Thanks for providing a simple explanation of the current financial mess.

Unfortunately, your proposed solution will only turn us into Zimbabwe or Argentina over the long haul. Look, we have had inflationary policies in this country for as long as I’ve been alive. Historically it never lasts long. The problem is the system; fractional reserve banking and fiat money have to go, or our republican form of government has to go. Take your pick.

Inflationary policies equate to un-backed paper ‘money’ whose value can be manipulated at will by those in power. This explains why real wages have remained roughly the same since 1971, even while the rich get steadily richer and more powerful. At rock bottom, this is why our constitution is a dead letter today. This is why the ‘new boss’ is the same as the ‘old boss’ complete with the same crew of entrenched political hacks, pulling the same old strings. Sound money and sound banking place very real limits on both greed and power. Sound money and sound banking reward those who are thrifty and productive, no matter what hand they’ve been dealt at birth. Sound money and sound banking helped make us the richest, most powerful nation on earth well before the FED was born.

Now look at us. In less then 100 years we have become the biggest debtor in the world. Our manufacturing is gone. The so-called information economy is going. Soon we will be a nation of hamburger flippers and used-car salesmen. We have been taught to endlessly consume, borrow, and buy, but have completely forgotten how to save, and how to produce for ourselves, and how to live within our means. Hell, everyone over 50 thinks the government owes them a healthy, worry-free retirement. We forget that ‘retirement’ itself was invented by our first socialist president, FDR. It was virtually unknown to previous generations.

Something called ‘reality’ is setting in now that the blizzard of paper has been exposed as just so much kindling. You say we should just have more of the same, only faster. Well, we the poor and disenfranchised already know the paper in our pockets is worthless, and bound to get more worthless as time goes on.. but we’re not stupid and we’re not helpless.

I’ll let you in on a little secret. Here in fly-over country, the local walmart can’t keep up with the demand for ammunition. There’s your next bull market.

1. AIG et al fail. The risk of holding stocks and bonds becomes unlimited. To rebalance that, Investors start moving into cash.

2. Panic ensues on all major exchanges as investors scramble to sell stock.

3. Public companies see their stock driven to pennies and their bonds rejected. To get money, they turn to banks, which don’t credit as they are being liquidated themselves.

4. Deep distress capital emerges and starts buying organizations at their commodity price. For example GOOG, C, BAC, INTC are all valued 1/10 of the market price of their buildings.

5. Since the distress capital is not interested / does not know how to / does not have the funds to run these organizations, the people are booted out and the property is sold at scrap prices (valid economic behavior).

6. Most sophisticated activities, such as banking, engineering, healthcare, education, logistics, etc are dramatically reduced as people who used to work in teams and produce IP for billions are now working alone selling T-Shirts at an makeshift parking lot bazaar.

The idea is that there’s then a track for this kind of financing which is more appropriate to the sorts of mental images we have as human beings about the financial realities of something like a home. Instead of swapping the obligations around home financing several times per day, the high-finance angle looks more like big institutions paying to sign up for pensions with each other.

It seems to me that this addresses the main two policy problems we have in this crisis. First: establishing whether these assets are really worth a lot less than their face value, and second, figuring out who is going to be forced to hold them until we learn the first answer.

StatsGuy has some great posts above arguing that indeed these instruments are *not* worth their face value. Most of the plans I’ve seen involve various permutations of what it will take to get taxpayers hold these assets.

But we can make new laws. What if we just declare these these assets are non-transferable and must be held to maturity? Would that be interpreted as “all banks just failed!” or would it be interpreted as “ok, so the problem is frozen in place for 30 years, and by that time, the right stock and bond and acquisition actions will have happened to make it come out ok.”

however, the issue raised was what the cds market was saying. simply put, mr. johnson suggested a forced trade from banks’ junior debt into common shares.

I don’t think markets are that precise, esp. when the two objects of the forced trade are in tatters already. both are essentially worthless.

i think we need to look for the message elsewhere, in a less precise, more all-encompassing way.

the broad message, given the nature of mr. johnson’s intoductory remarks concerning the governmental backstop, in my estimation is that the backstop is itself in doubt, that we are in a much more serious situation than even the gloomiest can imagine, perhaps even that a crash is imminent.

In a depression such as the ’30s, at least 75% of the population remained employed. Low prices weren’t a threat to them.

In inflation it’s the other way around, those at the top and with assets make out OK, the majority suffers.

One thing that should be apparent now is that it is unlikely that well paying jobs in the U.S. will come back in abundance (the competition from the global worker environment & other factors does not appear conducive to it).

Combine lack of jobs with inflation and very soon the majority of Americans will be on par with the average Chinese. True it might be coming regardless, but I submit it will arrive sooner via the inflation route.

Anyway, we might not even have the option. One whiff that the U.S. is trying to inflate its way out of debt and the rest of the world (our creditors) will quickly eschew Treasuries. If that happens then the Fed will have no option other than to buy U.S. debt itself. Very soon that will become apparent & likely cause a run on the dollar (and I’ll be in that run). A lost of confidence in the USD will quickly result in game over.

The very fact that many of you out there seem to be searching for this quick fix/silver bullet out of our predicament tells me that the days of yuppieism/unrealistic expectations aren’t over. It’s like the late night TV viewer paying $59.95 for these wondrous pills that magically melt fat away.

I think the root of the problem to our downwards spiral is simple. The financial system is corrupt and broken. There’s a case of lost of confidence and wouldbe investors sitting on the sidelines if not fleeing.

In the past, greed and physical/economic growth was enough to entice fresh money into Wall St, only now everybody smells a rat.

NOTHING in the Obama administration so far, signals a change to me. Yes there’s some window dressing such as the stimulus bill (what a porkfest), Obama is making some talk… bla,bla,bla. Beyond that I see he condones that the REAL money is flowing to the status quo, same as always.

Don’t know about you all, but lately I’ve been spending my weekends preparing for Financial Armageddon

What I see as a primary underlying cause to our predic

To quote James Saft at Reuters – who thinks we had better inflate and right away quick – and who was quoting the biggest stock market bear in the universe, Albert Edwards at Societe Generale:

“Banks aren’t the problem, they are a symptom of the problem.”

Exactly. The problem is deflationary expectations. They have taken firm hold. Fixing the banks should be done only when they have been replace with inflationary expectations. And the Fed can do that. And they can do so quite quickly. Then we could and should fix the banks, in a systematic way – just as this blog here proposes. Bernenke should make a public commitment to do two things:

1. Stop paying interest on reserves and start charging interest on reserves. The decision to pay interest was wildly radical and is deflationary. The stock market has not gone up for one single month after he announced that last year. It was not correct.

2. Commit to a price level target. Not an inflation rate target – a price level target. In x years the price level in the U.S. will by y percent higher than it is now – and we at the Fed will do whatever we have to do to get that.

We will believe that exactly because we know they can do that even if we don’t believe it. They can print and buy stuff. Or they can finance the whole Obama deficit with fresh cash. They should announce the target and commit to it. We will believe them and will start spending our now newly unattractive cash.

To quote again from the blog:

I could obviously go on and on. In a sense, my earlier “multifacted” proposal for monetary stimulus was aimed squarely at this endlessly complex and confusing phenomenon called the liquidity trap. It doesn’t boil down to any one thing. Just as AIDS patients do best with a “cocktail” featuring many drugs, the financial markets are desperately crying out for a credible, multifacted policy mix that would address the liquidity trap from all sorts of different angles at once. Once we scare this ghost away, we’ll see how weak it was all along (as FDR found out in 1933.)

Conclusion:

I keep searching for the perfect metaphor for how I envision monetary policy. Let me try this one out: I am an Archimedean. Archimedes claimed that given a fulcrum and a long enough lever (and a place to stand), he could move the world. I believe that the Fed is that fulcrum and the control of the supply (and perhaps demand) for base money is the lever. Give me (or anyone with similar views) control over that policy and we could stop the world’s nominal GDP from falling, and lift it back up. And do it surprisingly quickly.

http://blogsandwikis.bentley.edu/themoneyillusion/

Here is a striking post from the blog – which I think is entirely accurate.

Beginning of post:

Krugman has criticized people who view depressions as a necessary price to pay for our previous sins of profligate spending and borrowing, or as a way of purging excesses from the system. I think he is right that this attitude exists, especially (although not exclusively) among those on the right. I find that this mindset makes it especially hard to argue for monetary stimulus, even compared to fiscal stimulus.

When most people visualize the myriad economic crises that we face, it seems as if we carry an almost unbearable burden on our collective shoulders. If someone comes along saying that we merely have to debase our currency, and the burden will be magically lifted, the solution seems incommensurate with the problem–it seems to good to be true. Even fiscal stimulus, often called a politician’s dream, evokes thought of future sacrifice, as we eventually must repay the massive debts we incur.

FDR was probably the only U.S. president to deliberately set out to debase the dollar. Toward the end of 1933 he joked with his aides that he had used lucky numbers when deciding how much the dollar would be devalued that day. Even Keynes found this frivolity offensive. But it worked. Industrial production rose 57% in just his first 4 months in office, regaining half the ground lost in the previous 44 months. Prices also rose sharply. If the recovery had not been aborted in late July by his high wage policy, near complete recovery would have occurred by 1935.

The sober puritan ethic is probably well-suited for all sorts of serious, long term economic problems. (Social Security reform?) For an economy facing deflation, however, nothing could be worse.

End of post.

What is going on now, I think, is that we are expecting disaster and therefore getting it. The deflationists are in full cry. We have become our own
Andrew Mellon. They keep telling us: “you are Americans – you are too fat – you eat Twinkies – and you invaded Iraq. You are getting exactly what you deserve.”

And we believe it. Just listen to Jim Grant. He just keeps saying it. Or Alan Abelson. He says it with a nice sneer. And it is going to go on and on and on. Until we have reduced our debt burden by deflationary horror. So Roubini tells us – with a nice big smile.

Balderdash. We can inflate. Carefully and with no big fuss. Inflation can be controlled. A debt spiral into the dump cannot be controlled. And Bernanke can give us an inflation – just by announcing it.

There is a great chasm between micro, in which the family must act, and macro, in which academics, advisors, policy makers and politicians act. The attempt to build macro theories on extrapolations of micro theories has not worked well. Behavioural Economics may offer a way across, but that remains to be seen. I also think S’s creative destruction is too easily co-opted by anyone seeking to shift families’ gaze from the destruction wreaked by the manipulation of financial “markets” back on to their own micro travails.

As you said above, the failure is fundamentally a political one, and economic theory, like statistics, is available to any political position taken.