Markman: The New War to Save Credit

Jon Markman on the speed and veracity of our current Federal lending/bailout:

Yet money isn’t everything, even in the debt markets, and it will likely take a lot more than near-zero interest rates and massive boosts in the monetary base to ward off the painful effects of global deleveraging and a prolonged recession.

The main beef: Few of the government’s weapons in the crisis have been tried on this scale, if at all, so they amount to the most speculative experiment in modern financial history. And no matter what the suits at the podium say, they have no idea — no idea — whether their plans will work….

….In economics circles, this battle has another name and a set of theories. It’s called quantitative easing, or QE, and the only place it has been tried is Japan, starting in 2001. The fact that it has failed there doesn’t discourage U.S. policymakers, because they think they can get it right.

Quick primer: Central banks pursue their mission to stabilize a nation’s money supply and promote economic growth in two ways: changing the price of money via interest-rate cuts or changing the quantity of money by printing or destroying it. Ninety-eight percent of the time they pull the interest-rate lever, which is why we care about the rate-setting meetings of the Federal Open Market Committee. Yet in the rare cases when rates approach zero amid a collapse in inflation, central banks turn to quantitative channels to deliver economic stimulus.

This is the classic playbook from seminal 1930s-era British economist John Maynard Keynes, who proposed that governments should run big deficits to intervene directly into markets and maintain a zero-interest-rate policy, or ZIRP, when under extreme stress.

The idea didn’t work in Japan because a persistent recession had gutted demand for money, and, besides, banks didn’t think it wise to lend to failing companies. Economists call this a liquidity trap: When expected returns are low, investment falls, so economic activity slows. Then cash holdings rise because people expect returns to fall — which, of course, they do. Ergo, it’s a trap.

The Fed has tried to bust the U.S. economy out of this trap first by embarking on a path to cutting rates to zero by early 2009, then by increasing the size of its balance sheet through the printing press, then by changing the composition of its balance sheet by buying agency debt to keep yields down. Since none of this has jump-started the economy, the Fed has gone on to buying bank securities directly, taking over the role of private fund managers in a process economists call intermediation….

….So all the Fed efforts now are basically aimed at revving money velocity back up — and so far the ol’ girl just won’t go, largely because confidence that it makes sense is low. As one fund manager, who declined to be identified, told me in an interview this week: “We keep trying to find a silver bullet instead of just allowing deleveraging to run its course. Now that bullet is getting more and more expensive, and also requires so much gunpowder that it might destroy the gun.”

Shoveling cash at undeserving banks is just what you would expect from bureaucrats who didn’t have to earn that money in the first place — and who will be out of office before the plan blows up. Moreover, authorities who have studied Japan’s lost decade complain that cash-bombing the financial system will delay structural reforms and introduce dangerous market distortions.

Jon Markman On Our Present State

Have Past Crises Taught Us Anything?

…according to research by Niall Ferguson, a Harvard professor of economic history, there is ample reason for investors to thumb their noses at the conventional wisdom: All that taxpayer money is acting more like embalming fluid than artificial respiration, he says, keeping the banks looking eerily lifelike while they stiffen.

“You can stick money into every orifice of the big banks — their mouth, their nose, their ears, wherever — but if they can’t make loans because they have to reserve against future losses, and if they won’t make loans because there’s a recession, it won’t do any good,” Ferguson says. “If they can’t lend, there’s no money multiplier — they’re stuck, they’re zombies. It’s Japan all over again.”

That sounds about right. It’s the night of the living dead on Wall Street these days, a few weeks past Halloween, as the horror of asphyxiated credit that has plagued Japan since a debt bubble burst in 1990 is playing out all over again here. While it’s bad enough that our banks aren’t lending and private fund managers are shunning corporate bonds, it’s doubly concerning because U.S. policy experts have sworn they would never repeat Japan’s mistakes….

….Ferguson observes that the experts of each era swear they will never repeat their predecessors’ mistakes, yet they always end up making new errors of hubris and find that some old missteps are unavoidable. The U.S. Treasury and the Fed both know, for instance, that one key error made in the 1930s was the passage of a set of protectionist laws that prevented a free exchange of goods among countries, and they have overtly sworn to prevent that from happening. Yet at times of stress, new populist leaders always emerge, and they find it politically useful to blame foreigners for the country’s economic problems and try to protect jobs in the homeland….

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Think history can’t repeat?

  • President-elect Barack Obama pledged during his campaign to withdraw from the this)" href="http://www.ers.usda.gov/Briefing/NAFTA/">North American Free Trade Agreement until he has a chance to overhaul it.
  • Leaders of the top 20 world economies met in Washington, D.C., last weekend and emerged with no firm plan to coordinate on interest-rate cuts or currency balances.
  • French President Nicolas Sarkozy has proposed a socialist path for his country that irritates his European Union partners.
  • Russia has sworn to prevent its banks from making good on obligations to the United States and the EU.
  • And Ecuador’s president has said he would ignore “illegitimate” Wall Street claims for bond repayments.

Ferguson says that if history is any guide, the next steps taken by countries in an attempt to revive domestic economies will be to weaken their currencies. This makes exports cheaper, boosting sales, but it cannot be done by every country at the same time, or chaos ensues — and sometimes land grabbing.

“We will have a race to the bottom as every country tries to avoid depression,” Ferguson says.

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