Wednesday, November 26, 2008

Can the US Do An IMF On Itself?

In previous years and decades whenever a third world country would get into financial difficulty it would turn to the IMF for a bailout. Because of the way the global financial system was structured in the post-Bretton Woods era (World Bank, IMF, WTO, etc.), the US was always in the forefront of such efforts. The bailout examples are numerous and well known: Latin America, Mexico, Asia, Russia. By and large the process worked pretty well, based on the premise that in an interconnected world if your neighbor's house is on fire you don't haggle about the garden hose.

Let's explore this fire simile a bit further.

Picture the US as the Global Fire Department (GFD). In the last ten years or so the GFD became extremely irresponsible. It ignored the fire safety of its own firehouse, which became choked with highly flammable material (i.e. debt and derivatives), and relaxed the rules about the health and fitness of its firemen (i.e. oversight and regulation were weakened).

Seeing this, the good citizens in the neighborhood (i.e. other western nations) also adopted the same attitude. And why not? If the fire department itself didn't care about all that dead wood and turpentine piling up in its own back yard, why should they? A whole raft of nations from the UK and Australia, to Bulgaria, Poland, Iceland and Romania bought the same highly flammable "growth" model. Borrow - spend - inflate assets - borrow.

It was only a matter of time until a fire started somewhere. Unfortunately, it started in the worst possible place: the GFD firehouse itself. Predictably, the unfit firemen could not contain it and the fire quickly spread to the rest of the town. So, who's going to put it out now and how?

The current plan is to take all that dry firewood and turpentine and stow it someplace else: to replace and guarantee private debt, plus issue additional government debt. But with the entire town now threatened by the blaze, that's just a delaying tactic. What we need is less wood and less turpentine, plus more, better and smarter firemen. And even that's not enough. The entire town should get together to fight this fire before it scorches everything in its path.

Previous IMF bailouts transferred some of the risk from, say, Mexico or Argentina to the IMF (essentially, the US) by providing fresh loans and guarantees. By current standards, the sums involved were tiny: $20-50 billion.

But the US cannot perform a similar IMF bailout on itself, as it is currently attempting to do. The United States IS the IMF. Astronomical guarantees and bad-asset purchases merely transfer and spread out the problem internally, instead of solving it. There is simply way too much debt; too much dead wood, too much turpentine and, naturally, no one else wants it in his back yard. Just think of China, Japan, the Gulf States or Russia and how much US debt they have already piled up. How much more "firehouse debt" are they willing to accept, particularly when the flames are already licking their own houses?

What we need right now is water: a.k.a. debt liquidation. And the longer we fail to recognise this simple fact, the longer we fail to provide it, the worst it's going to get later on.

Can Old Dogs Learn New Tricks?

President-elect Obama is currently hiring firemen, his economic policy team; and it doesn't look good. They are the exact same bunch that let the firehouse get full of tinder in the past, if they didn't necessarily also strike the match. I sincerely hope they can teach new tricks to old dogs - but does Larry (Summers) look trainable to you? Woof.

Final thought (and Happy Thanksgiving to all): Turkeys destined to become roasters think they live in gobble heaven, right up to the point they turn into Butterballs. We got to change the way we look at things folks, and the past isn't necessarily the best guide to the future.


  1. book recommendation

  2. I totally agree. Obama administration will be a conti nuation of the same policies. I think FED already started with the monetization of the debt.

  3. Your last paragraph was most apt. The US has it's head on the chopping block, as we speak. The ax is being pulled back.

    I say within 3 months the paper-debt-trade will be history. The USD will be too.

    Joe M.

  4. Our university system has produced consumption driven economist clones that cannot think beyond there models. Their driven either to teach the same drivel they have recently learned in school or get a good job within the demand side business community.

    Obama will be a lame duck one term wonder by the time he gets it.

  5. Oh, it's 80s day at Sudden Debt: "Burnin' Down the House!"

    Self-IMF-olation is a bit like thinking you can pay off your credit card by putting it on your credit card -- which you can technically get away with until you run out of balance transfers and available credit. Then, all is bankruptcy.

  6. China, Japan, and the Oil States are the new IMF. The monetary policy of the US will have to be approved by the new IMF. I imagine they will demand strict frugality. Let's hope for leniency.
    After all these states don't want a hungry and desperate 500 pound gorilla tromping around the globe--in an accelerated pace at least.

  7. It will all end in tears. Until then, lack of a better place to get yield or more fugibility will continue to screw me on holding TBT, though I knew I'd have to take some deflation pain first.

  8. Joe M:

    You write: "I say within 3 months the paper-debt-trade will be history. The USD will be too."

    I'm going to book it down hard, Joe. Your calls are still lauded at another site where you used to post. I mentioned to "Wade" that I see you at Sudden Debt.

  9. Paul Volker is now Chairman of Obama's economic advisory board. Perhaps he will do some long term good.

    Also, when a fire is raging, the first thing is to move the flamable stuff to somewhere else, and only after the immediate crisis is under control, will the fireman work on reducing these hidden risks.

    We should all give Obama more time.

  10. Great post, Hell. Visitors who get your argument might also like Rosa Brooks' Sept. 18 tongue-in-cheek column welcoming the U.S. to the Third World:

    Dear United States, Welcome to the Third World!

    It's not every day that a superpower makes a bid to transform itself into a Third World nation, and we here at the World Bank and the International Monetary Fund want to be among the first to welcome you to the community of states in desperate need of international economic assistance. . . .

    Rest of the column here:,0,6908905.column

  11. ACME Hazmat Disposal Manual:

    1) Set up a limited company.

    2) Have the limited company rent some land.

    3) Deposit Hazardous materials on land.

    4) When the land is full, stop paying the rent and quietly leave town with the profits.

    5) The actual disposal is now the land-owners problem. You are happy.

    The FED's balance sheet looks an awful lot like a rented site ...

  12. Excellent insight! Looks like the PTB (Powers that Be) are pulling off a classic RCI (Rectal Cranial Inversion) - and not for the first time!

  13. This is an excellent analogy for the present situation in the United States. We indeed are facing a blaze of epic proportions, instigated by the inattention of the firemen.

    It is unlikely that anything at all can be done to pull the United States -- or indeed the world -- out of the present nose-dive. Further Keynesian economic meddling will only serve to worsen the Depression.

  14. Hi Hell,

    A lont time reader of your post, possibly from the start in what looks like ages ago.

    Not being here in the "comments area" of your blog for quite a long time.

    Last time i wondered about your views on the dollar. You answered that, owing to its reserve status, it would resist. I'd be glad to hear your current views on the subject again.

    Do you believe that Obama will succed at taming deflation?

    I certainly do

  15. The US has to do an IMF on itself.
    Otherwise, we'll end up with a OMG.

    The financial system was in cadiac arrest. It's currently being put on life-support with an artificial heart in the form of the Fed.

    Should the old ticker stop, all Hell will break loss. This may herald the dawn of the anti-Christ.

    The Antichrist will rise to power on a wave of world euphoria, as he temporarily saves the world from its desperate economic, military & political problems with a brilliant 7-year plan for world peace, economic stability & religious freedom.

  16. Hell, you presented the total USA debt to GDP ratio a few days back on your post Facts and Figures, Whys and Means.

    Do you have a similar chart for the entire world? (i.e. total world debt to world GDP)


  17. deflation = natural course of the economy

    taming deflation == destroying the economy

    So the equivalent question is 'do you think Obama will be successful in destroying US economy'?

    Why not, given that he gets help from Bernanke the magician?

  18. OT:


    I remember you once made the comment (can't find it, though) that "it is always a bad sign when the only banks and casinos are doing well." Well, look at this story:

    Trump Entertainment to miss interest payment

    OK, maybe we shouldn't be that surprised since it is Donald Trump after all. It's not like it's the first time that's happened. But still, is the converse also true: namely that it is a good sign for the economy when banks and casinos are doing poorly?

  19. Hmm, Hel, I've been visiting every now and then for 3 months now to read your (mentally stimulating) verbal diarrhea, and now I found this blog article:

    Knew some of that, had heard some other... But for the whole picture, while I'm not sure if there is no grain of salt in there, the conclusion seems simple: fractional reserve ends in tears for all but the chosen ones in the end.

  20. This comment has been removed by the author.

  21. Now I realize that as long as this is all accounted for properly it is technically not printing money...

    But I keep remembering that old story about the proverbial frog- put it in boiling water and it jumps out of the pot; put it in cold water and slowly turn up the heat and... (well you know)

    So what step would be required AFTER this to literally 'print money'? And how quickly could the Fed do it if they were allowed to borrow a lot of this stuff?

    And of course the bankruptcy of the Fed is not at all the same as the bankruptcy of the US government now is it???

    Hell, I recall you once said there was not enough long term (30 year) debt out there for the fed to eliminate most of our debt thru inflation. Could the Fed create enough this way (+ one step of course)?

  22. This is wkwillis posting. Livejournal does not work on my computer (windows and XP) on this site.
    Inflation was 20% a year at the end of Carter's term. The debt rolled over and we spent the next thirty years paying 20% real interest on the national debt. That's what Reagan did. Clinton issued short term debt so that it couldn't happen again. He figured out that if he just waited out the bond dealers by issuing short term debt, they couldn't lock in long term high interest rate bonds. He knew that he wasn't going to blow out the budget like the last three (Carter, Reagan, and Bush)presidents did, so interest rates would come down and the economy would boom. That was the 1992 to 2000 era.
    We can't destroy the national debt and the corporate debt and the family debt with inflation.
    Hyperinflation works quite well, though. So does just defaulting on the dollar and issuing new money.
    But as long as the foreign savers believe that the Democrats are going to pay back the money the Republicans borrowed, the dollar will continue to be strong.

  23. Money flows to US treasuries not because of "quality", but the total commitment of our elites to protect bond holders at the expense of the citizens. People mention Argentina negatively, but their government defaulted because politicians were more afraid of citizens than foreign bond holders. US citizens will be driven into total poverty and will not revolt, because both parties are bought by the same people, and the media is owned by them.

  24. Re: A US default

    A default by the US federal gov't would be a casus belli for China, Russia, Saudi, etc. And so would the equivalent debt wipeout by hyperinflation. The US is most definitely NOT Argentina.

  25. wkwillis posting

    Causus Belli is Latin for 'cause of war', as like Pearl Harbor or something.

    I think that it's been too long since the elites have fought a war. They've forgotten what they are like.

    Stage One

    Massive overseas elite financed terrorist attack on the US after we default to punish us.

    Stage Two

    A biotech engineer pissed about his dead family (killed in the massive terrorist attack) retaliates by wiping out 50% of humanity.

    Stage Three

    The world has all the houses, farmland, factories, oil, dams, etc, and one half as many people. Rich are no longer rich. Houses are free, farms are free, etc.

    Stage Four

    Overseas elites decide to start a war to destroy enough wealth to make their property holdings worth something again, starting by nuking all the cities in the world. They hit America first so we will retaliate and do the job on their countries.

    Stage Five

    World War Three lasts ten years. We win at the cost/benefit of absorbing the whole world as American citizens.

    The escalation can stop at any time. All you have to do is persuade the attackers/counter attackers that the price is just too high.
    How do we persuade the overseas elites that a massive terrorist attack on America is a bad idea?
    That maybe it would be preferable to just stop giving America credit and accept that they are not an unlimited open market where you can hide assets and relatives for after you flee your country?

    Here's hoping the elites have more sense than to start a war.

  26. Hell said "The US is most definitely NOT Argentina".

    Ah- so now we know the assumption in your mind's model!

    As this raging inflation-deflation debate is really at the very heart of the eschatological blogosphere, would you be willing to share why you believe "The US is most definitely NOT Argentina"?