The outsized financial sector in the US has been slowly strangling the real economy for the past twenty years. The most telling symptom of this has been the stagnancy in the growth of median real wages, and the growing inequality in income and wealth distribution. This is not the hallmark of a healthy, growing economy.
As an aside, globalization is a policy that favors the large financial interests in the US as the primary wielders of the global reserve currency. If there is a price to pay for this by a large segment of the domestic population, then so be it. We will speak more about this some future day.
There will be no sustained, legitimate recovery in the US economy until this imbalance is corrected. If this is true all the Fed's and Treasury's efforts to support the status quo of the current financial sector are not only going to be futile, but are exactly the wrong thing to do. They are painting over rot.
Short of serious reform or an exogenous stimulus shock to demand (such as war or natural disasters) we see a deepening stagflation. But with the bailout of Freddie and Fannie and the blank check handed to the Treasury by the Congress we are now seeing the glimmers of a more serious inflation, and a potential hyperinflation in the dollar.
The conventional wisdom of the street is that hyperinflation is not possible, because there will be no one to "borrow the funds into existence." Technically a hyperinflation implies the destruction and reissuance under duress of the currency, as opposed to a devaluation by even some large number, such as fifty or even sixty to seventy percent. We do expect the dollar's fall to be about that, considering its downfall started when the DX was 120. (The DX index by the way is far from an optimal index with which to gauge the true downfall of the dollar from here).
There are no rules or magic formula per se in the creation of fiat currency. No one HAS to borrow anything. The Treasury and Fed are the printing machine. The rules regarding the creation of fiat are part of the illusion of substance that surrounds a currency that is backed by nothing.
Yes there are some niceties about the Fed not buying the Treasury debt directly, but these are not hard wired, and are likely to fall rather quickly when circumstances dictate. When you see this happen, you will know that the US is on the path to a hyperinflation.
People like to create these rules in their own minds because otherwise the current financial system would appear to be insane. Who was there to 'borrow' the money into existence in the Weimar Republic? There was no need for borrowing because the Republic owed a substantial debt in real assets to exogenous forces (the Allies). Does this sound familiar? Does the US owe significant debt IOUs in the form of Treasuries to foreign holders?
We still view hyperinflation and deflation as outliers to the strongest probability of a stagflationary recession that is likely to be deep and protracted.
But the possibilities of other outcomes are there, and it is important to know what to look for as the situation develops.
IMF sees no end in sight to credit crisis
By Krishna Guha in Washington
July 28 2008 15:45
The Financial Times
Global financial markets are “fragile” and indicators of systemic risk remain “elevated” almost a year into the credit crisis, the International Monetary Fund said on Monday.
The fund warned credit growth in the US could fall further as a result of ongoing financial system stress and warned that emerging markets would be tested as global financing conditions tighten and policymakers grapple with rising inflation.
The IMF also noted that house prices had softened in a number of European economies including the UK, raising the possibility of further problems in those markets.
The assessment came in the July update to the Global Financial Stability Report, led by former Bank of Spain governor Jaime Caruana.
The IMF said that while likely losses on US subprime mortgages have “largely been acknowledged” in the form of writedowns, financial institutions faced a second wave of losses on other loans.
Credit quality “across many loan classes has begun to deteriorate with declining house prices and slowing economic growth.”
The Fund said bank balance sheets were under “renewed stress” and that the decline in bank share prices had made it more difficult for them to raise new capital.
This “increased the likelihood of a negative interaction between banking system adjustment and the real economy.”
With mounting inflationary pressure, the Fund added: “Policy trade-offs between inflation, growth and financial stability are becoming increasingly important.”
The IMF reaffirmed its controversial earlier estimate that total losses in this cycle could total $945bn – a number that combines mark-to-market losses on subprime-related securities and estimates of likely losses on loans. (Its probably light by about a half a trillion or more - Jesse)
Relative to April, when the Fund published its last GFSR, it said “systemic strains in funding markets continue” and the “low level of risk appetite remains unchanged.”
Interbank lending rates “remain elevated” while “long term funding costs have risen” for financial institutions.
The IMF said financial institutions globally have written off about $400bn since the crisis began last August, and that while they had raised substantial amounts of capital, the losses “exceeded capital raised.”
Banks also faced problems maintaining their earnings, weakening stock prices, and making it more difficult to raise further capital.
The Fund said that policy interventions – mostly by the US Treasury and the Federal Reserve – had so far succeeded in containing systemic risk.
But it said the “nature of resolution strategies and the extent of support have come into sharper focus” in recent months – a polite way of saying that the authorities in the US in particular have had to intervene further to preserve financial stability.
It in effect endorsed the need for the US to shore up Fannie Mae and Freddie Mac in the short term – saying their failure would have systemic consequences – but said “the policy challenge now is to find a clear and permanent solution” for the troubled government-sponsored mortgage groups.
The US Treasury has tried to deal with the immediate threat to Fannie and Freddie, while postponing discussion of their long term futures to a later date.
