Federal Reserve Admits Hiding Gold Swap Arrangements, GATA Says

Federal Reserve Admits Hiding Gold Swap Arrangements, GATA Says

MANCHESTER, Conn.--(BUSINESS WIRE)--The Federal Reserve System has disclosed to the Gold Anti-Trust Action Committee Inc. that it has gold swap arrangements with foreign banks that it does not want the public to know about.

The disclosure, GATA says, contradicts denials provided by the Fed to GATA in 2001 and suggests that the Fed is indeed very much involved in the surreptitious international central bank manipulation of the gold price particularly and the currency markets generally.

The Fed's disclosure came this week in a letter to GATA's Washington-area lawyer, William J. Olson of Vienna, Virginia (http://www.lawandfreedom.com/), denying GATA's administrative appeal of a freedom-of-information request to the Fed for information about gold swaps, transactions in which monetary gold is temporarily exchanged between central banks or between central banks and bullion banks. (See the International Monetary Fund's treatise on gold swaps here: http://www.imf.org/external/bopage/pdf/99-10.pdf.)

The letter, dated September 17 and written by Federal Reserve Board member Kevin M. Warsh (see http://www.federalreserve.gov/aboutthefed/bios/board/warsh.htm), formerly a member of the President's Working Group on Financial Markets, detailed the Fed's position that the gold swap records sought by GATA are exempt from disclosure under the U.S. Freedom of Information Act.

Warsh wrote in part: "In connection with your appeal, I have confirmed that the information withheld under Exemption 4 consists of confidential commercial or financial information relating to the operations of the Federal Reserve Banks that was obtained within the meaning of Exemption 4. This includes information relating to swap arrangements with foreign banks on behalf of the Federal Reserve System and is not the type of information that is customarily disclosed to the public. This information was properly withheld from you."

When, in 2001, GATA discovered a reference to gold swaps in the minutes of the January 31-February 1, 1995, meeting of the Federal Reserve's Federal Open Market Committee and pressed the Fed, through two U.S. senators, for an explanation, Fed Chairman Alan Greenspan denied that the Fed was involved in gold swaps in any way. Greenspan also produced a memorandum written by the Fed official who had been quoted about gold swaps in the FOMC minutes, FOMC General Counsel J. Virgil Mattingly, in which Mattingly denied making any such comments. (See http://www.gata.org/node/1181.)

The Fed's September 17 letter to GATA confirming that the Fed has gold swap arrangements can be found here:

http://www.gata.org/files/GATAFedResponse-09-17-2009.pdf

While the letter, GATA says, is far from the first official admission of central bank scheming to suppress the price of gold (for documentation of some of these admissions, see http://www.gata.org/node/6242 and http://www.gata.org/node/7096), it comes at a sensitive time in the currency and gold markets. The U.S. dollar is showing unprecedented weakness, the gold price is showing unprecedented strength, Western European central banks appear to be withdrawing from gold sales and leasing, and the International Monetary Fund is being pressed to take the lead in the gold price suppression scheme by selling gold from its own supposed reserves in the guise of providing financial support for poor nations.

GATA will seek to bring a lawsuit in federal court to appeal the Fed's denial of our freedom-of-information request. While this will require many thousands of dollars, the Fed's admission that it aims to conceal documentation of its gold swap arrangements establishes that such a lawsuit would have a distinct target and not be just a fishing expedition.

In pursuit of such a lawsuit and its general objective of liberating the precious metals markets and making them fair and transparent, GATA again asks for financial support from the public and from all gold and silver mining companies that are not at the mercy of market-manipulating governments and banks. GATA is recognized by the U.S. Internal Revenue Service as a non-profit educational and civil rights organization and contributions to it are federally tax-exempt in the United States. For information on donating to GATA, please visit here:

http://www.gata.org/node/16

People also can help GATA by bringing this information to the attention of financial news organizations and urging them to investigate the Fed's involvement in gold swaps particularly and the gold (and silver) price suppression generally.

Rich banks to benefit from loans to poor nations ~ says academic Buckley

MARK COLVIN: As leaders from the world's 20 biggest economies meet in Pittsburgh, one of the issues they are confronting is the plight of the world's poor.

Even though many poorer nations' own emissions are low, climate change is having a big impact on them.

And the global financial crisis has caused a collapse in trade and capital flows. It threatens poorer parts of the globe with poverty and hunger.

The G20 has committed hundreds of billions of dollars to the International Monetary Fund to help the hard hit emerging nations but critics argue that the IMF will only make their situation worse.

Among them is Ross Buckley, a professor of law at the University of New South Wales and an expert on global trade and finance.

He spoke to our economics correspondent Stephen Long.

ROSS BUCKLEY: A year ago nobody wanted to know the International Monetary Fund. Now it's the organiser for the international stimulus package which has been sold as a stimulus package for poor countries - but I don't really think it is.

STEPHEN LONG: Why not?

ROSS BUCKLEY: Because what it is is loans. Stimulus packages are usually grants. These are loans that are made by the G20 countries through the IMF to poor countries.

They have to be repaid and what they're going to be used for is to repay the international banks now. So it's really a stimulus package for the rich countries' banks.

STEPHEN LONG: So you think that the International Monetary Fund which has garnered what, somewhere between $US500 billion and $US750 billion to supposedly help the poor countries is actually in a sense a stalking horse for the big global finance houses.

ROSS BUCKLEY: I think that's precisely what's going on. And the reason it's going on is not enough people understand it. There's a democratic deficit if you like at the international level. I don't think rich countries' media or population would allow this but at the international level that's exactly what's happening.

STEPHEN LONG: Well explain why you think that that is the case.

ROSS BUCKLEY: Well because these loans, there's certainly over $500 billion, as you say, of loans. These loans are made by the rich countries to the IMF. They will be conditioned upon the poor countries using them to repay the debt that's due.

So these loans will be used to repay loans that are currently outstanding by poor countries to commercial banks. So the money won't really touchdown in the poor countries. It will go straight through them to repay their creditors.

The IMF lends the money to the countries. The countries use it to repay loans they have to the banks. But the poor countries will spend the next 30 years repaying the IMF.

In a way, if you'd like to see it this way, it's really an increase in seniority of the debt. At the moment the debt is owed by poor countries to banks and if the poor countries had to they could default on that.

The bank debt is going to be replaced by debt that's owed to the IMF which for very good strategic reasons the poor countries will always service.

STEPHEN LONG: How have we arrived at a situation then where as a result of the global financial crisis the International Monetary Fund has come out on top with so much of an increase in its resources?

ROSS BUCKLEY: I suppose because the rich countries need an intermediary to broker and channel the intervention that they want to have for their own interests. The rich countries have made this $500 billion available to stimulate their own banks and the IMF is a wonderful party to put in between the countries and the debtors and the banks.

STEPHEN LONG: Can we be that cynical about it? I've heard the head of the International Monetary Fund speak passionately about this crisis as the Great Recession and the terrible toll it will wreak amongst poor people in poor countries.

ROSS BUCKLEY: When you're adding $500 billion to the long-term debt of the poor countries, many of which are struggling under absolutely intolerable debt burdens already, yes I think we can be that cynical about it.

It's simply not in the, if we really wanted to act in the benefit of these poor countries we would cancel their interest for two years. We would, you know, do something that improves their cash flow now.

STEPHEN LONG: Before the last meeting of the Group of 20 in London earlier this year there was a push from some quarters, from Australia, from the former Reserve Bank official Stephen Grenville, the former prime minister and treasurer Paul Keating to, in effect, decapitate the IMF, take out its governing structure and put the G20 in its place to run the IMF.

Do you think that that would have been a worthwhile reform?

ROSS BUCKLEY: It's difficult to say, you know, the G20 is a broadly representative organisation. If the breadth of those diversity of views can get a voice in the G20 that might be a worthwhile thing.

But I think part of the problem with the IMF is the culture that's right the way through the organisation which is a very naive belief in the power of unfettered markets.

MARK COLVIN: Professor Ross Buckley from the University of New South Wales with Stephen Long.

http://www.abc.net.au/pm/content/2009/s2693454.htm

Self-righting markets and other shibboleths

The global financial crisis has revealed major weaknesses in conventional economics. Economists will need to face up to these if their discipline is to recover its reputation and relevance.

Many of these shortcomings arise from the belief that markets and economies are inherently stable. That is, the market system is self-righting. It's usually in ''equilibrium'' (balance) and, should some external event push it into disequilibrium, this sets off a process that returns the system to equilibrium quickly and easily.

Economists hold to this belief for various reasons. One is that it makes economics nice and neat, providing simple explanations and predictions (the predictions may not be very accurate, but who's counting?). It makes it easier to conduct economic analysis using maths rather than words, which makes academic economists feel scientific and intellectually high-powered.

But the belief in self-righting markets also fits nicely with the political philosophy of libertarianism - the supremacy of freedom of the individual, the minimal need for governments and taxes.

And it suits business interests, who want maximum freedom to make a buck in any way they see fit.

One of the many implications of the belief that markets are inherently stable is that there's no such thing as a business cycle. The economy is almost always at full employment because supply creates its own demand.

But surely, you may object, the whole discipline of macroeconomics is the study of how to stabilise the economy as it moves through the business cycle. Well, it used to be. Increasingly, however, it's been about trying to prove that governments are incapable of influencing the course of the macro economy and that what seems to be a cycle of deficient or excessive demand isn't really.

One notion is that the ups and downs are caused by people taking a bit of time to adjust to new advances in technology. Another is that unemployment is voluntary. Workers are so well off that when they consider the wage rates they're being offered are insufficient they take an unpaid holiday.

To the extent that some academic economists still believe in the existence of the business cycle, they study the concrete factors that cause it - the ups and downs in business inventories, for instance - not the more ephemeral, psychological factors such as optimism and pessimism, greed and fear.

But if the business cycle doesn't exist then it surely must also be the case that sharemarket crashes and financial crises don't happen.

Once again, you may think that the evidence of crashes and crises is readily apparent from the historical record. It is, but the dominant stream in academic economics has become adept at ignoring it.

Although on the one hand the study of economic history has fallen out of fashion in university economics courses, on the other some academics have sought to prove that the Dutch Tulip Bubble of 1624 and the South Sea Bubble of 1720 were really examples of wrong-headed government intervention in markets, not market failure.

Do you see what all this means? It means academic economists tend to focus their attention on what happens when everything is going right - when markets are in equilibrium - and give little thought to the circumstances in which things could go wrong.

Now do you see why so few economists could see the global financial crisis coming? They didn't see it because they weren't looking for it.

(Even those who now contrive to believe that the problems we've seen in the past year and more were caused by faulty government intervention in markets, rather than any fault on the part of markets themselves, weren't warning that these interventions could lead to disaster. No, markets were getting their way and the anti-government brigade was content that all would be well.)

This is the charge made by David Colander, of Middlebury College in Vermont, and six other American and European academics in a much-quoted paper, The Financial Crisis and the Systemic Failure of Academic Economics, that's come to be known as the Dahlem report.

One implication of this is that, despite its pretensions to the contrary, economics isn't very scientific. Like the rest of us, economists suffer from what psychologists call ''confirmation bias'' - they look for evidence that confirms their prior beliefs.

They tend to interpret evidence in ways that favour their beliefs. They remember evidence that goes their way and forget evidence that doesn't. We all do this, it's part of our lack of rationality - and economists are just as irrational as the rest of us.

In contrast, the scientific method involves trying to falsify your hypothesis, not confirm it.

Milton Friedman argued in a famous paper that it didn't matter if a model was built on unrealistic assumptions (such as human rationality). What mattered was whether the model led to accurate predictions.

You wouldn't believe it, but there are still economists who draw comfort from this pragmatic doctrine. You say economics produces inaccurate predictions? Not that I've ever noticed, it doesn't.

Another consequence of the assumption that markets always work well is that economists put a lot of effort into arguing for the removal of small inefficiencies caused by government intervention - restrictive shopping hours, for instance - while academics do little to study or help prevent the gross inefficiencies caused by having thousands of workers lying idle as a result of financial crises and recessions.

Now, economists are terribly defensive people and they'll be able to think of exceptions to every charge I've made. It's true that not all academic economists doubt the existence of the business cycle or asset-price bubbles. There are even some who study our lack of rationality. And economic practitioners, including econocrats, don't all share the extreme views of the academics.

But what I've described is the dominant view prevailing among academic economists. Behavioural economists, for instance, are a fringe minority. And it's surprising how much influence the doctrines of the high priests have on the beliefs and behaviour of practitioners.

The trouble with economics is that the conventional theory has come adrift from the real world and taken on a life of its own. The answer is for academic economics to become less theory-driven and more empirical.

There needs to be a lot more emphasis on testing theories against empirical evidence - and looking for falsification - and on simply seeking to identify empirical relationships and regularities.

With enough of these, economists could search for new theories to explain those relationships. But we also need more study of how markets and economies come unstuck.

Ross Gittins is the Herald's Economics Editor.
Ads by Google

http://www.smh.com.au/business/selfrighting-markets-and-other-shibboleths-20090918-fvb3.html

A 300-year-old example of quantitative easing ~ Law of easy money

“IF FIVE hundred millions of paper had been of such advantage, five hundred millions additional would be of still greater advantage.” So Charles Mackay, author of Extraordinary Popular Delusions and the Madness of Crowds, described the “quantitative easing” tactics of the French regent and his economic adviser, John Law, at the time of the Mississippi bubble in the early 18th century. The Mississippi scheme was a precursor of modern attempts to reflate the economy with unorthodox monetary policies. It is hard not to be struck by parallels with recent events.

Law was a brilliant mathematician who used his understanding of probability to help his gambling habit. Escaping from his native Scotland after killing a rival in a duel, he made friends with the Duke of Orleans, the regent of the young king Louis XV.

The finances of the French government were in a terrible mess. Louis XIV had spent much of his long reign fighting expensive wars. Tax collection was in the hands of various agents, who were more concerned with enriching themselves than the state. Not only was the monarchy struggling to pay the interest on its debt, there was also a credit crunch in the form of a shortage of the gold and silver coins needed to fund economic activity.


Law’s insight was that economic activity could be boosted by the use of paper money that was not backed by gold and silver. He was well ahead of his time.

Establishing confidence in a new monetary system was the trickiest part. Law had the benefit of working for an absolute monarchy which could decree that taxes should be paid in the form of notes issued by his new bank, Banque Générale. He also believed, having observed the success of the Dutch in exploiting the spice trade in the East Indies, that France could use paper money to develop its colonial possessions. Hence the Mississippi scheme, under which Law created the Compagnie d’Occident to exploit trade opportunities in what is now the United States. The money raised from these share issues was used to repay the government’s debts; on occasion, Law’s bank lent investors the money to buy shares.

Turn this into modern economic jargon and Law could be described as creating a stimulus package for French economic activity. But rather than rescuing sunset industries such as carmaking, Law was an early venture capitalist, financing the dynamic potential of the Mississippi delta.

The problem was that the delta was a mosquito-infested swamp. According to Niall Ferguson, a historian, 80% of the early colonists died from starvation or disease. Even though the company had monopolies over things like tobacco, it had little chance of generating enough income to fund the dividends Law had promised.

So a vicious circle was created, in which a growing money supply was needed to bolster the share price of the Mississippi company and a rising share price was needed to maintain confidence in the system of paper money. You can see parallels with recent times, in which money was lent on the back of rising asset prices, and higher prices gave banks the confidence to lend more money.

When the scheme faltered Law resorted to a number of rescue packages, many of which have their echoes 300 years later. One was for the bank to guarantee to buy shares in the Mississippi company at a set price (think of the various government asset-purchase schemes today). Then the company took over the bank (a rescue along the lines of Fannie Mae and Freddie Mac). Finally there were restrictions on the amount of gold and silver that could be owned (something America tried in the 1930s).

All these rules failed and the scheme collapsed. Law was exiled and died in poverty. The French state’s finances stayed weak, helping trigger the 1789 revolution. The idea of a “fiat” currency was perceived to be the essence of recklessness for another two centuries and the link between money and gold was not fully abandoned until the 1970s, when the Bretton Woods system expired.

Of course, the parallels with today are not exact. Law’s system took just four years to collapse; today’s fiat money regime has been running for nearly 40 years. The growth in money supply has been less excessive this time. Technological change and the entry of China into the world economy have generated growth rates beyond the dreams of 18th-century man. But one lesson from Law’s sorry tale endures: attempts to maintain asset prices above their fundamental value are eventually doomed to failure.

http://www.economist.com/businessfinance/displayStory.cfm?story_id=14215012

Global systemic crisis Alert - Summer 2009: Cessation of payment of U.S. government GEAB 37

GEAB N°37 is available! Global systemic crisis: In pursuit of the impossible recovery

- Public announcement GEAB N°37 (Septembre 16, 2009) -



Before this summer, LEAP/E2020's team announced that there would be no recovery in sight in September 2009, and not until summer 2010 in any event. Well indeed, contrary to the claims of the media, and financial and political circles, we confirm our anticipation.

The slowdown in the speed of collapse of the global economy, at the origin of all the « good news » (1), is only due to the world's enormous public financial effort of the last twelve months (2). But the « time saved » using taxpayers' money around the world should have been dedicated to redesigning the international monetary system at the heart of the current systemic crisis (3). Yet, besides a few cosmetic considerations (4) and huge gifts to US and European banks, nothing serious has been undertaken, and, when it comes to the future, the « every man for himself » rule prevails (5).

Now, as summer 2009 comes to a close, and as the three rogue waves start impacting the global economy hard (unemployment (6), bankruptcies (7) and monetary shocks (8)), the time to mend the system, or to prepare for a soft transition towards a new global system, is over (9). The first signs of a major decoupling (10) are beginning to appear: the rest of the world is rapidly moving away from the Dollar zone. As shown by the chart below, there is a 95 percent chance that 1,000 billion new USDs will be printed in a very near future... not very attractive for the Dollar zone.

Inconsistent statistics reflect a chaotic world economy
We are heading straight to the phase of geopolitical dislocation expected to begin in the fourth quarter of 2009 (11). In this issue of the GEAB, our team analyses the trends at work (real estate market, srategic issues…) within the current chaos resulting from a flood of unchecked public expenditure and a persistently uncontrolled financial system in a context of growingly inconsistent statistics. Paradoxically, dislocation has become, according to our researchers, the only way to economic recovery (a recovery that will take place around a global architecture and interaction between economic, social and financial spheres profoundly different from anything we knew in past decades. Our team believes that the first features of the “post-crisis world” should begin to appear by summer 2010 and, in the coming months, they will dedicate themselves to their identification.

Meanwhile, as anticipated in the previous editions of the GEAB, no one can now construct a true picture of today’s global economic situation as macroeconomic figures are more and more contradictory or simply absurd (12). Measurement data and instruments have been so manipulated (13) and limited to a volatile US Dollar as sole benchmark (14), that no government, international organisation or bank (15) can now tell in which direction the global system is heading. The media reflect this chaos and contribute to their readers’/auditors’/viewers’ bewilderment: depending on the day, or even the hour, that they give contradictory news on finance, economy or currency. Policy makers, entrepreneurs, employees,… economists or analysts… are reduced to Pascal’s wager (16) to assess what will happen in future months.


Global output, trade and consumer prices (2000 – 2009) – Source: BRI, 2009
According to LEAP/E2020, the chart above tells about facts that cannot be ignored: the global economic, financial and monetary system is drifting at an increasing rate, its weakness is reaching unequalled lows in modern history, and the slightest shock (financial, geopolitical or even natural) can now break it apart (17). The States’ breathtaking plunge into bottomless public debt (18) (governments feel that, without the support of public money, world economies would soon resume their collapse) is creating a literally explosive situation, conveying massive tax increase in Japan, Europe, the US… If there is any recovery in sight, it is that of tax. As a matter of fact, confronted to historic unemployment rates and a free-falling economy, Japanese voters decided to dismiss their decade-old leaders: they have probably inaugurated the great political upheaval of the next phase of the crisis (19). This summer, the Obama administration was also surprised to discover the importance of the popular anger which focused on his health system reform programme (though a much needed one).


Charter rates for container ships (in USD/day) – Showing the decline between the two first quarters of 2008 and 2009 - Source: Spiegel / ISL Port Monitor
Here is a very illustrative analogy of the crisis today that imposed itself on our researchers: a rubber ball in a staircase. It seems to rebound on every step (then giving the impression that the fall has stopped) but it falls even lower on the next step, “resuming” its collapse.

“Disoriented” economic players and policy-makers
Of course, all this doesn’t create a favourable investment climate for business. Production capacity is under-used everywhere in historic proportions. Stocks are only renewed at a drip-feed rate (eliminating any hope of a recovery based on their replacement). Consumers have become realistic economically: no money, no purchase. Their salaries fall when they haven’t simply been lost through job losses, the banks don’t lend any more because they know that they themselves are still insolvent (despite the “golden” powder thrown in the eyes of public opinion these last months) (21). The state itself, on its own, cannot substitute itself for the frenetic consumerism of the past. In the US, a return to the previous state would require about USD 2,500 billion pumped into the economy each year. Barak Obama’s stimulus package, less than USD 400 billion a year over two years is far from the amount needed if he has to replace the non-spending of households and businesses. The problem is that this is exactly the present situation of the US economy.


US retail sales during recent recessions (Rebased to 100 at recession inception, duration in months) - Source: Financial Sense, 2009
But the US are not alone in this regard. Asia and Europe are also confronted with a drastic unemployment surge that statistical manipulation (22) cannot hide beyond this summer: jobless no longer entitled to unemployment benefits, youngsters placed in waiting internships or jobless recruited for short-term public construction projects, lay-offs postponed by means of short-time allowance measures, plants artificially maintained in activity thanks to public funds,… from Beijing to Paris, in Washington, Berlin, London or Tokyo, every trick is being used to hide the situation as long as possible… until the recovery arrives. Unfortunately, the recovery will not arrive in time. It’s Blücher instead of Grouchy (23). Instead of a recovery in September, the world is suffering the impact of this summer’s three rogue waves:

. massive unemployment, for people soon to be excluded from further benefits in particular, and its disastrous consequences for nations’ political and social stability, are beginning to appear

. the number of bankruptcies (companies, municipalities,…) and deficits of all sorts, are exploding

. and, of course, the impact of all this on the US Dollar, Treasuries (and the UK, suffering collateral damage) .

The first wave already reached the shore at the end of summer 2009. The second one is coming up. And the third is beginning to appear on the horizon.

In any event, if the Eurozone and Asia are in a better situation to face up to the impact of these waves (as already analyzed in GEAB N°28 of last October), their situation is not so good that they can expect a recovery yet. It is however on the US, the Dollar and US Treasuries on the one hand, and on the UK and the Pound on the other , that the consequences of the three waves will be harder. Mid-summer night dreams also have an end!

But for those who still have enough money to travel, the holidays can go on as hotels, airline companies, holiday resorts… are giving discounts at prices never seen before. Another sign that the recovery is here!

----------
Notes:

(1) For example, the fact of talking in percentage points is part of this summer's « euphoria » operation. Indeed, many banks, whose stock price was close to zero could claim « rebounds » of +200 percent, +300 percent or +500 percent. Taking a look at Natixis, Citi or Royal Bank of Scotland stock prices helps to understand the trap: regaining 500 percent when the stock fell down to 1, that makes 5... which would leave you holding a loss of 40 if you bought 2 years ago (or if you borrowed money in exchange of this security).

(2) This is illustrated by France's recent announcement that the state wishes to continue to support the banking system until the end of 2010. Source: Reuters, 09/13/2009

(3) See LEAP open letter to the G20 published last April in the Financial Times on the eve of London's G20 summit.

(4) The great « traders' bonus hunt » is morally praiseworthy. However it should not make us forget that traders are nothing but the « privateers » of the banks hiring them and of the financial centres hosting the latter. These employers and their hosts give them their « letters of marque » (or should we say « of bonus »?) authorizing them to buccaneer the seas of global finance. Limiting their bonuses to their total salary would compel banks to hire them as master mariners instead of filibusters.

(5) Source: Times, 09/02/2009

(6) In the United States, the real rate of unemployment growth remains between 600,000 and 1 million new jobless every month, if we include those who decide to stop searching for a job (source: CNBC/New York Times, 09/07/2009). To get an idea of the socially explosive wave currently hitting the US economy, in California, since September 1st, 143,000 new jobless are no longer entitled to insurance benefits (including their families, that makes an extra 1 million people in distress... just for this month) – source : MyBudget360, 09/02/2009. In Europe, Asia, … everywhere, unemployment rates are almost the highest in modern history (at 5.7 percent, Japan already reached its historic high in July – source : Japan Times, 09/08/2009) ... despite all sorts of manipulation to reduce the figures.

(7) As an anecdote, there have been more bankruptcies in the US between GEAB N°36 (June 16, 2009) and GEAB N°37 (September 16, 2009) than during the whole of 2008, including two of the most important bankruptcies of the year. But, of course, the media cannot make their headlines on both swine fever and bankruptcies. The same goes for the rate of US corporate bankruptcies which has reached a 12.2 percent all-time high (source: Yahoo, 09/09/2009). In Spain, the number of bankruptcies in the first semester of 2009 is three times the number in 2008 (source: Spanish News, 08/06/2009). In France, employers expect 70,000 corporate bankruptcies by the end of this year (source: Capital, 09/02/2009).

(8) The accelerating pace of the weakening of the US Dollar is creating new monetary stress worldwide and the upcoming request, by the Obama administration, to increase the authorized US federal debt ceiling by USD 1,500-billion is not likely to slow down the selling of the US currency. Indeed the USD 12,000-billion debt ceiling is about to be reached. Sources: Wall Street Journal, 09/12/09; Bloomberg, 09/08/2009; Wall Street Journal, 09/12/09

(9) As we said, such a « window of opportunity » existed between spring and summer 2009. This window is now closed.

(10) See GEAB N°22, 02/2008

(11) See GEAB N°32, 02/2009.

(12) For example, US and French unemployment rate reductions at the beginning of this summer, or the growth in Chinese output. Sources: New York Times, 08/10/2009; Expansion, 07/27/2009; Wall Street Journal, 05/25/2009

(13) It is worth reading Marion Selz’s paper entitled « Statistics, a public service twisted » introducing a recently published book written anonymously by a group of French statisticians with the evocative title « The great fiddle: How the government manipulates statistics». Obviously, in these times of global crisis, the information revealed in this book applies to almost all governments. Source: La vie des idées, 09/02/2009

(14) When, in February 2008 in GEAB N°22, we anticipated that the world was heading to a « Dollar carry-trade », not many people believed us. However this is now exactly what is happening on currency markets. Source: Le Monde, 09/12/2009

(15) Banks which, in April 2009, were eager to get the right to return to the « fair value » system (I estimate my asset is worth 100) (source: Bloomberg, 04/02/2009) instead of valuing their assets at “market value” (on the market, your asset is worth 10). Thus they persist in keeping assets in their balance sheets which they cannot realistically value; precisely because they suspect these assets to be worth 10 or 20 percent of their ‘fair value. The countryside and cities of the US, UK, Spain, Latvia, Japan, China, and other countries are full of houses, flats and buildings that no one buys because their prices are artificially maintained high above the market price so that banks’ balances sheets do not show that they are in fact insolvent because almost all their assets are “rotten”. Bankers too are trying to save time, in the hope of a return to yesterday’s world. Are they old children nostalgic of their golden age or big offenders endangering society? The future will soon tell us as the next phase of global geopolitical dislocation will develop.

(16) Refering to Blaise Pascal’s argument to convince miscreants to believe in God: wager as though God exists because if it is so, paradise is the reward, and otherwise, it simply doesn’t matter; while the contrary wager might take you to hell.

(17) In the next GEAB, the October issue N°38, we shall update our country- and big region-based anticipations, including of course an assessment of the situation regarding US and UK defaults.

(18) With a record-high debt issuance in Europe (EUR 1,100-billion in 2009, and more than EUR 250-billion for the UK only), and with USD 9,000-billion federal deficit over the next ten years, there is no doubt on the fact that the situation is uncontrollable. Source: Yahoo/Reuters, 09/04/2009; CBS, 08/25/2009

(19) In the US, in Europe and in China too. Sources: Reuters, 09/08/2009; Financial Times, 09/06/2009; BBC, 07/26/2009.

(20) On the subject of banks, our team strongly recommends reading the excellent article by Matt Taibbi, “Inside the great American bubble machine” which appeared in Rollingstones on 07/02/2009. It sets out the history of Goldman Sachs and throws essential light on its financial practices and central role in the current financial crisis. In the way of deceased India companies, or the knights templars, it is likely that in five to a maximum of ten years from now, American political power, in the face of a socio-economic collapse and under public pressure, will be obliged to tear apart this institution which interferes in all levels of government activity.

(21) In the end, all these indicators depend on the US Dollar as a measure of value. But if Dollar volatility were to be transferred to a compass, we would see the needle swing between North, South, East and West every month. No wonder then that political, economic and financial leaders are so « disoriented »!

(22) Napoleon too, during the battle of Waterloo, firmly believed th at luck was still on his side and that reinforcements (Grouchy) would materialize at the decisive moment of the battle. Alas, the long awaited troops, whose dust showed their rapid progress, happened to be the enemy’s reinforcements (Blücher). We know what happened next… and we cannot bet that the G20 leaders are strategists as experienced as Napoleon was.

(23) The crisis has somewhat « British humour » and proves that we are far from having seen all its consequences. Indeed, London is now expecting to have to pay a heavy bill in order to rescue its little network of tax havens. The Cayman Islands, for instance, can no longer pay their civil servants. No doubt British taxpayers will be very happy with this perspective! Otherwise, these islands could also resort to a simple idea: create taxes. Source: Guardian, 09/13/2009

Mercredi 16 Septembre 2009


http://www.leap2020.eu/GEAB-N-37-is-available!-Global-systemic-crisis-In-pursuit-of-the-impossible-recovery_a3797.html

One Year After Financial Crisis, Reform Questions Loom

Watch

JUDY WOODRUFF: Jeffrey Brown looks now at where things stand one year later.

JEFFREY BROWN: And joining me for that are Nassim Taleb, a statistician, trader and author of several books on probability and risk, including "The Black Swan." He's an adviser to Universa Investments and teaches at New York University.

Donald Marron is chairman and CEO of Lightyear Capital, a private equity firm, and former chief executive of Paine Webber.

And Alan Blinder, professor of economics at Princeton University, he was vice chair of the Federal Reserve from 1994 to 1996.

Donald Marron, you were at the speech today. Was the president right to warn of complacency on Wall Street? Has enough changed in the year since Lehman collapsed?

DONALD MARRON, Lightyear Capital: Yes, I think a lot has changed. He was very straightforward. I think he gave an outstanding speech. He was articulate. He certainly knew the issues.

Basically, he said three things. The first one is, we need an agency to protect individuals against others who create products and against themselves. Secondly, we need more regulation to regulate all these securities firms and banks. And, third, we need legislative power to make sure this never happens again, that somehow it can be stopped before it goes over the edge.

And I think he delivered each of those positively. Obviously, God is in the details on these things. But this is certainly a speech and a set of issues that wouldn't have occurred a year or year-and-a-half ago. It was an important change.

JEFFREY BROWN: Well, Nassim Taleb, you had warned of instability for many years before what came to pass occurred. So where do you think we are now?

NASSIM TALEB, New York University: Still the same situation. We have the same leverage in the system that we had before. The too-big-to-fail effect is right there, no different from what it was before. And banks are taking the same reckless risks they don't understand as they did before with the very same pseudo-scientists managing the risks.

So I don't see what changed. And we have 6 million Americans at home now more than we had before. I don't see what changed. The risks are still there. We need to lower the leverage, make the world more robust, and it's not.

JEFFREY BROWN: All right, a lot of things to pick up there, but let me bring in Alan Blinder. First, a kind of general assessment. The president did talk about growing stability and gave credit to his team for bringing that about. You've talked about that on this program in the past, the need for all of that. What do you think now?

ALAN BLINDER, Princeton University: Well, I think things look enormously better than they were, say, six months ago, I guess the bottom of the stock -- I think President Obama called the bottom of the stock market on March 9th.

I think things his team has done have helped a lot. I think things the Fed have done have helped even more. The Fed's not part of his team, I might point out. It's an independent agency and needs to stay that way.

But between the Treasury and the Fed and the FDIC and a few others, I think they've made an enormous difference doing, by the way, extraordinary things that I'm sure if you asked any of them two years ago would they ever do something like that, they would have said no.







Nassim Taleb
Author, The Black Swan

I think what's happening is both risky and immoral.





The problem of too-big-to-fail
JEFFREY BROWN: Well, let's pick up on some of the issues you've all raised. Mr. Marron, Mr. Taleb was talking about the too-big-to-fail doctrine. Now, in part of the consolidation of the industry of the last year, part of it was to allow a lot of institutions to survive. So have we created larger institutions that are still too big to fail or even bigger than they were before?


DONALD MARRON: Yes, it's a key question. I think what we did, first of all, is we brought a larger percentage of Wall Street under the banking regulators, the Fed. And that was a necessary thing to do. I'm not sure it was the best thing to do, but we had to do it. And that, in turn, has resulted, obviously, in lower leverage in various controls that are going there.

The other thing that we did, obviously, is tell the public and the clients and the world that there's a few institutions that are going to be there no matter what. The result of that is they are getting bigger proportionally to the rest of the system. I'm not sure that's a great thing.

And I think one of the questions you have to ask about too big to fail, are they too big to manage? Part of this whole business that we don't talk about is talent, the talent to manage all these complex products, services that are produced. And this is an industry that can easily spawn other organizations.

So I think what you're going to see going forward, particularly with the limitations on compensation, is a lot of talent moving to smaller organizations, finding a way to build them and to compete in the real world. The question is, will the new regulatory environment encourage that? Or will it discourage it?

This country and Wall Street is built on being entrepreneurial. The trend that we're going to now is basically the reverse.

JEFFREY BROWN: But, Mr. Taleb, you're taking this further.

NASSIM TALEB: Yes.

JEFFREY BROWN: You see the chance for continued major failures looking ahead?

NASSIM TALEB: Well, I think what's happening is both risky and immoral. Why immoral? Number one, we're transforming private debt into public debt. Private debt normally with a system of transforming debt into equity or through bankruptcy would disappear. When you fail, you disappear.

We're transforming that into debt for our children. And, of course, we're going to have to raise bonds with the deficits, and that may cause inflation.

The other problem is that the Obama administration has been rewarding failure, OK? Instead of strengthening people who are countercyclical, just like they gave a deal with the Cash for Clunkers to people who bought the wrong car -- I bought the right car, I'm not eligible for Cash for Clunkers, so I'm subsidizing the one who made the mistake, likewise, you have a raise of taxes, penalizing those who are countercyclical, doing OK in 2009, and giving a tax break to those who got us here, the Wall Streeters.

I have not seen from the Obama administration the right kind of leadership that we should be having. I haven't seen anybody stand up and said, "We need blood, sweat and tears." Let's reduce the debt in the system, and let's not tax our children with all these stimulus programs, have not seen that.

The only people who are talking about are the U.K. Conservative Party. Outside of that, I have not seen anything. The risk in the system is being transferred to our children. That's not acceptable.







Alan Blinder
Princeton University

[W]e're a lot better off today than if we had tried to balance the budget on the backs of a dying -- I don't want to say a dying -- a sick economy at the beginning of this year.





Grading Obama
JEFFREY BROWN: Mr. Blinder, why don't you come back on that? Because you're talking about the role of the government in trying to intervene and at the right time, so respond.


ALAN BLINDER: Yes, let me separate that into two responses, very briefly. First is the fiscal stimulus. The argument for this is as old as Cane's. When there's not enough demand in the system to get people employed or to prevent them from losing their jobs, one thing the government can do is spend more or cut people's taxes and get them to spend more or something else to induce spending, but all of those things raise the deficit transitorily, not forever, but transitorily, and we're still in that position.

And we're a lot better off today than if we had tried to balance the budget on the backs of a dying -- I don't want to say a dying -- a sick economy at the beginning of this year. The rest of it, hopefully, will not be spending. It's in the form of guarantees, asset purchases, loans. Some of it, as President Obama has mentioned, has already come back, turning a modest profit to the U.S. government.

Some of it will probably be lost, but lost for a good reason, lost so as to prevent or at least reduce, to de minimis the risk of what Ben Bernanke called Great Depression 2.0. If we had gone down that path, the amount -- the losses to Americans would be a multiple of the debt that's piling up.

Now, one last point. We do need to address that debt. I don't want to sound like I'm completely relaxed about piles and piles of debt, about $9 trillion in deficits over the next 10 years, or maybe more. I'm not relaxed about it; we do need to do something about it. But the paradoxical answer is not yet. It's not time to withdraw that stimulus.







Donald Marron
Lightyear Capital

[W]hat we know for sure, is all the money that's gone into the system, only some of it will work, and some of it won't.





Unwinding government support
JEFFREY BROWN: Mr. Marron, you want to come in on this subject?


DONALD MARRON: Yes, I do, I think. I think the answer is, one has to be very practical about this. Wall Street for 100 years was in the business of making illiquid assets liquid, first bonds, then stocks, even companies with LBOs.

What happened in the last couple of years is, liquid assets, including mortgages, became illiquid. The whole system started to fail because people in big firms and traders, recognizing they made a mistake, couldn't sell what they had to sell -- that was the first thing -- and values declined, as well as the economics that underlied those values. By throwing all this money into the system, the government has certainly improved that.

The second thing is what we know for sure, is all the money that's gone into the system, only some of it will work, and some of it won't. Will the administration be capable of taking the money that isn't worked and redeploying it? That's the key thing.

And, third, what's going to happen to the flow of money in the system? For example, before this started, money market funds had about a billion -- $1.5 trillion or $2 trillion. It's now up to about $3.7 trillion. Why? In the main, because people are scared. You know, putting money essentially in cash, getting no return.

The way markets work and the way a system works is you have to have people having a fundamental confidence in the system. A key element of that is, if they buy something, they're getting value, and they should be able to sell it whenever they want to. That fear of that situation is one of the reasons that we have this problem.

So the final issue for the government now, I think, when it thinks about what to do in building this confidence, it has to raise the ability to lend to small business. It has to raise the ability for people to buy houses.

And in the broader sense, they have to regain the confidence in the system. One way to do that is transparency. We created too many products that nobody, even the pros, can understand. And the second way is standardization, so you have enough of a single product so you can have a market.

It's a simultaneous equation. If we don't do these things, then the Bear story will happen again. If we do these things, then we'll set the base, as Alan said, for going forward, not now, not yet, hopefully soon.







Nassim Taleb
Author, The Black Swan

[R]egulation can do a good job, but just blind regulation is not the solution. The solution to me is the cancer we have in the system -- too much debt





Pushing for stricter regulation
JEFFREY BROWN: All right, let me let Mr. Taleb back on this, because, I mean, part of this question is about government regulation and what the government might be able to do, while preserving the ability of risk in the system.


NASSIM TALEB: Well, before talking about regulation -- and, again, regulators failed us here -- let's talk about the economic establishment. All these measures I hear, oh, transitory deficit, oh, we'll repay it back, come from people using models that did not predict what's going on. They did not see the elephant in the room -- too much debt -- and all these models are completely unpredictive of anything. So don't predict. Let's try to lower debt so we don't have to predict.

As to the regulators, we have to realize that the regulators got us here by favoring a risk measurement system by banks -- and banks lost $4.3 trillion on failures of risk management systems -- that the regulators (inaudible) the value at risk, and regulators are the ones who help people get into the pseudo-AAA securities, but with these regulations.

So regulations is not a panacea. I agree, regulation can do a good job, but just blind regulation is not the solution. The solution to me is the cancer we have in the system -- too much debt -- and let's stop talking about painkillers. Let's remove the tumor.

It takes, you know, work to remove the tumor. It's painful to remove the tumor. But the sooner we remove it, the better, instead of delaying, saying, "Transitory, transitory, transitory." The debt today is the same debt as we had a year ago. Actually, it's increasing.

JEFFREY BROWN: Mr. Blinder, we just have a minute left. I was thinking of something that Mr. Taleb just said. A year later, nobody comes off looking all that good, do they, the pros on Wall Street, the regulators in government, and the economists in your own profession? I see there's a lot of debate about, what did we know? Were our models all wrong?

ALAN BLINDER: Absolutely. And I wouldn't absolve economists or my own profession from the guilt list. I think the guilt list is very long, not equally weighted, of course, but very, very long, from the government to the private sector and almost anybody you can think of.

The heroes were few and far between. There were a few people that were sounding the alarm. They were not listened to very much.

And, you know, you don't get in to a catastrophe like this with just one or two small errors. It takes a whole lot of very large errors. And that's what we had, unfortunately.

JEFFREY BROWN: All right, we'll leave it there. Alan Blinder, Nassim Taleb, and Donald Marron, thank you all very much.

JUDY WOODRUFF: There's much more about the financial crisis on our Web site, newshour.pbs.org. You can listen to all of President Obama's Wall Street speech, see what experts say about the origins and the impact of the meltdown on Paul Solman's "Business Desk"; and read about lessons learned from the collapse of Lehman Brothers.

"I think we're going to experience a stagflation like we have never seen." ~ the Dude

The Lessons of Lehman...and Leeson
Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we're still recovering, they're choosing to ignore those lessons. President Obama

I burst out laughing when I read the above line in the President's speech yesterday. "The lessons of Lehman!" I thought, "he's got to be joking." I have no doubt Big Finance took that lesson straight to heart.

Let's consider the meaning of the "lessons of Lehman." Given the context, I suspect the President wants Big Finance to see the demise of Lehman as an object lesson- as one might warn a friend trying to ride out a hurricane in New Orleans by reminding him to remember the lessons of Katrina. If this friend had just moved to New Orleans and was unfamiliar with Gulf Coast hurricanes, the "lessons of Katrina" reminder would likely be sufficient.

If, however, this friend owned a house in the French Quarter and had ridden out Katrina the reminder of the lessons thereof might evoke a chuckle and a quick retort, "Katrina taught me that the French Quarter is safe." "The lesson of Lehman," Big Finance CEOs might chuckle to themselves, "is to make sure we're too big to fail." Lehman's balance sheet wasn't big enough, thus failure was an option for them, but not for the biggest banks.

Or so they seem to think.

One of the reasons I didn't write much over the past few months (besides a general laziness and desire to enjoy the summer) was a strong feeling, whenever I looked at the data, of watching a horrible car crash in slow motion. Better, I thought, to avert my eyes.

Yesterday I spent a few hours filling up my spread sheets and catching up on policy speeches and decided the feeling that came over me wasn't as if I was watching a slow motion car crash. I feel now as if I'm a position clerk for Nick Leeson, the bane of Barings Bank, and everyone in the country works for them.

As is my wont, when a feeling like that hits me a quick Google search for "Nick Leeson" is just a few clicks away. Among the more familiar reports I was surprised to find a scholarly examination of the event from NYU's Stern School of Business, about which, more later.

In the movie, Rogue Trader, Nick Leeson explains the secret of his success in a sound bite Big Finance would love, "You keep doubling up, and sooner or later you're bound to win." In the event, Mr. Leeson found this not to be true as the losses on his long position in Nikkei futures (and related derivatives) exploded after the Kobe Earthquake sent the Japanese market plunging early in 1995.

The lesson of Leeson is that doubling up is no guarantee of success. Indeed, according to the NYU paper: Our interest in Mr. Leeson comes from the fact that doubling strategies are potentially dangerous from a systemic point of view. An important attribute of doubling strategies is that the inevitable and devastating loss is preceded by a period of high returns with low volatility. Conditional on the bad event not having happened (yet), the doubler’s investment performance appears to indicate significant investment skill. The doubler may then become too big to fail, both from the perspective of the investment firm and from the market regulators, so that the inevitable failure can have catastrophic effects, both for the firm and for the market. Among other things, this has important consequences for the effectiveness of Value at Risk-controls. Being able to track and take out these traders sooner, would limit possible systemic risks.

Of course, I'm not arguing that Big Finance is doubling up on a hidden (losing) long position in the Nikkei. Their losses are reasonably well known (if not well quantified) and, at least with respect to real estate, not about to turn into profits any time soon. This rogue is out in the open.

Like Leeson, Big Finance doesn't consider liquidation, which would realize the losses, an option. Like Leeson (whose book would make a great study in a Psych course), Big Finance would have us believe their motives are pure. I, however, find this view from the NYU paper interesting: That managers take additional risks to escape from a threatening situation is a well known theme in the field of managerial decision making. For example, Shapira (1997) and Kahneman and Tversky (1986, p. S258) show that people will take greater risks to escape losses than to secure gains. As a consequence, people's behavior tends to change in unexpected and unattractive ways when they are confronted with increasing losses. Thus in finance, where many occupations are high-wire acts, the fear of falling is constantly in the background and sometimes can lure people into disastrous activities. Individuals can become gripped by a frantic panic and may try to conceal these losses, or double up their bets like crazed gamblers trying to punt their way out of their mounting debts. This is the classic gambler’s fallacy.

There are, however, differences between the two.

Unlike Leeson, Big Finance has a supporter who agrees that liquidation isn't an option in the form of the Fed. If Nick had the Fed on his side he could have held on for a few more years (although current levels around 10K for the N225 suggest a loss orders of magnitude larger). The Fed (and Treasury) upon discovering the huge losses, not only provided liquidity to Big Finance, they provided capital support and relaxed accounting rules. As many others have covered (so I'll be brief) this support is unprecedented and ongoing. The "tide" of liquidity is high, as Warren Buffett might put it, and financial markets have responded (albeit with far less bang per buck).

Thus Bernanke, Geithner and even President Obama are engaged in a bit of cautious back-slapping.

This back slapping reminds me of another scene in Rogue Trader: 1994 is coming to a close and Leeson is long Nikkei futures and short Nikkei calls. The price is shown in big numbers, dominating the screen. He cheers and congratulates his team as as the Nikkei keeps rising and closes on its high.

In the NYU paper on the event the authors write: Leeson first sold options on the Nikkei index in October 1992, but his activity in this market really started in the second half of 1993. The value of the option portfolio fluctuated wildly over time, but it had mostly been positive. The highest value was reached by the end of December 1994, when the total value of the options was approximately US$178 million. Mainly due to the Kobe Earthquake, this reversed to a loss of approximately US$108 million by the end of February 1995 (SR App. 3K, p.179)

Given that he wasn't unwinding his risk into the rally, the cheers and back-slapping in December 1994 proved a bit premature. I'm pretty sure if he tried to unwind his position the market would have reversed.

Given that Big Finance isn't unwinding its balance sheet (I know that position can't be unwound without serious market damage) in the current environment, I suspect Bernanke's victory laps and Obama's reassurances may also prove premature, if, as I suspect, the transfer of "toxic" debt to the Fed proves as successful as similar operations in Japan. The reason for this, I surmise, is that such transfers merely buy time, which, when the losses are a large percentage of GDP, is only useful if one can grow out of the problem (which would require rapid growth) or if underlying conditions which created the loss, reverse.

These "underlying conditions" are the crux of the issue. When positions sizes are small enough for a given market, managers can play (and win) under the greater fool theory. The illusion of demand can be created long enough to sell out (or vice versa). However, when positions grow such that they cannot be dumped, the greater fool theory is disproved- you are the greatest fool. This doesn't necessarily guarantee a loss. It does, however, bring finance back to its beginning- the bets must prove out in the real sector.

Thus my concern.

Leeson bet the ranch on Japan returning to its go-go days. But Japan was an aging population with high wealth concentration in the aftermath of a bubble- a perfect recipe for risk aversion. Fortunately, Japan could self-finance and until recently seemed reasonably content to be a mature economy.

Big Finance, in a far more profound sense, has bet the ranch (our ranch) on the US returning to its go-go days. But the US (somewhat obscured by looser immigration standards) is an aging population with high wealth concentration. From whence will come the next productivity enhancing investments that (importantly) can operate within the existing capital structure (since liquidation is off the table). The computer and related communication boom was a perfect way to extend the life of the post WWII infrastructure, but those productivity effects are in the past.

Unfortunately, unlike Japan, we cannot self-finance. We need those capital markets flowing, however inspired.

Thus we took a page from the BoJ playbook and adopted a ZIRP (the world's reserve currency managers opt for a zero interest rate policy....amazing), and the effects are manifesting. Cheap $ finance is already working its magic in the commodity and equity markets. Gold is trading at $1000 as the US$ nears all time lows.

We're inflating all right, but the US real sector will be last in line to catch those flows- the conduits are broken. In the 90s above trend employment growth came, as noted, from the Tech boom, albeit with income gains that were far lower than in previous post WWII expansions. During this century there was no above trend employment growth and income is lower. The real estate wealth effect kept people happy on the margin but that is over too. Once a critical mass of the population is underwater on their mortgages real estate inflation will lag, not lead, more general inflation- an effect we would have experienced in the 90s but for the Tech Boom.

As a comic aside, we are like a team of old baseball players who just got purchased by Steinbrenner and don't want to be replaced by newer younger guys.

I think we're going to experience a stagflation like we have never seen.

But first, we will see a Leeson-esque collapse, first of the US$, and then, when they try to tighten to save it, of large chunks of Big Finance.

Sudden and swift.

I could, of course, be wrong.

Have a nice day.

http://dharmajoint.blogspot.com/2009/09/lessons-of-lehmanand-leeson.html

There will be no recovery until debt tumour is excised

YOU have just come from your annual medical check-up, where your doctor assures you that you are in robust health.

Walking jauntily down the street, you bump into a practitioner of alternative medicine. He takes one look and declares: "You have a serious tumour. It must be removed or you will die."

You ignore him as you always have. One day later, a stabbing pain cripples you. You call your doctor, who initially refuses to send an ambulance because he knows you are well. Only when you lapse into a coma does he send one. Initially the doctor waits for you to revive spontaneously. But as your pulse starts to weaken, reluctantly he calls a retired doctor who has experience of a similar inexplicable malady in the distant past.

She prescribes massive doses of tranquillisers, painkillers, vitamins, and oxygen - all substances that had been removed from the medical panoply due to recent advances in medical theory.

After a year of expensive medical treatment, you return to health, and are released from intensive care. As you stride from the hospital, you bump into the practitioner of alternative medicine. "But they haven't removed the tumour," he declares.

One shouldn't have to spell out the details of such an analogy, but in times of widespread denial, it is necessary.

You are the economy; the tumour is a massive accumulation of private debt; your doctor is neoclassical economics; and the retired colleague is a so-called ''Keynesian'' economist (who doesn't know it - since her medical textbooks were poorly written - but she's actually following another economist called Paul Samuelson, not Keynes).

The alternative medicine practitioner follows Hyman Minsky's financial instability hypothesis (based on what Keynes actually did say - as well as the wisdom of Joseph Schumpeter and, in whispers, Karl Marx).

The collapse of Lehman Brothers is the moment you slip into a coma, and the day the doctor takes you off life support and declares all is well … is next month.

The final reason for me being a bear is that I am that practitioner of alternative medicine. Minsky's financial instability hypothesis has been ignored by conventional economists for reasons both ideological and delusional. A small band of "post-Keynesian" economists, of whom I am one, have kept this theory alive.

According to Minsky's theory, capitalist economies can and do periodically experience financial crises (something believers in the dominant neoclassical approach to economics vehemently denied until reality - in the form of the global financial crisis - slapped them in the face last year).

These financial crises are caused by debt-financed speculation on asset prices, which leads to bubbles in asset prices. These bubbles must eventually burst, because they add nothing to the economy's productive capacity while simultaneously increasing the debt-servicing burden the economy faces.

When they burst, asset prices collapse but the debt remains. The attempts by both borrowers and lenders to reduce leverage reduces aggregate demand, causing a recession.

If the economy survives such a crisis, it can go through the same process again, with another boom driving debt up even higher, followed by yet another crash. But ultimately this process has to lead to a level of debt that is so great that another revival becomes impossible, since no one is willing to take on any more debt. Then a depression ensues.

That is where we were in 1987. The great tragedy of today is that naive neoclassical economists like Alan Greenspan and Ben Bernanke allowed this process to continue for another three or more cycles than would have occurred without their rescues.

Last year they did it again - only with methods they would have disparaged a mere year earlier (rational expectations macroeconomics, a modern neoclassical fad, preaches that government intervention cannot influence the level of economic activity at all - yet another belief that reality has recently crucified). This time, while the rescue has worked, the recovery they expect afterwards cannot happen - because there is almost no one left who will willingly take on any more debt.

This time, there is no re-leveraging way out. The tumour of debt has to be removed.

Steve Keen is associate professor of economics at the University of Western Sydney.

http://www.smh.com.au/business/there-will-be-no-recovery-until-debt-tumour-is-excised-20090914-fnug.html

Why capitalism fails ~ Minsky saw the meltdown coming and has another troubling insight: it will happen again.

Amid the hand-wringing and the self-flagellation, a few more cerebral commentators started to speak about the arrival of a “Minsky moment,” and a growing number of insiders began to warn of a coming “Minsky meltdown.”

“Minsky” was shorthand for Hyman Minsky, a hitherto obscure macroeconomist who died over a decade ago. Many economists had never heard of him when the crisis struck, and he remains a shadowy figure in the profession. But lately he has begun emerging as perhaps the most prescient big-picture thinker about what, exactly, we are going through. A contrarian amid the conformity of postwar America, an expert in the then-unfashionable subfields of finance and crisis, Minsky was one economist who saw what was coming. He predicted, decades ago, almost exactly the kind of meltdown that recently hammered the global economy.

In recent months Minsky’s star has only risen. Nobel Prize-winning economists talk about incorporating his insights, and copies of his books are back in print and selling well. He’s gone from being a nearly forgotten figure to a key player in the debate over how to fix the financial system.

But if Minsky was as right as he seems to have been, the news is not exactly encouraging. He believed in capitalism, but also believed it had almost a genetic weakness. Modern finance, he

argued, was far from the stabilizing force that mainstream economics portrayed: rather, it was a system that created the illusion of stability while simultaneously creating the conditions for an inevitable and dramatic collapse.

In other words, the one person who foresaw the crisis also believed that our whole financial system contains the seeds of its own destruction. “Instability,” he wrote, “is an inherent and inescapable flaw of capitalism.”

Minsky’s vision might have been dark, but he was not a fatalist; he believed it was possible to craft policies that could blunt the collateral damage caused by financial crises. But with a growing number of economists eager to declare the recession over, and the crisis itself apparently behind us, these policies may prove as discomforting as the theories that prompted them in the first place. Indeed, as economists re-embrace Minsky’s prophetic insights, it is far from clear that they’re ready to reckon with the full implications of what he saw.

In an ideal world, a profession dedicated to the study of capitalism would be as freewheeling and innovative as its ostensible subject. But economics has often been subject to powerful orthodoxies, and never more so than when Minsky arrived on the scene.

That orthodoxy, born in the years after World War II, was known as the neoclassical synthesis. The older belief in a self-regulating, self-stabilizing free market had selectively absorbed a few insights from John Maynard Keynes, the great economist of the 1930s who wrote extensively of the ways that capitalism might fail to maintain full employment. Most economists still believed that free-market capitalism was a fundamentally stable basis for an economy, though thanks to Keynes, some now acknowledged that government might under certain circumstances play a role in keeping the economy - and employment - on an even keel.

Economists like Paul Samuelson became the public face of the new establishment; he and others at a handful of top universities became deeply influential in Washington. In theory, Minsky could have been an academic star in this new establishment: Like Samuelson, he earned his doctorate in economics at Harvard University, where he studied with legendary Austrian economist Joseph Schumpeter, as well as future Nobel laureate Wassily Leontief.

But Minsky was cut from different cloth than many of the other big names. The descendent of immigrants from Minsk, in modern-day Belarus, Minsky was a red-diaper baby, the son of Menshevik socialists. While most economists spent the 1950s and 1960s toiling over mathematical models, Minsky pursued research on poverty, hardly the hottest subfield of economics. With long, wild, white hair, Minsky was closer to the counterculture than to mainstream economics. He was, recalls the economist L. Randall Wray, a former student, a “character.”

So while his colleagues from graduate school went on to win Nobel prizes and rise to the top of academia, Minsky languished. He drifted from Brown to Berkeley and eventually to Washington University. Indeed, many economists weren’t even aware of his work. One assessment of Minsky published in 1997 simply noted that his “work has not had a major influence in the macroeconomic discussions of the last thirty years.”

Yet he was busy. In addition to poverty, Minsky began to delve into the field of finance, which despite its seeming importance had no place in the theories formulated by Samuelson and others. He also began to ask a simple, if disturbing question: “Can ‘it’ happen again?” - where “it” was, like Harry Potter’s nemesis Voldemort, the thing that could not be named: the Great Depression.

In his writings, Minsky looked to his intellectual hero, Keynes, arguably the greatest economist of the 20th century. But where most economists drew a single, simplistic lesson from Keynes - that government could step in and micromanage the economy, smooth out the business cycle, and keep things on an even keel - Minsky had no interest in what he and a handful of other dissident economists came to call “bastard Keynesianism.”

Instead, Minsky drew his own, far darker, lessons from Keynes’s landmark writings, which dealt not only with the problem of unemployment, but with money and banking. Although Keynes had never stated this explicitly, Minsky argued that Keynes’s collective work amounted to a powerful argument that capitalism was by its very nature unstable and prone to collapse. Far from trending toward some magical state of equilibrium, capitalism would inevitably do the opposite. It would lurch over a cliff.

This insight bore the stamp of his advisor Joseph Schumpeter, the noted Austrian economist now famous for documenting capitalism’s ceaseless process of “creative destruction.” But Minsky spent more time thinking about destruction than creation. In doing so, he formulated an intriguing theory: not only was capitalism prone to collapse, he argued, it was precisely its periods of economic stability that would set the stage for monumental crises.

Minsky called his idea the “Financial Instability Hypothesis.” In the wake of a depression, he noted, financial institutions are extraordinarily conservative, as are businesses. With the borrowers and the lenders who fuel the economy all steering clear of high-risk deals, things go smoothly: loans are almost always paid on time, businesses generally succeed, and everyone does well. That success, however, inevitably encourages borrowers and lenders to take on more risk in the reasonable hope of making more money. As Minsky observed, “Success breeds a disregard of the possibility of failure.”

As people forget that failure is a possibility, a “euphoric economy” eventually develops, fueled by the rise of far riskier borrowers - what he called speculative borrowers, those whose income would cover interest payments but not the principal; and those he called “Ponzi borrowers,” those whose income could cover neither, and could only pay their bills by borrowing still further. As these latter categories grew, the overall economy would shift from a conservative but profitable environment to a much more freewheeling system dominated by players whose survival depended not on sound business plans, but on borrowed money and freely available credit.

Once that kind of economy had developed, any panic could wreck the market. The failure of a single firm, for example, or the revelation of a staggering fraud could trigger fear and a sudden, economy-wide attempt to shed debt. This watershed moment - what was later dubbed the “Minsky moment” - would create an environment deeply inhospitable to all borrowers. The speculators and Ponzi borrowers would collapse first, as they lost access to the credit they needed to survive. Even the more stable players might find themselves unable to pay their debt without selling off assets; their forced sales would send asset prices spiraling downward, and inevitably, the entire rickety financial edifice would start to collapse. Businesses would falter, and the crisis would spill over to the “real” economy that depended on the now-collapsing financial system.

From the 1960s onward, Minsky elaborated on this hypothesis. At the time he believed that this shift was already underway: postwar stability, financial innovation, and the receding memory of the Great Depression were gradually setting the stage for a crisis of epic proportions. Most of what he had to say fell on deaf ears. The 1960s were an era of solid growth, and although the economic stagnation of the 1970s was a blow to mainstream neo-Keynesian economics, it did not send policymakers scurrying to Minsky. Instead, a new free market fundamentalism took root: government was the problem, not the solution.

Moreover, the new dogma coincided with a remarkable era of stability. The period from the late 1980s onward has been dubbed the “Great Moderation,” a time of shallow recessions and great resilience among most major industrial economies. Things had never been more stable. The likelihood that “it” could happen again now seemed laughable.

Yet throughout this period, the financial system - not the economy, but finance as an industry - was growing by leaps and bounds. Minsky spent the last years of his life, in the early 1990s, warning of the dangers of securitization and other forms of financial innovation, but few economists listened. Nor did they pay attention to consumers’ and companies’ growing dependence on debt, and the growing use of leverage within the financial system.

By the end of the 20th century, the financial system that Minsky had warned about had materialized, complete with speculative borrowers, Ponzi borrowers, and precious few of the conservative borrowers who were the bedrock of a truly stable economy. Over decades, we really had forgotten the meaning of risk. When storied financial firms started to fall, sending shockwaves through the “real” economy, his predictions started to look a lot like a road map.

“This wasn’t a Minsky moment,” explains Randall Wray. “It was a Minsky half-century.”

Minsky is now all the rage. A year ago, an influential Financial Times columnist confided to readers that rereading Minsky’s 1986 “masterpiece” - “Stabilizing an Unstable Economy” - “helped clear my mind on this crisis.” Others joined the chorus. Earlier this year, two economic heavyweights - Paul Krugman and Brad DeLong - both tipped their hats to him in public forums. Indeed, the Nobel Prize-winning Krugman titled one of the Robbins lectures at the London School of Economics “The Night They Re-read Minsky.”

Today most economists, it’s safe to say, are probably reading Minsky for the first time, trying to fit his unconventional insights into the theoretical scaffolding of their profession. If Minsky were alive today, he would no doubt applaud this belated acknowledgment, even if it has come at a terrible cost. As he once wryly observed, “There is nothing wrong with macroeconomics that another depression [won’t] cure.”

But does Minsky’s work offer us any practical help? If capitalism is inherently self-destructive and unstable - never mind that it produces inequality and unemployment, as Keynes had observed - now what?

After spending his life warning of the perils of the complacency that comes with stability - and having it fall on deaf ears - Minsky was understandably pessimistic about the ability to short-circuit the tragic cycle of boom and bust. But he did believe that much could be done to ameliorate the damage.

To prevent the Minsky moment from becoming a national calamity, part of his solution (which was shared with other economists) was to have the Federal Reserve - what he liked to call the “Big Bank” - step into the breach and act as a lender of last resort to firms under siege. By throwing lines of liquidity to foundering firms, the Federal Reserve could break the cycle and stabilize the financial system. It failed to do so during the Great Depression, when it stood by and let a banking crisis spiral out of control. This time, under the leadership of Ben Bernanke - like Minsky, a scholar of the Depression - it took a very different approach, becoming a lender of last resort to everything from hedge funds to investment banks to money market funds.

Minsky’s other solution, however, was considerably more radical and less palatable politically. The preferred mainstream tactic for pulling the economy out of a crisis was - and is - based on the Keynesian notion of “priming the pump” by sending money that will employ lots of high-skilled, unionized labor - by building a new high-speed train line, for example.

Minsky, however, argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government - or what he liked to call “Big Government” - should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work. Such a program would not only help the poor and unskilled, he believed, but would put a floor beneath everyone else’s wages too, preventing salaries of more skilled workers from falling too precipitously, and sending benefits up the socioeconomic ladder.

While economists may be acknowledging some of Minsky’s points on financial instability, it’s safe to say that even liberal policymakers are still a long way from thinking about such an expanded role for the American government. If nothing else, an expensive full-employment program would veer far too close to socialism for the comfort of politicians. For his part, Wray thinks that the critics are apt to misunderstand Minsky. “He saw these ideas as perfectly consistent with capitalism,” says Wray. “They would make capitalism better.”

But not perfect. Indeed, if there’s anything to be drawn from Minsky’s collected work, it’s that perfection, like stability and equilibrium, are mirages. Minsky did not share his profession’s quaint belief that everything could be reduced to a tidy model, or a pat theory. His was a kind of existential economics: capitalism, like life itself, is difficult, even tragic. “There is no simple answer to the problems of our capitalism,” wrote Minsky. “There is no solution that can be transformed into a catchy phrase and carried on banners.”

It’s a sentiment that may limit the extent to which Minsky becomes part of any new orthodoxy. But that’s probably how he would have preferred it, believes liberal economist James Galbraith. “I think he would resist being domesticated,” says Galbraith. “He spent his career in professional isolation.”

Stephen Mihm is a history professor at the University of Georgia and author of “A Nation of Counterfeiters” (Harvard, 2007).


http://www.boston.com/bostonglobe/ideas/articles/2009/09/13/why_capitalism_fails/?page=full

Cheap dollars are sowing the seeds of the next world crisis

In a world of systemic instability, reserves mean power. Reserves mean you can defend your currency, stabilise your banking system and boost your economy without resorting to yet more borrowing – or, worse still, the printing press.

More than half of China's reserves are denominated in dollars. So when the dollar falls, China loses serious money. When you're talking about a dollar-reserve number involving 12 zeros, even a modest weakening of the greenback sees China's wealth takes a mighty hit.

In recent years, America has run massive budget and trade deficits, both of which put downward pressure on the dollar – so devaluing China's reserves. Beijing has remained tight-lipped, worried less about diplomatic niceties than the financial implications of voicing its concerns. If the markets thought China would buy less dollar-denominated debt going forward, the US currency would weaken further, compounding Beijing's wealth-loss.

American leaders have relied on this Catch-22 for some time, guffawing that China is in so deep it has no choice but to carry on "sucking-up" US debt. But Beijing's Communist hierarchy is now so worried about America's wildly expansionary monetary policy that it is speaking out, despite the damage that does to the value of China's reserves.

Last weekend, Cheng Siwei, a leading Chinese policy maker, said that his country's leaders were "dismayed" by America's recourse to quantitative easing. "If they keep printing money to buy bonds, it will lead to inflation," he said. "So we'll diversify incremental reserves into euros, yen and other currencies".

This is hugely significant. China is now more worried about America inflating away its debts than about those debts being exposed to currency risk. Economists at Western banks making money from QE still say deflation is more likely than inflation. As this column has long argued, they are talking self-serving tosh.

The entire non-Western world rightly sees serious inflationary pressures down the track in the US, UK and other nations where political cowardice has resulted in irresponsible money printing.

Following Mr Cheng's comments, the dollar fell throughout last week, hitting a 12-month low against the euro. As the dollar's "safe haven" status was questioned, gold surged above $1,000 an ounce to an 18-month high.

The US currency could well keep falling. America's trade deficit grew in July at the fastest rate in almost a decade. Imports exceeded exports by $32bn last month – a gap 16pc wider than the month before. One reason was that as oil prices strengthened, so did the cost of US crude imports.

Oil touched $72 a barrel last week. If the greenback weakens further, prices will keep going up. That's because crude is priced in dollars and global investors will increasingly use commodities as an anti-inflation hedge.

These forces could combine to send the dollar into freefall. US inflation would then soar and interest rates would have to be jacked up. Even if a fast-collapsing dollar is avoided, Fed rates may have to rise quickly if China is serious about dollar-divesting and the US has to sell its debt elsewhere. Under both scenarios, the world's largest economy could get caught in the stagflation trap – recession and high inflation.

Beijing doesn't want the US to stagnate. China has too much to lose. But even if China and US work together to avoid a meltdown, the currency markets could provide one anyway.

The dollar is now being used as a "carry" currency. Traders are using low Fed rates to take out cheap dollar loans, then converting the money into currencies generating higher yields.

"Carrying" credit in this way is currently the source of huge gains. No one knows the true scale, but the world has, of course, been flooded with cheap dollars.

This presents serious systemic danger. A dollar weighed down by Chinese divestment, then suppressed further by carry-trading, could easily spring back. Those who had borrowed in dollars would owe more, while their dollar-funded investments would be worth less. This "unwinding" could send financial shock around the globe.

This is what happened in 1998, when yen carry-trades went wrong, causing the collapse of Long-Term Capital Management and sparking a global slowdown.

So even if the Western world manages to fix its banking system, the Fed's money printing could well be stoking up the next financial crisis. The dollar carry-trade. You heard it here first.

http://www.telegraph.co.uk/finance/comment/liamhalligan/6179482/Cheap-dollars-are-sowing-the-seeds-of-the-next-world-crisis.html
Liam Halligan is chief economist at Prosperity Capital Management

And No Dialing Back

Nolan says it still looks crook!@

And No Dialing Back:

CNBC's Steve Liesman: "Mr. Secretary, how much concern do you have right now - how much pressure are you under right now to dial back on these programs. Dial back spending. Dial back - getting to the audience question right there that I think is critical and that is really indicative of how Americans feel: Get the government out of the private sector. How much pressure are you under right now?"

Treasury Secretary Geithner: "No one is going to be more eager than I am. You're just not going to care about that more than me. We do not want to be in any of these institutions a day longer than is necessary. And look at what we have already done. We already have $80bn of capital coming back into the Treasury. If you look at what I said today in my testimony on the hill, we've seen these emergency programs we put in place already be used at a tiny fraction of their scale in emergency. We designed these things so that they would not be used a day longer than necessary.

But we're going to be careful not to withdraw too soon. Again, the classic mistake countries make in crisis is that they put on the brakes too early and reignite the recession, ultimately at much greater fiscal cost and much greater damage to the economy. So that's the balance we've got to get right. And we are not now at the point - even though the challenge is shifting - we're a bit moving now from emergency to the harder challenge, frankly, of repair and recovery. That's going to change the mix of what we do. We're going to get out and walk these things back as soon as we are confident we can get out of this thing."

September 10 - Bloomberg (Jody Shenn): "'Credibly' privatizing Fannie Mae and Freddie Mac... may be too difficult given the precedent set by the Treasury Department's financial assistance, according to a Government Accountability Office analysis. 'The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency,' the GAO said... 'Consequently, such privatized entities may continue to derive financial benefits, such as lowered borrowing costs, resulting from the markets' perceptions.' The Treasury today reiterated that the government intends to make recommendations on Fannie Mae and Freddie Mac next year... 'Any transition to a new structure would need to consider the enterprises' still-dominant position in housing finance and be implemented carefully (perhaps in phases) to ensure its success," the GAO said."

My interest is not in taking shots at today's policymakers. They have been faced with incredible challenges, and proceed now on a course they hope and believe is best for returning the country to sound footing. And while I disagree strongly with the current path of policymaking, it has been predictable. From a policymaking perspective, the greatest error came with the Greenspan/Bernanke Fed's failure to act to rein in systemic Credit excess, asset inflation, and financial Bubbles. Many belatedly recognized the Fed's failings, yet few today appreciate that the costs and risks of flawed analysis and theories only keeps mounting.

I retain keen interest in debunking the Fed's thesis - articulated most clearly by then Fed governor Bernanke - that central banks should avoid the business of popping Bubbles and instead focus on post-Bubble "mopping up" strategies. It was, after all, post-Russia/LTCM "mopping up" that fueled the tech Bubble, and then the post-Tech and 9/11 mopping fostered the Wall Street/mortgage finance Bubble. And the latest big mop up job sets the stage for perhaps the greatest Bubble all them all - the Global Government Finance Bubble.

They appear as free lunches at the time, but there are myriad financial and economic costs associated with government intrusions into the marketplace. Most are subtle and tend to remain quiescent for years. When (market pricing, resource allocation and economic impairment) distortions do eventually manifest into a crisis, policymaking will have a strong proclivity to treat misdiagnosed ills with only greater government manipulations and intrusions. And the greater the degree of intrusion into the markets, the greater the ongoing costs involved. Huge intrusions ensure open-ended government involvement and increasing governmental command over the economic system.

As much as I believe Secretary Giethner is speaking earnestly, there is no way at this point government influence in the marketplace can be meaningfully dialed back. The damage has been done - historic distortions to both the financial system and real economy. The damage began with the activist Greenspan Fed manipulating interest rates, promising market liquidity, and pandering to the leveraged speculators. The damage worsened as the government-sponsored enterprises came to dominate our nation's market for housing finance. And the damage turned unmanageable when the markets listened back in 2002 to Dr. Bernanke profess the virtues of helicopter money and whatever other unconventional measures the central bank might deem worthwhile.

Federal government finance (Treasuries, agency debt and GSE MBS) has expanded about $2.0 TN over the past year. I expect it to inflate another $2.0 TN over the coming twelve months. The private sector Credit apparatus is simply not up to the task of generating the necessary $2.5 TN (or so) of total system Credit expansion necessary to sustain the current economic structure. In this post-Wall Street Bubble environment, only government and government-related Credit retains sufficient "moneyness" in the marketplace. Systemic reflation today depends on a massive inflation of this government helicopter "money."

This week's GAO analysis on the GSE's was spot on and certainly applies to more than just the GSEs: "The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency." Over five Trillion - and counting - of GSE securities are valued and traded in the marketplace as (money-like) government-backed obligations. Policymakers would not today risk the negative financial and economic ramifications from dialing back from Washington's explicit and implicit guarantees.

And as much as moral hazard and "too big to fail" are recognized as fundamental facets of the previous Bubble excess, our policymakers have nonetheless been compelled to expand only further toward backstopping the entire Credit system. Obviously, the GSE's were too big to really fail, while markets appreciate that policymakers now believe it was a mistake to allow Lehman to collapse. The markets - more than ever before - operate with the view that policymakers have no tolerance for a major financial institution failure.

When one contemplates the issue of "getting the government out of the private sector," these various market liquidity support programs being wound down are an insignificant issue. Fundamentally, for the economy to move toward sounder and sustainable footing would require at least a semblance of a market-based Credit pricing mechanism. Regrettably, the vast majority of system Credit today is "public." Government intrusion chiefly dictates the cost of finance and the allocation of financial and real resources. Furthermore, I would argue that the limited amount of private sector debt being issued these days is dependent upon the system-stabilizing effects of massive government debt issuance and spending.

As I have stressed repeatedly, in the neighborhood of $2.5 TN of non-financial Credit growth is required to stem systemic implosion - a massive Credit expansion with only our federal government up to the challenge. It is this fundamental facet of Bubble economies - a maladjusted economic structure sustained only through ongoing Credit excess - that prohibits Washington from extricating itself from very public "private sector" intrusions. Fixated on the notion of sustainable recovery, policymakers will not be dialing back from massive borrowing, spending, or market backstopping endeavors. And this gets to the core of the unquantifiable costs of failing to rein in Credit and asset Bubbles.

As I have written over the years, the entire notion of "mopping up" is as flawed as it is dangerous. Clearly, the notion of inflationism remains as seductive as it has throughout history. If, God forbid, deflation ever becomes a risk the central bank must aggressively raise the price level to preclude a downward spiral. We heard this dogma in the early nineties, heard it again earlier this decade, and have had it repeated too often over the past year.

And the more intense the necessity to reflate - the greater the government's evolving role throughout both the financial and economic systems. This is a fact of life, human nature and politics. And at the end of the day inflationism tends toward socialism. And there is only one way to reverse this course; it is anything but painless. The economy must be weaned off of Credit and financial excesses and government intrusions - and allowed to proceed through the arduous task of adjustment and rebalancing. Choosing instead a course of sustaining current financial and economic structures implies a huge and ever-expanding role for the government. There will be no dialing back.

Many hope the private-sector can again rise to the occasion. It is expected that as recovery gains a foothold private sector borrowing and lending will increase, tax receipts will rise, and the government enjoy the luxury of dialing back as the system normalizes. I don't expect this dynamic to work as it has traditionally because of the confluence of Bubble economy Credit requirements, acute private sector Credit system impairment, and the government's predominant influence on the recovery.

The dynamic today is one of a shallow recovery induced by a flood of government borrowing and spending and marketplace intrusions. Rampant financial speculation has reemerged, which leaves the marketplace increasingly vulnerable to any serious move to dial back. In a normal recovery, the system tends to gain strength and stability over time. Credit requirements are manageable, and speculative excesses have been largely wrung out of the system. In stark contrast, today's combination of huge Credit expansion and a highly speculative financial backdrop ensures only more acute systemic fragilities over time. And the distorted marketplace will simply not function well at even the notion of fiscal and monetary exit strategies.

Conceptually, somewhere along the line there reaches a tipping point where government intrusions are no longer stabilizing. They become invariably destabilizing, as the quantity of government monetary inflation becomes massive and uncontrollable. This is the nature of inflationism, although this dynamic is nowhere to be found in Keynesian doctrine. It is my view that this tipping point was reached some time back. It is with this analysis in mind that I fear the emerging Government Finance Bubble risks destroying the creditworthiness of our entire economy.


Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10271