So, Wall Street put a gun to the head of the American public two months before the election and got what they wanted. I wrote before that a liquidity crisis in a fiat money system is only possible during hyperinflation. In September of 2007, I wrote:
As I pointed out before, Bernanke’s solution to the “liquidity crisis” is utterly destructive because it implies more inflation down the road.
I never thought there was a liquidity crisis to begin with because for a liquidity crisis to exist (in the traditional sense) money should have real value. A liquidity problem can only exist if any liquid instrument is scarce.
In that same article (back when “the fundamentals of the economy” seemed solid and the Dow was 200 points off the top), I expected either a break out of the Dow Jones fueled by excess liquidity or a continued fall pointing to a recession. The second scenario came true.
This brings us to the Wall streeters pointing a gun to our head. Money is plentiful, and the banks are still able to create large amounts of it out of thin air (yes, private banks, without the need of anybody else). However, Wall Street is in a state of panic, unable to perform, and desperate for a handout.
The origin of the latest liquidity crisis that prompted the fear of Mr. Paulson is due to the banks being unwilling, not unable, to lend each other money. In their small-minded fear, they put to risk the entire economy of the United States and then some.
To be clear, in a deregulated economy, failures are expected and are needed. The alternative was always regulation and government intervention every step of the way, which is expected to create economic stability. There are historical reasons why the American public gave up on managed capitalism and opted for a revived version of free market. This nice historical exercise proved once again why, after 1929, the US turned to Keynesian Economics: the free market does not work in large economies. In the end, you always finish with government intervention.
I do not feel that this crisis is deep or cruel enough to make the American public find again Keynesian economics, as they found again free markets by the hand of Reagan after the inflation crisis of the 70s. At least, it is not cruel enough so far.
This brings me to the title of the post. As we pour 350 billion into the financial markets, we are not creating any bank of last resort. We are not nationalizing (what did I just say!!!) any banks, or creating any way to continue providing credit. We wish and hope that the same people who created the crisis by shitting their designer pants will willingly start lending money away. Why again?
Now, the savings rate of the Americans is either cero or negative, and it has been like that during the past eight years, so the only way to create or sustain consume is by extending more credit. This means extending credit to risky borrowers (as of today, about 30% of the American consumer).
So we understand. We are expecting that the same group of people who was afraid to lend money to other banks will start lending money to a public overburdened by debt and facing a recession. My take is that such scenario is unlikely.
After they receive their precious money, the banks will hoard it and will only lend to the least risky borrowers, which are those who do not need access to credit to survive until things get better. As the old lines of credits are tapped out, and new credit is hard to come by, consumption will decrease and about a half of the economy will revert to living on the bare essentials. The result will be a recession in the country that will infect the Chinese and other economies that depend on a positive trade balance with the United States.
Perhaps, when we hit that point, and the last illusion of the possibility of a “free market” vanishes in the minds of the American public, we come full circle to accept that a managed economy is the only way to produce sustainable wealth in large modern societies. This will imply the creation of institutions that now sound repugnant but that will be necessary, such as a “National Bank” that would be a lender of last resort funded by the American People moneys, and other “socialist” institutions like “universal healthcare.” These are not going to be fancy things to have, but the only way to guarantee that the majority of our people has access to the basic protections that make life in a modern society possible.
Franklin @ September 28, 2008