Tuesday, December 18, 2007

Ding, Dong...It's Been Tried Already

Messrs. Bernanke, Paulson and the less eponymous Eurobankers are throwing liquidity at anything that moves, in hopes of averting a recession - why? What troubles them so deeply about the global financial system that they are willing to do unprecedented things, like provide unlimited liquidity at below market rates? From the Financial Times:

Emergency help for financial markets entered new territory on Monday as the European Central Bank announced it would on Tuesday offer unlimited funds at below market interest rates in a special operation to head off a year-end liquidity crisis.

**** Flash Update: The ECB pumped in a whopping 348 billion euro, i.e. half a trillion dollars. Baby, bathwater, the sink, the attendant, even the bath house were thrown in. Reach your own conclusions - my own will appear in tomorrow's post.****

Regular readers know the answer: in our fiat system, all debt is money and all money is debt, therefore the authorities are panicking at the prospect of a sudden economic implosion caused by credit destruction, i.e. the evaporation of large amounts of money. In other words, Depression. (The title of this blog, Sudden Debt, was chosen a year ago because such a terminal outcome was becoming obvious to yours truly. Permit me, then, this small bit of self-accolade: things are unfortunately developing as I thought.)

The natural response of central bankers, when faced with the prospect of monetary implosion, is to use the sole weapon at their disposal: offering cheap money. Nevertheless, people can't be forced to borrow, even if rates go to zero. This condition is known as a liquidity trap, and Mr. Bernanke is infamous for suggesting - tongue firmly in cheek - the extreme cure for it: raining down cash from a helicopter (the idea came from Milton Friedman).

We know that a massive liquidity cure has already been employed in the United States under Mr. Greenspan, "the original" depression fighter. He took rates to near zero following the implosion of the NASDAQ bubble, thus creating the pernicious real estate bubble. The result was more debt, i.e. more money upon which the global economy floated these past 5-6 years. The Chinese economic "miracle" is largely a product of more dollars, created not only in the US but also in China, masquerading as yuan.

The bottom line is that Mr. Bernanke's monetary thunder has already been stolen by the previous Fed and the Chinese monetary authorities, who created massive amounts of liquidity. We now face a condition where consumers are loath to borrow more, because they have already borrowed too much. Offering more credit, even at low rates, does not alleviate their plight.

The one way out is also likely to be the most painful: a long period of downward adjustment in debt/asset and price levels, so that obligations can once more be adequately serviced from economic "rents", i.e. earned income from employment and corporate operating profits. The era of capital gains as constant booster shots is clearly over.

Smart college administrators in Harvard (Yale is jumping in, too) are fast adjusting to reality: they slashed tuition for students whose families earn up to $180.000 by 30% to 50% and expect that no student will need to take out college loans. In addition, and very tellingly, Harvard will "no longer consider home equity in determining a family’s ability to pay for college". It is well worth reading Harvard's release in the link above.

If it were a public announcement, it would go like this:

Ding, dong... Harvard is proud to announce that deflation has now commenced, starting at the very top. Essential service prices for the vast majority of Americans making less than $180.000 per year are 30%-50% too high and taking out more debt won't help. In addition, we would like to point out that regular capital gains are a thing of the past, at least in housing. Our opinion, which we are backing with our hard cash, is that low interest rates and capital gains as drivers for the economy, are finished. This concludes our announcement...Ding, Dong.


  1. There are still some clever persons working in Harvard. What a pity that they have been excluded from the Bush administration.

  2. This Harward change of policy is very interesting. But I do not think they are simply liberal.
    I remember somebody (maybe you) posted a picture showing that education suffered inflation the most in the past decades: they should be sailing on a sea of cash by now....
    It also very timely: increasing difficulties in qualifying for students loans and MEWs gone?
    Take care

  3. If a cash infusion of $500B from the ECB is really needed, it is a big, big, problem.

    What do the central bankers know about possible January writedowns that they are not telling us about?

    And are they making short term loans to let the banks postpone realizing losses for a few more weeks?

  4. Offering $500 Billion at Below Market Rate seems like a straight bailed out.

    When does "market rate" mean? Does that means the rate required between banks, that is like 100 basis point higher than the ECB rate? Thanks

  5. ECB really demonstrated its "though stance" of 350 Billion euros.
    I remember monsieur Trichet at the last Davos forum, scolding everybody: "be careful, we will not bailout anyone".
    350 Billion euros is a sum commensurable to the public debt of at least some of the 15 euro contries.
    We now know: we will have no bank failures, no matter how crappy their past loans are.
    No destruction of money and credit.
    Just the slow drippling into the real life world of last years inflation.
    It will take some time.
    Buy now. Anything. You can still grab.

  6. Dear All:

    Please see tomorrow's post for what is happening re: ECB/money market.


  7. Hellasious,

    Excellent post! People have for a long while now assumed a condition of limitless credit inflation, which is also to say that they have become progressively less conscious of the possibility, never mind reality, of debt deflation.

    In saying that, I do not mean exactly what Fisher did in his 1930s paper on same since, by assigning causality to the financial, he neglected real economy weakening prior to the Crash.

    With our tendency to think in national terms and finance induced short temporal horizons, we easily forget that the global economy has for a long time not performed particularly well even as a massive cloud of claims to its 'rent' has been created, so evidently a rising tension between real and financial which was absolutely guaranteed to reach limits and enter into a process of transformation, of 'de-financialization'.

    Having said that, and not expecting agreement with his far left political perspective, I would recommend taking a look at Loren Goldner's 1998 and later work on international liquidity crisis and fictitious capital.

    Una vez mas, Gracias
    Feliz Navidad

  8. It's only a loan for short terms.
    Two weeks.
    At 4,88% instead of 4,95 before.

  9. I'm guessing demographic trends are going to support tuition increases until about 2010-2012.

    The peak of the "echo boomers" was born in 1990 and is just about to turn 18. The demand in 2010-2012 will be enourmous as early peak echo boomers won't have matriculated and late peak boomers are still flooding in as freshman.

    It's going to put a large strain on household finances for boomer parents. Most likely, they are going to need to cut back household spending in other areas which may throw the US in a recession.

    I pulled some graphs and it was interesting to see how peaks in US births tended to produce recessions about 20-22 years later.


    For example, the boomers peaked in about 1960 and we had a serious downturn in 1980. Another small peak in 1970 and we had another downturn in 1990.

    It's also interesting that college tuitions was one of the few things in those downturns that *didn't* drop in price. In most cases showing strong year-over-year increases in tuition.

    It may just be a fluke, but there may be something to this demographic stuff.

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