The Shaking Tower of Debt
The repercussions of the turmoil in the US subprime mortgage market are increasingly being felt around the world. What was initially thought to be a problem confined to a US credit market segment has increasingly transformed itself into an erosion of investor confidence in credit quality in general and, in some countries, concerns about the reliability of the banking sector.
The most obvious symptom of eroding confidence is the alleged "liquidity crisis." The term "liquidity" usually denotes the possibility to buy or sell a financial asset at any one time without causing noticeable changes in the price of the product being bought or sold. Market participants speak of "illiquidity" when it is no longer possible to sell financial products, or if selling is possible only at greatly diminished prices.
In recent weeks, a number of financial market segments have indeed become illiquid in the sense defined above. FULL ARTICLE
Comments (11)
David C
While I agree with the article, I think the Fed is NOT in panic mode because of the asset-backed commercial paper, but instead because of the 20+ trillion dollars worth of interest rate sensitive derivatives hiding out there - all of which are relying on the credit worthiness of the looser in the transaction to pull thru.
For the last several decades the Fed has sent the market the message loud and clear that there is absolutely NO counter party risk, because they have bailed out every failure. The market has received that instruction loud and clear and translated it into 20+ Trillion in interest rate sensitive derivatives, and 400+ trillion in other derivatives.
IMHO, that's why the fed is going to lower the interest rate all the way to 0. They know darn well the inflationary damage it will cause, but don't give a damn because that is nothing compared to covering 400+ trillion dollars worth of bets gone wrong.
Unfortunately for all of us, they are stupid. Lowering the interest rates like this is going to drive up prices. While the Fed might have their head up their ass about the real inflation rate, the people maxed out in debt who are already barely able to pay their mortgage will almost certainly face it head on. Their expenses will go up drastically, but not their pay making them unable to pay their bills and mortgage, making the situation even worse.
Published: September 26, 2007 10:27 AM
David C
One more thing. If the Fed doesn't have the discipline to stop increasing the money supply now, I can't see any reason why they're suddenly going to get religion in the future as the default problem gets even worse. At this point, it looks like the probability of a hyper inflationary blow out is very high. Zimbabwe here we come!
There is a glimmer of hope though. The modern market is very efficient at passing on costs, by time election day comes around the problem will probably be so out of control that the pressure to elect Ron Paul will be absolutely insane.
Published: September 26, 2007 10:45 AM
mikey
Although Prof. Polleit writes that the Fed is pumping money into the system, Gary North wrote
2 days ago that the adjusted monetary base is actually shrinking, even as they cut interest rates, they accomplish this by selling assets(t-bills and bonds).Would appreciate everyones take on this.
Published: September 26, 2007 11:56 AM
Fundamentalist
Very informative! Thanks! Please do more articles like this!
mikey: "Gary North wrote 2 days ago that the adjusted monetary base is actually shrinking..."
The Fed may be trying to boost psychology without actually doing anything to the money supply. Or, as in the Great Depression, the falling money supply demonstrates the Fed's impotence in the face of the real economy. As Polleit writes, people have loft confidence in the credit worthiness of many borrowers and are refusing to loan money. When business people get scared, they quit borrowing and build cash reserves; banks quit lending. The Fed can do nothing but wait for confidence to return. Greenspan called this "pushing on a string."
Published: September 26, 2007 12:32 PM
david whetsell
I think when this is done in the economy that it will make 1929 thru 1950 look like a practice run.
Published: September 26, 2007 2:50 PM
mark
The Fed may be trying to boost psychology without actually doing anything to the money supply. Or, as in the Great Depression, the falling money supply demonstrates the Fed's impotence in the face of the real economy. As Polleit writes, people have loft confidence in the credit worthiness of many borrowers and are refusing to loan money.
This is the old "You can lead a horse to water but you can't get him to drink"
Because I haven't heard this talked about, I'm wondering if this theory has gone extinct?
Published: September 26, 2007 3:41 PM
JIMB
Mikey - Gary North is way off base. All the Fed has to do is set rates lower and "lending comes out" to create more debt irrespective of the monetary base - until we really do reach a point where the market won't lend at all. If you think we're there, check out the MZM stats:
http://research.stlouisfed.org/publications/mt/page3.pdf
Note also that the Fed can push money into the system by "changing the rules" about what they can and will put on their balance sheet, or immunize a market player against loss to a greater degree than before, etc, etc. What is "money" (i.e. electronic settlement or physical cash) then is replaceable with "what the Fed says".
Published: September 27, 2007 8:54 AM
JIMB
Thorsten Polleit - I am pretty sure the legend or the time series in Fig 2 is incorrect. The Fed Funds target rate is 4.75. I didn't check the other figures.
Published: September 27, 2007 9:15 AM
sharon
I have always assumed that an increase in the money supply necessarily leads to inflation, but others, who seem to have a deeper understanding of the complexity of the present situation, make the point that increasing the money supply leads to asset inflation, but not necessarily to wage/price inflation.
If I am following the arguments I'm hearing correctly, this was demonstrated (up to a point) by Japan.
This link seems to explain where the disjunction comes in:
http://www.itulip.com/forums/showthread.php?p=16690#post16690
What the author is saying is that the central banks are quite well able to apply an inflationary policy to the asset-price economy, and a deflationary policy to the wage/consumer price economy.
The mechanisms for doing this should be fairly obvious by now: create asset bubbles using cheap money, while holding wages and prices down through immigration, outsourcing, job scarcity, union busting (to the small extent they're not already busted), etc. You can easily greatly expand the money supply in the asset economy, while concurrently contracting the money supply in the wage/consumer price economy--for awhile--maybe even for quite awhile.
The author also seems to be suggesting that, ultimately, inflation cannot be contained to asset prices.
Published: September 27, 2007 12:50 PM
mikey
http://globaleconomicanalysis.blogspot.com/
Thank you to those who commented on Gary North's
article.I found an interesting piece by "Mish" at the above.
Published: September 27, 2007 2:40 PM
Reino
The Fed can not push interest rates to zero. They might push their interest rate target to zero, though.
Japan could stretch out their deflationary trend by zero interest rate, but that was because the debt was mostly internal to the system.
The US in a huge external debt and an external current account deficit. Foreign lenders will not be willing to lend to US entities with zero interest. If the Fed attempts to push rates significantly lower, a significant cut in the current account deficit will be forced on the US, resulting in a drastic collapse of American living standards.
The American standard of living will go down anyway, having been sold off to external creditors over the decades. But I am pretty sure, that a sudden period of forced self-subsistence is not in the wish list of the average American.
So you should hope that the Fed doesn't attempt to do anything that is actually incapable of doing.
Published: September 28, 2007 6:57 AM