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Mon

13

Oct

2008

Why Bernanke and Paulson are Failing
Monday, 13 October 2008 01:32
by Stephen Bindman PhD

Tuesday night after the Dow Jones dropped some five hundred points continuing Monday’'s and last week's decline there was near unanimity about what needed to be done. But moderate Robert Shiller author of Irrational Expectations who saw the problem coming reasonably well and knew there was a housing bubble had an interview in der Spiegel, the German news magazine saying that the effects on the market would be limited. “Shiller: ... The market has already lost $5 trillion in value and the problem will remain with us for some time to come.” However “ The banking problem must be resolved -- there is no way around that. If the banks have more playing room, it would also put them in a better position to refinance problematic mortgages more easily. It doesn't mean that these foreclosures won't continue.”

Monday night Ambrose Evans-Pritchard was as hysterical as Jim Cramer or anyone I have ever heard about the immediate collapse of the world economy. Writing in London’s Daily Telegraph he says “Chancellor Angela Merkel has been forced to pull her head out of the sand, guaranteeing all German savings, a day after she rebuked Ireland for doing much the same thing. Reality intrudes...

“During the past week, we have tipped over the edge, into the middle of the abyss. Systemic collapse is in full train.”

There is more:”We are fast approaching the point of no return. The only way out of this calamitous descent is `shock and awe’ on a global scale, and even that may not be enough.”

Writing of Angela Merkel, he is totally contemptuous: one day after she criticizes Ireland for guaranteeing bank deposits she does the same thing. He sees her veto of French efforts to launch a pan-EU rescue package from a narrow nationalist German point of view. She doesn’t want German taxpayers transfer colossal wealth to Latin Europe.

In the end only a massive alliance led by the Fed can save the world. And the Fed “As for the US itself, it has not yet exhausted its policy arsenal. It can escalate further up the nuclear ladder. The Fed can cut interest rates from 2pc to zero. If that fails, it can let rip with the mass purchase of US debt.”

If not the world will end.

Monday night Ambrose Evans-Pritchard was not alone. Bob Brian of Barrons on Tuesday morning said that no lending was taking place in europe. Banking had dried up. The judgment of the market was that the bailout wasn’t going to save things. The Dow is down about 10% since Congress first began to discuss the bail out.

James Grant was more right on Sunday October 5, 2008 in the Washington Post

when he said “Low interest rates, easy money and malleable accounting rules are what plunged Wall Street into crisis. Yet it is low interest rates, easy money and malleable accounting rules that top the list of federal fixes. The unifying theme of the new bailout bill, all 451 pages of it, is the hair of the dog that bit you.”

Since we have built too many houses pay too much for them, he seems to be in favor of handling it in the old fashioned capitalist, by writing off the losses and bankrupting whomsoever. This is not the Federal Reserve’s policy. “Credit creation is the Fed's signature crisis-management policy: Let a bubble inflate, then watch it burst; clean up with lots of dollar bills.”

He points out that the news of this crisis was hidden behind misinformation by types like Bernanke, Merrill Lynch and company for some time: constantly saying that the problems were contained. That was false, but now, they said about the bailout “When the Fed insists it has no choice but to print up hundreds of billions of new dollars and when the keepers of accounting standards bend in the face of criticism that market prices hurt, what they are really saying is the that financial truth is too awful to bear. Heaven help us all if they're right.” Apparently the world’s equity markets read the situation the way he did.

That the markets understand that the old games aren’t working and are not likely to revive, means that the economic world is collapsing. Economic activity is based on confidence, like most activities. Giving money to the same scam artists does not tell them a new game they can play successfully. That ignores the recognition that this is a statist economy, but covertly planned one. The market is circumscribed by the government. Its actions and inspirations are the largest and most important source of economic direction. Whether it be in research to go to the moon, or arms to defend ourselves from the Mongolian hordes or build infrastructure, or try and improve quality in education of the mentally retarded. And of course there is the long-term research budget, which provides the impetus for so much.

In my book Pseudo Capitalism, Socialism for the Rich, I show how the new elite class manages the existing economy in a way that chiefly benefits them. To reverse this the government must plan more openly than the flatlanders who profits from the illusion that we live in a primarily free-market economy.

Bernanke and Paulson have gotten it wrong. The markets this time have gotten it right. [Although it is important to remember that even in the worst Bear markets there are tremendous bounces and one is overdue at present.] Why should anyone invest in anything when the world economic model is broken. Until a new model of expansion will emerge who can tell what will work and what will fail. Building factories in China to sell products cheaply to almost bankrupt American consumers losing their jobs and their credit lines won't work anymore. Neither will building new hotels, or manufacturing SUV’s in the US. The factory building by the way has been subsidized by the US government which allows China to only take part of the price of eve their low priced goods in cash. The rest it takes in 100's of billions of US bonds. With the Chinese and Indian economy steaming hot the price of oil zooms higher.

Of course this is an oversimplification. But the outlining of powerful forces is correct and there are other examples. For more details, and less simplification, look in Pseudo-Capitalism, Socialism for the Rich.

Simplifying once more in an effort to underline some central truths, here are some questions and answers. What was the major economic force in feudalism?

Probably the weather, and disease. Neither of which people had much control over.

What was the major economic force in capitalism?

The alliance of new inventions and technology with private savings.

But in this new world the State and its projects are the major economic players. Financial manipulation, and cheap money aren’t generally enough. The adventurous but tough minded and clear sighted entrepreneur risking his life blood and fortune in alliance with new scientific truths are no longer the main players in stimulating and building the foundations of the economy. The state often must often establish goals and directions and enter into the tricky area of economic planning. Hard to do given congressional corruption and narrow self-interest and foolish ideas, not to speak of the passivity, inexperience and lack of knowledge of the electorate. But without some degree of central planning three bad outcomes are very probable now: a war to rescue the economy; inflation from printing too much money based on no concrete value; or tremendous deflation and financial collapse. Trying to breathe life into this old model will fail. The equity market collapse and the freeze up of credit show that this time the Market has got it right.

Saturday, October 11 the Los Angeles Times says that Paulson understands that the original design of the bailout with $700 billion won’t do it. Instead he wishes to buy shares in banks to recapitalize them. But they won’t be voting shares. Too much like nationalization one presumes. Best not to give the government too much control. So we give the money to those who made a housing bubble? The dot.com bubble? And mortgage securitization? And all Paulson’s old friends? I don’t think that is going to work in the long term, likely not even in the medium term.
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Ron Holland said:

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Many investors and concerned citizens around the world are showing their outrage at what the Federal Reserve has done to the American economy with their easy money policies which caused the credit & real estate bubble and subsequent global financial meltdown.

Join the thousands who are signing & commenting on the Abolish the Federal Reserve Petition at http://www.petitiononline.com/fed/petition.html


 
October 12, 2008
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