Comments on Liquidity boom and looming crisis - iTulip.com Forums

Comments on Liquidity boom and looming crisis - iTulip.com Forums: "Comments on 'Liquidity Boom and Looming Crisis'

by John Craig - Centre for Policy and Development Systems, Queensland (CPDS)

Editor's Note: John Craig qualified initially as a civil engineer and has had over 30 years involvement in strategic policy R&D, the majority of it working in government agencies in Queensland. This has particularly involved a systems approach to both organizational and economic development. His commentary on Henry Liu's analysis of the potential for a global liquidity crisis is mainly based on study of the different ways Western and East Asian societies have developed, and the implications that this has for their economic, financial and monetary systems.

John has generously provided his thought provoking commentary, from the perspective of an economic policy professional based in Australia, for iTulip readers.

In May 2007 Henry C K Liu produced an interesting and challenging analysis of the possibility that a 'liquidity trap' (which can arise if few want to borrow even at very low interest rates) could prevent the US Fed from again protecting the 'real' economy from an imminent financial crisis - so that the prevailing global financial market boom and sustained pattern of economic growth could be seriously disrupted (Liquidity boom and looming crisis, Asia Times Online, 9 May")
In brief Henry Liu's article seems to argue that:

* US economic growth is slowing;
* there is a 10 year cycle of financial crises (ie the US market crash of 1987 and the 1997 Asian financial crisis), which have similar causes (ie dubious leveraged international short term funding of long term investments);
* another financial crisis could be looming associated with the spreading effect of weaknesses in US sub-prime mortgage markets which adversely affects demand, while at the same time Fed responses are constrained by both inflation risks and a potential liquidity trap (ie an inability to increase liquidity if few want to borrow);
* the wealth effect which is now disappearing has been driven by international capital flows (linked to US current account deficits) over which US authorities have little control;
* the difficulties are compounded by: the mal-distribution of wealth and growing unemployment (which constrain consumer demand) and financial market techniques such as securitization (which increase systemic risks);
* China faces difficulties associated with current account imbalances and $US hegemony, but has little scope to pick up the slack as US demand declines - and can only try to isolate itself from the coming financial crisis;
* in 1980, before dollar hegemony allowed the US to finance current account deficits from a capital account surplus, the Fed had to raise interest rates to nearly 20% to curb the stagflation resulting from the US trade deficit. The Plaza Accord tried to force a revaluation of the Yen to cut that deficit - and this forced Japan into a deflationary depression from which it it has not really recovered;
* the subsequent liquidity boom (under which growth has been driven largely by increasing asset values) has its origin in Fed policies, $US denominated structured finance and $US hegemony;
* the liquidity boom requires many things to be just right and could easily be disrupted, resulting in a prolonged bear market. Thus a global financial crisis is inevitable.

This article presents the present writer's summary of Henry Liu's paper interspersed with comments which suggest that, while the potential risk is real, it originates as much in East Asian economic strategies and financial/monetary systems as anything else, and that the prospects that others can be isolated from the consequences are much less than Henry Liu's paper suggests.


In brief, CPDS' comments suggest that:

* the most obvious common feature of both the 1987 and 1997 financial crises was that they were triggered by large-scale withdrawal of Japanese capital;
* the liquidity boom (whose bursting could dislocate global growth) is partly a consequence of the need for trade surpluses by major economies in East Asia to protect financial institutions that have poor balance sheets due to a lack of commitment to the profitable use of capital;
* Japan's need to stimulate its economy (long at risk because of weak consumer demand and business investment) is another key factor in the liquidity boom - and arose because of its failure to properly reform its financial system after the 1980s property bubble burst;
* some of Henry Liu's interpretations of past events, and of financial market imperfections, seem to need refinement;
* the key question is how to unwind trades imbalances, capital transfers and easy money policies that have been associated with the emergence of a liquidity bubble. This seems to require international collaboration in reform of global and national trading, financial and monetary regimes.

CPDS Comments
on a Summary of Liquidity boom and looming crisis
(Henry C K Liu, Asia Times Online, 9 May 2007)


Economic growth in the US slowed to 1.3% in the first quarter of 2007, the worst performance in four years of an overextended debt bubble. Yet the The DJIA is now 82% higher than its low in 2002, during which US GDP grew only 38%.

There is a 10-year cycle of financial crises. This included the 30% US market crash of 1987 which was set off by the 1985 Plaza Accord (to push down the Japanese yen so as to cut the US trade deficit with Japan) and the Asian financial crisis of 1997.

COMMENT: Presumably this includes an inadvertent mis-statement. The Plaza Accord was surely intended to increase (not reduce) the value of yen (and other currencies) relative to the $US.

While there seemed to be many causes of the 1987 US market crash including a bubble linked to rapid growth associated with high rates of public spending and a very large budget deficit, the trigger for the crash seemed to be Japan's sudden large withdrawal of capital from the US (by sale of about $US 400bn in assets) - which resulted in rapid rises in interest rates. Such a withdrawal of capital would be expected to reduce the value of $US relative to the yen - though whether this was done in the Plaza Accord context or as a result of Japan's domestic financial predicament (noting that Japan's 1980s' real-estate bubble subsequently burst) or for other reasons is unknown.

The 1987 market crash was unexpectedly prevented from affecting the real economy because the US Fed boosted liquidity to support distressed financial institutions in ways that would traditionally have been impossible (ie before the gold standard was abandoned, this action would have led to a current account crisis).

The Asian financial crisis of 1997 was associated with unproductive use of capital under 'crony capitalism' arrangements - and appeared to be triggered (as in 1987) when Japan suddenly withdrew large amounts of capital from elsewhere in Asia (Hartcher P. ‘Look East, Dr Mahathir, for the source of Asia’s decline’, Australian Financial Review, 25-26/10/97).

A wave of deflation spread over all of Asia from which Japan has yet to fully recover. Now in 2007, a debt-driven financial crisis threatens to end the liquidity boom associated with the flow of trade deficits into capital-account surpluses which US dollar hegemony has permitted.

COMMENT: The liquidity boom is also due to the circular flow of (mainly) Asian trade surpluses and capital deficits (which are the mirror image of the US trade deficit/capital surplus). It is also due to creation of cheap credit (a) by Japan to stimulate its domestic economy otherwise long at risk of deflation due to low consumer demand and stagnant business investment and (b) by the US and others to maintain global growth to compensate for the (mainly) Asian demand deficit - an initiative that had been made possible with limited inflation risk by cheap imports.

Asset bubbles have appeared in Asia (driven by trade surpluses and easy credit) just as they have elsewhere (driven by easy credit).

The financial crisis that could be looming is partly a feature of East Asian economies in which return on capital has not been taken seriously - and financial institutions are often burdened with bad debts. The consequence of any US inability to drive global demand will be an end of East Asian current account surpluses, and thus an urgent need for (say) Japan's and China's banks to have the sound credit rating needed to borrow internationally.

While details differ, these financial crises have similar causes - leveraged short-term borrowing of low-interest currencies financing high-return long-term investments in high-interest currencies through "carry trade" and currency arbitrage, with projected future cash flow supporting share prices.

COMMENT: As noted above, the situations were not all that similar and there were other factors involved.

Eventually the rise in asset prices beyond market fundamentals ended. On one occasion a steady fall in the value of the US dollar, the main reserve currency, caused a sudden market meltdown that spread across national borders through selling in strong markets to try to save hopeless positions in distressed markets.

COMMENT: A fall in the value of the $US was not involved in both 1987 and 1997.

The strength, not the weakness, of the $US was its only impact on the 1997 Asian financial crisis. Countries such as Indonesia tried to maintain a fixed exchange rate with $US without the large current account surpluses that Japan and China (for example) used to prevent the weak balance sheets of their financial institutions from being exposed.

As noted above, the most obvious common feature in triggering these events seemed to be a sudden large withdrawal of Japanese capital.

Such a point is now again imminent - given weak US GDP growth associated with a housing slump caused by a meltdown in the subprime mortgage sector. This has not bottomed, and its full global impact has not yet been felt.

COMMENT: Fair point.

Deprived of expanding wealth by falling home prices, US consumer spending was up only 0.3% in April 2007. The US Federal Reserve and Treasury have denied that a recession is likely - though former Fed chief Alan Greenspan has put the odds at one in three. Inflation pressure continues to complicate Fed policy deliberations.

While the Fed views inflation as the main danger, it hopes that inflation will fall as monetary policy remains tight. The Fed's stated goal is to cool the economy to limit inflation without provoking a recession. Yet in an age of derivatives, the Fed's interest-rate policy does not dictate the supply of liquidity. Virtual money created by structured finance has reduced central banks to the status of players not controllers of financial markets. A liquidity boom that allows rising equity markets while the economy slows can turn toward stagflation, with slow growth and high inflation.

COMMENT: Fair point about Reserve Banks' limited influence.

However 'stagflation' (in the 1970s) was associated with increasing wages and consumer prices while the economy stalled - rather than with asset price inflation. It is not clear that asset inflation driven by a liquidity boom must lead to wage and consumer price inflation.

The wealth effect from rising equity prices has been caused by a debt bubble fed by liquidity created beyond the Fed's control, by the US trade deficit denominated in dollars returning as capital-account surpluses.

COMMENT: The liquidity boom - which is global rather than confined to US - has been driven by others' trade surpluses as much as by US trade deficits (as these are simply mirror images of the same thing).

Also, the wealth effect has not been broadly distributed, resulting in a boom in the luxury consumer market while the general consumer market stalls.

COMMENT: Fair point - though it is noted that restraint on wage earnings has been due significantly to international competition from economies who workers' increasing skills and education have perversely not yet properly increased their wages.

While the DJIA rose 5.9% in Q1 2007 with inflation at 2.2 %, wages and benefits grew by only 0.8%.

COMMENT: Presumably the DJIA (etc) reflects corporate earnings which derive increasingly from global, not simply US, operations.

By acting as the dominant HQ for global businesses, the US may be best positioned for flow-on of corporate profits to the rest of the workforce.

There was concern in the 1980s that the benefits of US high tech industries would not be widely shared - then in the 1990s the emergence of the 'new' (knowledge/network) economy allowed those benefits to be shared. Perhaps something like this effect will occur with respect to globalization of operations.

Labor's share of the US GDP growth of 1.3% was -2.6% (after a 3.4% inflation) while capital's share was +2.5%. If labor's share of GDP growth remains negative, companies won't be able to sell their products and will be forced to lay off workers, thus further slowing growth.

COMMENT: This further demonstrates why stronger demand in Europe and Asia, and the reforms of trading, financial and monetary systems needed to make this possible, are vital to maintaining global growth.

US job creation has slowed, and unemployment has risen. The slowdown in job creation reflects recent economic weakness but is likely to be viewed perversely by the Fed as a sign that wage inflation pressures are easing.

COMMENT: Presumably a recession is possible, but 4.5% unemployment is by no means high by international and historical standards.

Before the age of securitization, risk was evenly spread and all mortgages shared the cost of default. Securitization through collateralized debt obligations (CDO) permits the unbundling of risk into tranches of increasing risk and return levels, while squeezing additional value out of the mortgage pool by increasing risk / return efficiency.

COMMENT: Arguably value was genuinely 'created' by this means. The unbundling of risk leaves the debt instrument holder initially in the same position - i.e., with an overall risk and return package the same as before. It is just that the components are separately worth more to others.

This extra value, when siphoned off repeatedly from the overall mortgage pool, requires an ever larger supply of risky subprime mortgages, thus increasing the systemic risk further.

COMMENT: Why are sub-prime mortgages needed to make this arrangement work? Surely any set of mortgages can be used.

Subprime borrowers are no longer just low-income borrowers. The extra risk-premium value taken out of the mortgage sector increases liquidity to feed the debt market further, further reducing credit standard of subprime lending. When prime-credit customers have borrowed to their limits, growth can only come from lowering credit standards.

COMMENT: This seems a bit simplistic. The 'value taken out' through this function is no different to the value-added in any other business dealing. The goal of any marketing strategy is to identify where others value goods or services a great deal more than they cost to produce.

And 'value-added' through securitization does not go only to increasing liquidity. It may for example be used to pay wages or taxes, and thus ultimately increase demand and improve real returns on capital.

This is the structural unsustainability of CDO securitization.

COMMENT: For reasons suggested above, perhaps this suggestion is in need of more development.

China's foreign-reserves data showed as much as $US73 billion in unexplained new reserves. If these funds were swaps, this would have only minor economic implications, but if they were $US inflows this could further stimulate an overheated economy.

Dollar inflows would require further monetary tightening by the PBoC to reduce the risks of an equity bubble fuelled by expanded money supply. China has been raising required bank reserves, reducing funds available for lending trying to cool an investment boom that could spark a financial crisis. The effort has had only limited success. China's international balance-of-payments problem is boosting excessive liquidity in its economy.

COMMENT: Fair point. The solution presumably is more balanced trade (which in turn requires more determined efforts to strengthen financial systems in trade-surplus countries).

Chinese global trade surplus increased 74% to $177.5 bn in 2006 - though, ignoring $73 billion of capital inflow and $60 billion in returns on foreign capital, the net trade surplus was only about $40 billion (less than Japan's $168 bn and Germany's $146 bn surpluses).

COMMENT: Why take away capital inflow and returns on capital? China's trade surplus was still $177bn.

And the trade surplus of China plus that of countries to which component production for products finished in China is sub-contacted was presumably much greater.

The US trade deficit with China widened to $233 billion in 2006, out of a global total of $857 billion. If the US trade deficit with China falls, China will reduce its own trade deficit with other trading partners, with little effect on the US global trade deficit.

COMMENT: Fair point. The problem is unbalanced trade generally, not exclusively that with China.

The question is how trade surpluses in countries such as China, Japan and Germany can be reduced, and how US deficits can be reduced.. This might require changes to global and national trade, financial and monetary systems, as all seem to be involved in this imbalance.

Dollar hegemony is hurting the Chinese economy. As the $US-denominated trade surplus mounts, the PBoC must tighten domestic monetary measures to neutralize the increased yuan money supply which results from buying up the surplus dollars in the Chinese economy with yuan.

COMMENT: Fair point.

However presumably the $US has hegemony for a reason - partly as a result of history, and partly because US financial markets take more seriously than many others the business of producing a return on invested capital,

The solution to this is (perhaps) more attention to the profitable use of capital elsewhere.

The new yuan money doesn't finance interior development but is attracted by speculative real estate and equities, pushing prices up beyond fundamentals.

COMMENT: Fair point. However the asset bubbles are as much due to demand deficits / trade surpluses in East Asia, as they are to trade deficits that lead to capital account surpluses in US.

Led by China and Japan, all the exporting economies are fuelling a global liquidity boom focused on the importing economies (led by the US).

COMMENT: Fair point.

China has kept the global cost of manufacturing too low by not paying adequately for pollution control and worker wages and benefits. Domestic political pressure is forcing the government to normalize production costs, and boost global inflation.

COMMENT: Fair point.

Financial globalization has not banished inflation, nor ended the business cycle - though the cycle now lasts longer than 7 years. To avoid a market collapse, anti-inflation measures need to be implemented slowly - making a crash inevitable as a system that requires ever rising asset values can't survive years of slow growth.

Bonds will be the first asset class to fall in this anti-inflation cycle, and others will follow. Deflation can't be cured by printing more dollars, as this would merely convert price deflation into monetary devaluation. Globalization and hedging have merely postponed, not eliminated, inflation.

The bursting of the tech bubble, the September 11 shock, and outsourcing caused disinflation in 2002 which neutralized debt-driven dollar inflation. Then, facing dollar deflation, the Fed cut its Funds Rate to 1% in July 2003 while the Bank of Japan maintained a zero interest rate. This led to a massive liquidity boom that increased the US trade deficit.

COMMENT: It is unrealistic to suggest that the Fed's actions were solely based on US domestic considerations.

Its actions were also presumably motivated by a desire to maintain global growth in the face of the deflationary demand deficit implicit in the export driven economic strategies of major East Asian economies - on the not unrealistic assumptions that (a) those economies would simply have to continue financing the resulting US current account deficit or themselves face economic disaster and (b) cheap imports would keep inflation in check.

In 1980, before the emergence of dollar hegemony, which allowed the US to finance it trade deficit with a capital-account surplus, the Fed had to raise its Funds Rate to 19.75% to curb stagflation caused by its trade deficit. In 1985, the Plaza Accord aimed to revalue the Japanese yen against the dollar to curb the US trade deficit with Japan. This pushed Japan's economy into a deflationary depression from which it has not yet fully recovered.

COMMENT: Why suggest that stagflation in the 1970s was due to a trade deficit? It seemed to be due to inflationary shocks associated with (a) rapid increases in oil prices, that were transmitted without restraint into a wage-price spiral, and (b) serious difficulties in maintaining productivity (due to Japanese and Asian tiger competition in capital intensive manufacturing) which could not be overcome without huge structural adjustment (that took market liberalization and many years to achieve).

Why suggest that the $US was not the dominant global currency before 1980? If it was not, what was its competition, and why did that competition subsequently lose ground?

Japan's deflationary depression was not due to the Plaza Accord. Japan had a massive property bubble in the 1980s, funded by the government dominated banking system, and the bubble burst. Japan then endured many years of deflation and slow growth because, rather than writing off losses and reforming its financial institutions as was common elsewhere, those problems were covered up - presumably because the bureaucratic elite, who govern Japan behind a democratic facade, would otherwise have lost control of Japan's financial system.

The source of the global liquidity boom (which has boosted demand by inflating asset values) is the increased supply of US dollars, both as a result of Fed monetary policy and of $US-denominated structured finance under dollar hegemony.

COMMENT: As indicated above, the liquidity boom also has its genesis in: recycling of trade surpluses back into investment in $US assets - which is heavily associated with a defensive approach to weakness in the balance sheets of East Asian banks; and cheap credit generated in Japan which is cycled through the carry trade into US financial markets.

Moreover, the hegemony of the $US reflects the weakness of financial systems in countries that might otherwise challenge its role.

Liquidity is affected by the monetary environment created by central-banks. It can be increased by lower interest rates or easing money-supply relative to nominal economic activity. However availability of money alone does not create liquidity. There must also be a market in which assets can be traded without regulatory restrictions or causing big shifts in price levels. The demand for assets relative to their supply also affects liquidity.

COMMENT: Fair points. However, a key factor in increasing the demand for assets (and thus increasing liquidity) has been the large capital inflow associated with recycling of trade surpluses and the Yen carry trade.

Hedge funds contribute significantly to the increase of liquidity by enlarging investor appetite for risk-taking.

COMMENT: Hedge funds only increase liquidity because they are seen to be using capital profitably. These arrangements may, however, increase systemic risk.

The liquidity boom requires all these factors to continue - as even slight changes could end it. A sudden fall in the $US could trigger market sell-offs, as it did after the Plaza / Louvre Accords of 1985 and 1987, first to push down and later push up the $US, which contributed to the 1987 crash.

COMMENT: Good point regarding potential instability.

However there seems to be a need to further justify claims about the effect of a fall and rise in $US in the 1980s.

In 2007, the market won't cause the $US to fall rapidly in value unless there is something to take its place - eg the currency of a country whose financial markets take profitability in the use of financial assets more seriously than the US does. A serious $US crisis could also be triggered by politically motivated action by large holders of $US assets - a step that would be most damaging to the interests of economies that rely on exports to US.

Other causes of the 1987 crash were proposals for changes to tax legislation that would have disadvantaged investors.

COMMENT: As noted above, there were many other factors that contributed to that situation.

There are many ways in which the current liquidity boom could turn into a liquidity bust (eg hedge fund regulation, rapid revaluation of yuan, imbalance between assets and credit).

COMMENT: Fair point. The Bank of International Settlements has argued that global financial imbalances - which are central to the emergence of the liquidity boom - represents the world's key economic problem.

Dislocation in the real economy could also potentially end the liquidity boom rather than the other way around (eg consider the effect of a pandemic (a more dangerous successor to SARS and Bird Flu) or disruption of global oil supplies as a result of political instability in the Middle East).

Financial globalization and the dominance of derivative plays by hedge funds and private-equity firms could turn a minor disruption into a crisis. The main uncertainty in the coming adjustment is the effect (perhaps beneficial or destabilizing) that these new players could have on international markets as liquidity recedes. Alternatively, the global growth boom and bull market may simply run out of steam.

The liquidity boom has allowed growth through asset inflation without much expansion of the real economy. Unlike real physical assets, virtual financial mirages can evaporate without warning.

COMMENT: It is unwise to assume that 'real physical assets' are more solid than financial assets. The symbolic economy is vital to coordination of actions within the 'real' economy. If the symbolic economy were to fail, those with 'real' assets would often be left with piles of rusting junk for which they had no use.

The emphasis that many in East Asia place on a strong 'real' economy with disregard for the symbolic economy is a major cause of (a) their need for current account surpluses to protect their weak financial institutions (b) global trade imbalances and (c) the emergence of the liquidity boom and asset bubbles that have the potential to be economically disastrous.

Massive fund flows from less experienced investors into hot-concept funds have caused a financial mania that must unwind.

Inflationary pressure in OECD economies makes a bear market inevitable and an orderly unwinding unlikely. Central banks can't ease because of a liquidity trap - that arises when banks can't find creditworthy borrowers at any interest rate or, when interest rates are near zero, people don't expect positive investment returns and so hoard cash.

COMMENT: While a liquidity trap is possible, why will this necessarily happen now? Certainly the fact that some asset values have been high and are likely to devalue suggest the possibility than few will want to borrow, but could not new asset classes be identified (e.g., in alternative energy) that make borrowing profitable and so re-generate liquidity?*

As the decade-long US consumption boom collapses, an ongoing bear market will arise. Asia's growth has been driven by low-wage exports, so it will not be ready fill in as the growth engine in time to prevent a crash. China is just starting to change its development model to boost worker incomes and consumption. Its only option is to insulate itself by resisting US pressure to open its financial markets. Its purchasing power is too low to save the global economy from a deflationary depression.

COMMENT: It isn't only China that needs to do more to boost domestic demand to prevent a global crisis. Japan (and various other countries whose positions are not constrained by low income levels) also need to make a major contribution.

It seems most unlikely that China would be able to protect itself from a global economic meltdown - because of its export dependence. Moreover, the political 'legitimacy' of ruling elites seems to depend heavily on continued economic growth - so any disruption could lead to political instability as well.

A global financial crisis is inevitable and this could trigger a global economic hard landing. Global financial markets look like a pyramid game (noting complex derivative products catering to short-term trading strategies and that, in the absence of good returns in the US, investors allocate funds to emerging-market and commodity specialists - whose investment in small and illiquid stocks has been all that has supported the latter's rise in value). Rising leverage has also artificially boosted liquidity in hot markets.

Before financial globalization, if short-term $US interest rates were higher than longer-term rates, US Treasury bonds could not be boosted by carry trades. Now however this is routine. More profitable still has been borrowing in Japanese yen to invest in Brazilian or Turkish bonds, using various derivatives to hedge currency or credit risk.

Financial markets experienced minor shocks recently when the BOJ soaked up a lot of liquidity and hinted at the need to commence a rate-hike program. A liquidity boom will continue as long as a central bank with large foreign reserves, such as the BOJ, price short-term credit at low levels and lends to all comers.

COMMENT: Fair point. The BoJ deserves close attention in this respect - especially given that withdrawal of Japanese capital seemed to play a role in triggering both the 1987 and 1997 financial crises.

The People's Bank of China also contributes to the global liquidity boom.

COMMENT: Fair point.

The US current-account deficit is the key driver of the liquidity boom. Those who call for a cut in the US trade deficit are calling for a US recession.

COMMENT: As noted above the US current account deficit does not exist in isolation - but is a reflection of economic strategies and financial institutions elsewhere - especially in Asia.

Given sounder balance sheets in (say) Japanese and Chinese financial institutions, there would be no reason that the US capital account surplus / current account deficit could not be reduced without a recession - because stronger demand in Asia would then compensate for a reduction in US demand.

When the meltdown in the subprime mortgage market spreads to other parts of the credit markets, the Fed will be forced to try a monetary ease. But a liquidity trap will complicate matters - as long-term rates may fall faster than the Fed Funds Rate. When demand for bank reserves falls because of a slump in loan demand, then the Fed will have to destroy bank reserves to prevent the Fed Funds Rate falling to zero.

A liquidity trap can be a serious problem because the world is still plagued with excess liquidity potential. A global liquidity trap with $50 trillion of currently idle assets will implode like a doomsday machine.

CONCLUDING COMMENT

In summary, it seems to be being predicted that:

* Many factors could trigger a liquidity "bust" which brings an end to to the asset boom and strong demand associated with rapidly expanding liquidity;
* Inflationary pressures will lead to a bear market which reserve banks won't be able to stop by monetary easing, because few will want to borrow creating a 'liquidity trap';
* US demand will collapse - and Asia's export-oriented economies will be structurally incapable of filling the gap;
* A global financial crisis is inevitable;
* Derivate products and globalization (which encourage funds to flow to illiquid emerging markets, and create 'hot' money via carry trades) increase the potential damage in a financial crisis;.
* Japan has moved towards higher interest rates to soak up liquidity;
* Any reduction in the US trade deficit will result in recession;
* Poor credit quality in subprime mortgages will spread, forcing the US Fed to ease monetary policy - but this will not be effective in stopping a liquidity bust.

All these things could happen, but are not guaranteed.

This paper has presented it's author's perspective on a diverse range of current economic parameters - and these comments have attempted to present another point of view on them.

The paper predicts a plausible, but not inevitable, financial crisis that would have severe economic consequences (i.e., a collapse in demand and a recession/depression) with attendant global social pain and political instability.

Clearly it behoves political and financial authorities to collaborate more effectively in developing global and national trade, financial and monetary regimes in which these risks are reduced.

* This point will resonate with iTulip Select readers. John did not get his thoughts on our theories on a future Alt Energy and Infrastructure bubbles from reading iTulip nor did we get these ideas from John. His belief that a deflationary bust does not necessarily follow a global asset bubble is also consistent with ideas we have developed independently over the years. Given John's background, experience, and location, we find the areas of agreement most intriguing.