Nouriel Roubini, writing over at Roubini Global Economic Analysis, a fellow who allegedly saw all of this coming, has a great (and long!) assessment of the situation. Because of the debts that we created - debts across the government, business and personal spheres - deflation must be fought at all costs and right now. Here's why.
In all of its forms and manifestations debt deflation sharply increases the risk that borrowers will be forced to default on real obligations that they cannot service. Thus, debt deflation is associated with a sharp rise in corporate defaults and household defaults that creates a spiral of deflation, debt deflation and defaults.When you have deflation, existing dollars become worth more. That includes the existing debts you have. 5% deflation means your debts just increased by 5%. If you were on the hairy edge of insolvency before, deflation just pushed you over the cliff. That leads to a new round of bankruptcies and more deflation and more bankruptcies and on until only the very strong have survived.
The problem is even worse for banks who count on the values of the assets they hold as collateral (houses, cars, etc.) for loans. If those values drop, they no longer meet their asset to debt ratio requirements and they have to declare bankruptcy.
If Bernanke and Paulson are thrashing around, trying every wild scheme they can concoct, that's why. They're just trying to shove financial calamity down the road a bit. Instead of screaming and pointing fingers, maybe we ought to apologize to them. I doubt they dedicated themselves to becoming experts in their fields just so they could come and clean up after us after we turned the nation's finances into confetti.
Yesterday I read an article explaining the downward spiraling prices for Holiday shopping and it seemed to exactly describe deflation. Retailers are slashing prices now and dumping excess inventory in hopes to reduce losses, but the public is waiting to see if things will go down further - so they are not buying.
ReplyDeleteOn the other hand, despite the drop in energy costs, we should expect significant increases in food prices. Not as much as last year, but still pretty steep increases.
So does this blog describe strategies to control the situation?
Not really. As far as I can see, this is kind of like methadone for the addict. These spasms of debt bailouts need to be accompanied by stern and sincere vows to stop borrowing and spending by everyone.
ReplyDeleteLet's listen and see if we hear that ...
(crickets chirping)
... nope. All I hear is talk about Universal Health Care and increases in education spending and helping get the consumer loan carousel going again and ...
I have way too much of my depression-era grandparents in me. They lived in the same house since about 1928, and you wouldn't believe some of the stuff we cleared out of the basement when they moved out sixty years later. Talk about pack rats :-)
ReplyDeleteFrugality is not a bad thing.
KT,
ReplyDeleteI really have to disagree with the conclusion that the particular course of action was needed because something had to be done.
You hit the root cause for panic, when you point out that the bankruptcy laws for financial institutions requires them to declare bankruptcy when the value of their assets drop below the value of deposits. This creates a cascading credit crunch and calamitous deflation. But the proper way out of the mess would have been to pass an emergency, perhaps temporary change to the bankruptcy laws that would have allowed financial institutions to keep operating, even if technically bankrupt. Additionally, the Fed could have kept to it's intended role by supplying credit in the form of short term loans. Ultimately, to unwind this situation, the depositors are going to have to share in the pain. But better to limit their losses by keeping the banks alive as going concerns, by changing the bankruptcy laws. Instead we just throwing good money after bad, not dealing with root causes.
B-daddy,
ReplyDeleteYour solution is correct except for one small problem. It involves Congress. Paulson and Bernanke don't live in a rational world. They straddle a rational one and an irrational one. What you describe would have been the right way to do things, but it would have to have been enacted by the same people who have borrowed and spent like mad during 7 years of growth and prosperity.
My sympathy for Paulson and Bernanke is that they're had to be the only adults in the process for quite some time. They're like the beleagured guy in the Career Builder ads who works surrounded by monkeys.