale crises will be the norm - business as usual, you might say -- in the years ahead.

Michael J. Panzner
financialarmageddon.com

Michael J. Panzner is a 25-year veteran of the global stock, bond, and currency markets and the author of Financial Armageddon: Protecting Your Future from Four Impending Catastrophes, published by Kaplan Publishing.

Copyright © 2005-2007 Michael J. Panzner

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