Expect nothing, live frugally on surprise.

Thursday, November 13, 2008

US Economic Meltdown - Part 3 Solutions

One of the cardinal principles of economics is how changing supply and demand affect price. Ordinarily, decreased supply in relation to demand leads to increased price and reversed supply demand relationship leads to decreasing price. A decreased price by itself can on occasions increase demand just as price increases can decrease demand by making things less affordable to greater numbers of people. Supermarkets and retail stores advertise reduced price sales to attract buyers and get rid of inventories. Another gimmick they use is to reduce the price of one common item (potatoes) to lure buyers and jack up the prices of other essential items (onions) even more, which the shopper is likely to purchase at the same time to avoid two separate shopping trips.Stock markets, collectibles dealers, trendy merchandise retailers (including housing bubbles and tulip manias) use reverse psychology. They raise the price of an asset and this increases demand due to the greed of investors and speculators who pile on to the bandwagon. Prices go to irrational and unsustainable heights like 5000 Dutch Florins for a single tulip bulb during the tulip mania in the seventeenth century Holland, and presently millions of dollars for a small condo in Manhattan, Los Angeles, Shanghai, New Delhi or Mumbai or the astronomical values of Chinese, Indian and American stock markets. The mania leads to the greater fool price escalation until the greatest fool is left holding the house, stock or collectible, now with a much reduced market price. Greed and delusions of grandeur overcome caution, rationality and deliberation, and individuals, corporations and nations plunge in to face future disaster as in stocks and houses for the first, mergers and acquisitions for the second and wars like Iraq for nations.US Congress and presidents have abandoned fiscal responsibility for the last 60+ years mostly to satisfy their lust for power and wealth and the Federal Reserve Chairmen and Governors have been their partners in crime at least since Arthur Burns (with the sole exception of Paul Volcker). The latter have run the printing presses to create excess money and slept on the job as regulators by permitting private financial institutions to create even more money and increase the money supply by means of leverage with Structured Investment Vehicles (CLOs, CDOs, CDOs squared, VIEs etc.). The sloshing flood of dollars inundated not only America, but became a proverbial Biblical flood the world over, and led to real estate bubbles in the UK, Ireland, Spain, US, Canada, China and even Australia.China was willing to take a depreciating dollar to provide employment for its teeming displaced rural masses and laid off state employees. China also locked its currency and that of Hong Kong to a fixed parity with the dollar. This assured Chinese employment no matter how low the dollar fell, but has led to the current galloping inflation in China and resulting unrest. China intends to use it dollar reserves to blackmail America over Taiwan. It succeeded by causing the defeat of the separatist independence faction in the recent Taiwan elections. The newly wealthy Taiwanese have huge investments in the mainland and wish to avoid confrontation (like the Indians and few Chinese who stayed on in apartheid South Africa). Sooner or later China will now use its financial clout to force the US to abandon Taiwan. China has paid a hefty financial price as its 1.5 trillion dollar reserves have lost over a third of their purchasing power but Chinese leaders are not answerable to their population and though crooked and corrupt like those of India or America, they are not stupid or idiots like those of the last two. The US claims to be the locomotive pulling the world economy at the cost of personal sacrifice of running huge trade deficits. It does so to numb its predominantly naive and ignorant population, to distract it while the thieving leaders and elite raid the national treasury. It set up the middle tier developing countries to be patsies holding depreciating dollars. During the Russian and Asian crises, it had brainwashed the Asian developing countries about the perils of not having adequately high dollar reserves to counter the wild gyrations of fleeing private capital in search of a quick profit. The US had used its Trojan horses, the World Bank and IMF to force developing countries to permit free capital flows while limiting the flow of people and labor itself to cause the financial catastrophe and now used it to impose the draconian measures of currency devaluation, elimination of subsidies to the poor and slashing of social spending on Thailand, Malaysia, South Korea, Indonesia and even Russia. This allowed US financial institutions to buy Asian assets for a pittance (Thai real estate, Korean banks, Indonesian mines etc.). Now that it is in a similar mess, it continues to run increasing deficits, asks other nations to revalue their currencies and puts obstacles to prevent them from buying US companies (China and Unocal, Dubai Ports and US ports management). Thus the Asian Central Banks buy dollars from their exporters and give them local currency which they have to sterilize by selling local currency bonds increasing the domestic national debt on which they pay a higher interest rate than they receive on their increasing dollar reserves rapidly depreciating in value and purchasing power. This stokes the fires of domestic inflation while the dollar reserves are invested in US treasuries keeping US interest rates and inflation lower than what they should be. The asset bubbles created by sloshing liquidity have pushed house prices the world over higher than affordable income and they have begun crashing in Ireland, Spain, UK, Australia and America. There is a glut of housing in America and no shortage of land. Just like in Japan in the nineties, house prices will fall by 25% or more. Japan at that time had a trade and current account surplus and no inflation so it could run huge budget deficits and keep interest rates at half a percent for a decade and is still not fully out of a deflationary quagmire. The US with its current account, trade and budget deficits, a high inflation and drastic cuts of rates by the Fed has no ammunition left to counter a recession or economic meltdown. The huge losses of capital by financial institutions reduce their lending ability by twice or thrice their losses. The secretive lack of transparency leads to mistrust and fear reducing lending and transactions due to counter-party risk. This clogs up the credit markets and increases credit default swap prices, which the Fed printing money cannot remedy. Sovereign Wealth Funds like those of Abu Dhabi, China, Singapore have already seen their first foolish investments in Western Banks lose a third or more in value in six weeks and are presently reluctant to throw good money after bad. Thus America faces a decade or more of privation, stagnation, inflation in commodities and deflation in assets if it does nothing, a marked reduction in status and hegemony if it can successfully beg the Sovereign Wealth Funds to recapitalize its banks (unlikely because China will need over a trillion dollars to recapitalize its own bankrupt state banks with corrupt lending and humongous non-performing assets or demand Taiwan, and oil rich Gulf States may ask for a pound of flesh from the Israelis). The last alternative is a Federal bailout like what the RTC did for Savings and Loan Banks in the Reagan era. This may save the domestic economy somewhat, but will increase inflation and pressure the dollar further. A final alternative more in keeping with the temperament of the nation is to use its military might to capture new wealth and resources and compel creditors to wipe out the debt of America. All choices like those for Iraq are bad.


tanyaa November 14, 2008 at 2:55 PM  

While India Incorporated pundits are worrying about the spillover effect of the sub-prime crisis in the United States; the Indian Government believes the recent economic meltdown that has devastated the robust American banking sector, will have no direct impact on India thanks to the overflowing foreign cash reserves, the regulatory nature of our banking sector and the carefully calibrated, cautious and gradual liberalization policy designed by architects of the economy.

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