Best of the Week
Most Popular
1. Market Decline Will Lead To Pension Collapse, USD Devaluation, And NWO - Raymond_Matison
2.Uber’s Nightmare Has Just Started - Stephen_McBride
3.Stock Market Crash Black Swan Event Set Up Sept 12th? - Brad_Gudgeon
4.GDow Stock Market Trend Forecast Update - Nadeem_Walayat
5.Gold Significant Correction Has Started - Clive_Maund
6.British Pound GBP vs Brexit Chaos Timeline - Nadeem_Walayat
7.Cameco Crash, Uranium Sector Won’t Catch a break - Richard_Mills
8.Recession 2020 Forecast : The New Risks & New Profits Of A Grand Experiment - Dan_Amerman
9.Gold When Global Insanity Prevails - Michael Ballanger
10.UK General Election Forecast 2019 - Betting Market Odds - Nadeem_Walayat
Last 7 days
What ECB’s Tiering Means for Gold - 17th Nov 19
DOJ Asked to Examine New Systemic Risk in Gold & Silver Markets - 17th Nov 19
Dow Jones Stock Market Cycle Update and are we there yet? - 17th Nov 19
When the Crude Oil Price Collapses Below $40 What Happens? PART III - 17th Nov 19
If History Repeats, Gold is Headed to $8,000 - 17th Nov 19
All You Need To Know About Cryptocurrency - 17th Nov 19
What happens To The Global Economy If Oil Collapses Below $40 – Part II - 15th Nov 19
America’s Exceptionalism’s Non-intervention Slide to Conquest, Empire - and Socialism - 15th Nov 19
Five Gold Charts to Contemplate as We Prepare for the New Year - 15th Nov 19
Best Gaming CPU Nov 2019 - Budget, Mid and High End PC System Processors - 15th Nov 19
Lend Money Without A Credit Check — Is That Possible? - 15th Nov 19
Gold and Silver Capitulation Time - 14th Nov 19
The Case for a Silver Price Rally - 14th Nov 19
What Happens To The Global Economy If the Oil Price Collapses Below $40 - 14th Nov 19
7 days of Free FX + Crypto Forecasts -- Join in - 14th Nov 19
How to Use Price Cycles and Profit as a Swing Trader – SPX, Bonds, Gold, Nat Gas - 13th Nov 19
Morrisons Throwing Thousands of Bonus More Points at Big Spend Shoppers - JACKPOT! - 13th Nov 19
What to Do NOW in Case of a Future Banking System Breakdown - 13th Nov 19
Why China is likely to remain the ‘world’s factory’ for some time to come - 13th Nov 19
Gold Price Breaks Down, Waving Good-bye to the 2019 Rally - 12th Nov 19
Fed Can't See the Bubbles Through the Lather - 12th Nov 19
Double 11 Record Sales Signal Strength of Chinese Consumption - 12th Nov 19
Welcome to the Zombie-land Of Oil, Gold and Stocks Investing – Part II - 12th Nov 19
Gold Retest Coming - 12th Nov 19
New Evidence Futures Markets Are Built for Manipulation - 12th Nov 19
Next 5 Year Future Proof Gaming PC Build Spec November 2019 - Ryzen 9 3900x, RTX 2080Ti... - 12th Nov 19
Gold and Silver - The Two Horsemen - 11th Nov 19
Towards a Diverging BRIC Future - 11th Nov 19
Welcome to the Zombie-land Of Stock Market Investing - 11th Nov 19
Illiquidity & Gold And Silver In The End Game - 11th Nov 19
Key Things You Need to Know When Starting a Business - 11th Nov 19
Stock Market Cycles Peaking - 11th Nov 19
Avoid Emotional Investing in Cryptocurrency - 11th Nov 19
Australian Lithium Mines NOT Viable at Current Prices - 10th Nov 19
The 10 Highest Paying Jobs In Oil & Gas - 10th Nov 19
World's Major Gold Miners Target Copper Porphyries - 10th Nov 19
AMAZON NOVEMBER 2019 BARGAIN PRICES - WD My Book 8TB External Drive for £126 - 10th Nov 19
Gold & Silver to Head Dramatically Higher, Mirroring Palladium - 9th Nov 19
How Do YOU Know the Direction of a Market's Larger Trend? - 9th Nov 19
BEST Amazon SMART Scale To Aid Weight Loss for Christmas 2019 - 9th Nov 19
Why Every Investor Should Invest in Water - 8th Nov 19
Wait… Was That a Bullish Silver Reversal? - 8th Nov 19
Gold, Silver and Copper The 3 Metallic Amigos and the Macro Message - 8th Nov 19
Is China locking up Indonesian Nickel? - 8th Nov 19

Market Oracle FREE Newsletter

How To Buy Gold For $3 An Ounce

Contraction of the Whole Financial and Economic System

Economics / Deflation Oct 26, 2008 - 02:03 PM GMT

By: Mike_Whitney

Economics

Best Financial Markets Analysis Article"The great inter-war slumps were not acts of God or of blind forces. They were the sure and certain result of the concentration of too much economic power in the hands of too few men (who) felt no responsibility to the nation." From the 1945 UK Labour manifesto Let Us Face The Future

There are signs that the credit crunch is easing. Interbank lending in dollars has fallen for a ninth straight day. The various indicators of stress in the market--Libor, the TED spread, and the Libor-OIS spread--are all gradually returning to normal, but the damage to the broader economy has been substantial.


Major corporations have had to stretch their credit lines just to get the money they need to cover routine operating expenses and a lot of retailers have not been able to get funding for their inventories for the holiday season, so they'll either have to hire fewer workers or simply shut their doors for Christmas. Also, corporate defaults have increased as businesses have been unable to turn over their short-term debt.

According to Fitch Ratings, the "crisis will cut growth in credit this year by 50 percent as financial firms reduce leverage, investors' appetite for risk declines, and the worldwide economy slows." When credit is less available, there's less business activity and the economy slows. Unemployment goes up and quarterly earnings go down. It's a vicious circle that starts with speculation and ends in panic. The financial system has to reestablish its equilibrium by purging the excessive credit that developed through low interest rates and lax lending standards. Financial institutions everywhere are in the process of deleveraging which is putting downward pressure on the main stock indexes and creating turmoil in the currency markets.

The US Treasury and Federal Reserve are now underwriting the entire financial system. The free market has been abandoned altogether. Everything from commercial paper to money markets is now backed by the "full faith and credit of the United States". Without that explicit government guarantee, the credit markets would still be frozen and the system would crash. But government guarantees do not address the real problem, which is toxic assets that must be accounted for and written down. All it does is take hundreds of billions of dollars in mortgage-backed garbage onto the nation's balance sheet and undermine the creditworthiness of the United States. Eventually, foreign central banks will see the folly of this maneuver and refuse to buy more US debt. When that happens, there will be a run on the dollar and a major dislocation in the bond market. Then, the financial system will grind to a standstill once again.

Secretary of the Treasury Henry Paulson's $125 billion capital "giveaway" to nine of the country's largest banks has helped to calm the credit markets, but it won't last. The "real economy" is beginning to stumble and the stock market is gyrating more wildly than anytime in history. Wall Street is consumed with fear and investors are ducking out the exits as fast as their feet will carry them. According to the New York Times, the banks probably won't even use Paulson's money to extend loans to consumers and businesses (as intended), but will hoard it to make sure they are sufficiently capitalized when their mortgage-backed assets are downgraded.

Even worse, the banks may use the money to gobble up smaller local and regional banks. On Tuesday's Jim Lerher News Hour, New York Times journalist Andrew Ross Sorkin put it like this: "The other thing that some of them may do with that money is go out and make acquisitions and buy other banks, (which) means that you will not be getting this money into your pocket anytime soon....I think the larger issue is the economy and these banks, in terms of lending, are not going to start lending real money until the economy turns."

Paulson knows what the banks are up to; after all, these are his friends. The truth is, the $125 billion was not given to the banks to soften the effects of the recession or increase lending. It was given to make the strong banks even stronger so they could monopolize the industry. Paulson's real plan is "more consolidation" and less competition, or as economist Michael Hudson says, "Big fish eat little fish". The Treasury Secretary is using his authority to reward his friends rather than doing what is best for the country.

In the last few weeks, the broader economy has deteriorated faster than anytime in the last 70 years. That's why Fed chief Ben Bernanke has given the nod to another stimulus package of $150 to $300 billion dollars. The gears are rusting in place and the desperation in Washington is palpable. Calculated Risk web site provided a transcript of a conference call by MSC Industrial Supply (MSC) which summed up the prevailing mood in today's business world:

MSC: “In the last several weeks, customers' sentiment has turned dramatically downwards. Here are a few of the things we have recently heard and I'll quote a few of them. One quote is our new orders are down substantially in the last few weeks. Another is that corporate has told us to reduce inventory. What we have also heard is make due with what you have. And finally, another quote is capital expenditures are on hold. Customers are concerned about the economy and the lack of available credit. They're reducing inventories, orders, and order size and there has been a trend toward deferring capital expenditures..."

MSC: "David, we view this time as unprecedented in history. The economy is undergoing a huge change, how that is going to shake out all remains to be seen, but I think what is important to know is it's a huge change that, frankly, no one had a chance to see coming, so we than specifically in our customer base there is a tremendous amount of fear that is gripping customers and evidenced by what we have seen the last couple of weeks in October, almost buying paralysis, that is really the way that we think about it, and frankly, in speaking with so many customers what we see happening.... What is has happened here with the credit crisis is while the economy was by no means booming, it was kind of rolling along and we almost think that what typically would have taken six, seven, eight, 9, 12 months to start to come down happened almost literally overnight." (Calculated Risk)

Events are now unfolding so quickly, they're impossible to follow. But this much is clear, the wheels have fallen off the cart. The Fed has lost control of the system. On Monday, Bernanke announced the creation of the Money Market Investor Funding Facility (MMIFF), which will provide $550 billion in liquidity to U.S. money market investors. It is another in a long list of steps to try to provide liquidity to a system that is burning through trillions of dollars of credit via the deleveraging of hedge funds and asset downgrades. Of course, the Fed does not really have the money it has committed. It will have to expand its balance sheet, issue more Treasurys, and hope that foreign central banks do not see that the US financial system is headed for the rocks.

"It is essential we preserve the foundations of democratic capitalism,'' Bush bellowed on Monday.

All that's left of the free market is the threadbare rhetoric of our lame duck President. The world's biggest creditor is now the most ardent defender of market fundamentalism.

Last week, banks borrowed a record $437 billion per day, topping the previous week's $420 billion per day a week earlier. Hundreds of banks cannot meet their capital requirements without regular low interest loans from the Federal Reserve. The banking system is in shambles. The FDIC needs to determine which banks can be saved and which need to be shut down, otherwise the insolvent banks will use the money they get from the Treasury on risky bets to dig their way out of bankruptcy. Without restrictions on how they can issue credit, many of the banks will engage in the same reckless behavior and speculation that brought on the current calamity.

92 year old Anna Schwartz, who co-authored "A Monetary History of the United States" with Milton Friedman, said in a recent Wall Street Journal interview that Paulson and Bernanke "should not be recapitalizing firms that should be shut down." Rather, "firms that made wrong decisions should fail.... By keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis." At the same time, they have not alleviated the uncertainty among lenders "that would-be borrowers have the resources to repay them." This is the very heart of the matter; the distrust will remain until the bankrupt institutions are shut down and confidence is restored.

The good banks have to be strengthened, the bad banks have to be closed, deposits have to be insured, foreclosures have to be reduced (to stabilize home prices), and consumers need immediate stimulus (including food stamps, extended unemployment insurance, infrastructure spending and aid to states) to rev up the economy. All of these have to be done as quickly as possible to avoid further damage to the economy and greater personal suffering. According to an estimate by the UNs International Labour Organisation (ILO) "Twenty million jobs will disappear by the end of next year as a result of the impact of the financial crisis on the global economy...Construction, real estate, financial services, and the auto sector are most likely to be hit, according to the ILO's estimate which is based on International Monetary Fund projections for the world economy." It could be worse if the Bernanke and Paulson botch the rescue.

The FDIC's Sheila Bair has been the one "bright light" in the ongoing financial train-wreck. She has done a first-rate job of closing "sick" banks and renegotiating mortgages. Last week, Bair blasted Paulson for focusing all his attention on the banks and financial institutions instead of homeowners, many of who are now facing foreclosure. In an article in the Wall Street Journal, she said: "We're attacking it (the crisis) at the institution level as opposed to the borrower level, and it's the borrowers that are defaulting. That is what's causing the distress at the institution level...So why not tackle the borrower problem?"

Unlike Paulson, Bair seems to grasp that the hemorrhaging in the financial sector cannot be stopped unless the rate of foreclosures is slowed and housing prices stabilize. The FDIC chief has taken a sensible approach to the crisis by writing down the face-value of mortgages and putting homeowners in conventional 30-year fixed rate loans that make it possible for them to avoid foreclosure. According to Bloomberg, "(Bair) now has the authority to offer loan guarantees that could encourage modifications by mortgage-servicing companies in an effort to avert foreclosures. The new financial rescue plan "allows the government to set standards for mortgage changes and offer guarantees for loans that meet the standards." This gets to the root of the larger problem which is stopping the slide in housing prices so that the mortgage-backed securities market can normalize.

The actions of the Fed, the Treasury and the FDIC are likely to cost in excess of $2 trillion. That does not include the trillions in market capitalization that are wiped out by plummeting home and stock prices. Nor does it include the incalculable suffering from rising unemployment, falling living standards, and personal hardship. Eventually, the Fed's emergency measures will result in higher taxes, soaring deficits and slower growth. As America's "consumer-based" economy flags and the recession deepens, capital will flee US Treasurys and securities and create a funding crisis. This may be hard to imagine now that the dollar is strengthening and US Treasurys appear to be in great demand, but the handwriting is already on the wall.

Brad Setser explains the dollar's surprising reversal in his latest blog-entry: "The dollar's rise since July is part of a reversal in longstanding investment trends that prevailed during years of plentiful borrowing, strong growth and low financial-market volatility. “Essentially, every large trade that built up a head of steam in the go-go years has blown up or is in the process of blowing up,” wrote Alan Ruskin, chief international strategist at RBS Greenwich Capital, in a report to clients. “That goes for almost every asset class.”(Brad Setsers Blog)

The recent surge in US Treasurys is also misleading, much of it having to do with terrified investors that are dumping their shares in stocks, mutual funds and hedge funds for the perceived safety of US debt. Foreign investors, however, seem to be losing their enthusiasm for Treasurys as America's future continues to darken.

The net foreign purchases of long term securities in August was a mere $14 billion following an even more dismal $8.6 billion in July; not nearly enough to meet $55 billion per month the US needs to balance its consumption of foreign goods. Even worse, the purchases of long-term US securities "went negative" by for foreign private investors (by $8.8 billion) which means that the dollar is being artificially propped up by foreign central banks to avert a disorderly unwinding of the currency.

Foreign investors and central banks are no longer providing the capital to support the US $700 billion current account deficit. They have lost confidence in America's ability to bounce back from the credit crisis which has swept through the financial system and is now hammering away at the broader economy. That means the demand for US debt will fall and the prospect of hyperinflation will grow. Even if the dollar is able to weather the storm ahead (and the nation can avoid a funding crisis) the massive deficits brought on by Bernanke's "emergency" spending spree will force interest rates upwards and tighten credit even more. As Michael Panzer, author of "Financial Armageddon" says:

"While the U.S. may not suffer from a funding crisis in the immediate future, the voracious money-raising appetite will make life much more difficult for the private sector, in the sense that, they will be 'crowding out' increasingly desperate borrowers who will find their options are more and more limited."

The Fed now faces the daunting task of trying to maintain America's dominant place in the global system while the economy contracts, deficits skyrocket and the pillars of US-style capitalism come crashing to earth.

By Mike Whitney

Email: fergiewhitney@msn.com

Mike is a well respected freelance writer living in Washington state, interested in politics and economics from a libertarian perspective.

Mike Whitney Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules