The solution to the “liquidity” problem has apparently been found. So giddy are banks, big banks, and central banks about the Federal Reserve’s latest device for injecting just enough juice into the system to keep it from collapsing, that the Bank of England is about to do the same (at the behest of HSBC (HBC) et. al.).
I've described a probable path to nationalization/socialization, and unfortunately central banks seem to be following it step-by-step. The Fed has finally admitted to taking off the books of banks troublesome debt - debt in derivative form that's carried at a price that doesn’t reflect where it could be sold into a free market.
Because it's still being carried at an artificially high price, it can't be used as collateral and thus banks couldn’t lend new money even if they wanted to. So the Fed, and it seems now nearly every other central bank, is now exchanging the banks’ bad debts for their pristine debt: “give us the bad debt off your balance sheet and we'll give you treasuries that are on ours”.
Unlike the troublesome debt, treasuries can be used for capital (at least for now); thus, the Fed is injecting capital directly onto banks’ balance sheets. Where does the Fed get this “money”? It prints it. And that's the cost: a devalued dollar and lower standard of living.
I would like to ask a question at this point. If the Fed is saying it's getting plenty of bad debt to act as collateral in exchange for the good debt, why are banks not taking significant losses when the exchange is being made? By definition there can't be both a fair exchange and no loss incurred, because the root of the problem is that no one will buy the banks’ bad debt at the price they have it marked at. The answer unfortunately is akin to closing your eyes at the scary part of the movie… it’s just too awful to contemplate.
If the Fed (and in more permanent form some government trust) is becoming de facto landlord to a significant part of the populace, is serfdom far behind? But all this is being presented in the form of innocent looking short-term arrangements that aren't meant to become permanent, even though the Fed has not taken such actions since the Great Depression.
Do you remember 20 months ago when we were being told that “central banks have now mastered the management of an economy”? How far we have come since then in understanding what was really going on?
As the Fed kept real interest rates negative, it encouraged vast bad debts to be incurred. While it was happening, volatility was very low as liquidity, or debt, was being created, and people had money to buy things. Now that the debt is contracting the warts are showing. All those “shysters” never would have had the money to make those bad loans if it weren't for the Fed gunning the money supply and polluting it with debt.
This is no liquidity problem; that implies we just need to generate more debt. Taking the bad debt away from banks and making taxpayers pay the bill does nothing but shift the burden from those that made the error to those that didn't. The bill will be paid regardless.
Stocks may gyrate wildly if and when our “wise” central bankers announce their final plans of ridding the banks’ of a small percentage of this bad debt. But unless the government nationalizes a significant portion of it (the end game that will significantly change the world, and not for the better I might add), it won’t do much for banks’ willingness to lend and it certainly will not make the consumer more worthy to borrow.
The world has had debt corrections before. Some we have hardly noticed as the market was allowed to correct imbalances fairly quickly. Others have created sustained periods of deflation and negative economic growth because the debt was allowed to grow too large. Unfortunately, the size and scale of the debt in our economy today (thanks to the derivative markets) I have described as perhaps the largest in history by any measure (100 ways).
As the same economists who never saw a recession coming in the first place and now see just a shallow recession, and as Meet the Press invites two young people from TV to explain economic conditions they really don’t understand, I thought I would share with you another opinion.
The following is from an old friend of mine who has been around for almost as long as I have and makes his living understanding these things. You won’t hear what he has to say from mainstream commentators:
“All roads lead to deflation, particularly acute in the current regime due to the degree of credit/debt expansion. Every measure being enacted by world central banks is to forestall/reverse any further credit-related broad-based asset contraction. This is very difficult, and very unlikely to succeed, for any reasonable length of time.
That is, as a shift in psychology has already occurred with respect to undertaking debt/credit expansion -- i.e. readily accessible liquidity is being used to shore-up balance sheets, to the degree possible; thus, any such measures to encourage risk-taking, are likely to have difficulty in overcoming this hurdle.
The significant shift that has occurred recently is the Fed, and by inference, other central banks, willingness to increasingly risk the viability of their respective balance sheets in order to influence a shift in risk preferences. A new broad-based asset bubble is unlikely as any 'pullback' in asset trajectories that such a central bank move attempts to create will almost certainly be met by asset liquidation, i.e. it's akin to being long a position well below the entry price -- it's a natural reaction to let ride any rallies as long as possible, but to reduce risk, when it appears any such rallies have run their course. This is the result of the shift in psychology.
So, overall, any initially positive equity-related reactions are likely to resolve in further downside, until such time a broad-based capitulation has occurred.”
That capitulation is a long way away in time and price. The U.S. is in for a long process of debt liquidation, and that means a shrinking GDP.
(20min delay)