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The Paulson Plan = MLEC Version 2.0

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I can be painfully slow to see things sometime…..

Long-standing readers and finance junkies may remember the Treasury’s structured investment vehicle fiasco of last fall. By way of background, banks had created off balance sheet entities called structured investment vehicles (SIVs) which contained subprime (and sometimes other) assets, funded by commercial paper and short-term debt. Like a regular bank, the economics worked because the assets were of longer maturity (3-5 years) than the funding sources, and short term money is generally cheaper than long-term funding.

Then the subprime crisis hit, lenders became very leery of funding subprime related assets, and the SIVs looked pretty certain, as it indeed played out, to produce losses. The banks had assumed they could simply let the SIVs fail, but were told in no uncertain terms by the debt investors that There Would Be Consequences if the SIVs went bust. Suddenly an off balance sheet exposure was not off balance sheet at all.

Hank Paulson attempted to ride to the rescue with an idea, the so called Master Liquidity Enhancement Conduit, that we said virtually from the get-go would not work. He wanted to set up a vehicle, to be managed by a third party that would buy the junky SIV holdings, which included risky real estate assets and murky stuff like collateralized debt obligations, and be funded by private investors. The problem was that there was no price which would solve the basic conundrum: investors were not willing to pay above market prices, and the banks were unwilling to sell at market. Paulson & Co. wasted nearly two months trying to breathe life into this stillborn idea, then abandoned the effort.

Ah, but the MLEC lives! It’s been retooled into the Paulson plan We still have a fund that will be managed by third parties. We still have the buying of drecky, hard to value assets, with emphasis on mortgage-related paper. And the taxpayer is being told that it is an investor, that it might actually make a profit on this venture.

And as with the MLEC, the big issue will be how to price the paper or at least some commentators treat that as an open question. But by foisting this on to chumps taxpayers, the problem goes away. It is clear now that the intent is to pay over whatever the book value of the paper is, both to recapitalize the banks and to generate high valuations that let other financial firms use these phony favorable prices for preparing their financial statements.

But the MLEC was designed to address the pressing problems of a year ago. The crisis has advanced considerably since then.

Remaining fixated on a solution that is badly out of date is tantamount to fortifying the Maginot Line when the blitzkrieg has rolled into the fields of France and the British are beating a retreat to Dunkirk. And I expect it will prove every bit as effective.

Update 6:20 PM: Paul Krugman linked to this post, saying he saw the MLEC/Paulson plan similarities before we did. Fair enough. But we were out earlier with the “banana republic with nukes” observation.

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59 comments

  1. Richard Smith

    Looks as if M-LEC and Paulson Plan were part of a year long quest for a bigger fool. Mission accomplsihed.

  2. Anonymous

    Then the subprime crisis hit, lenders became very leery of funding subprime related assets, and the SIVs looked pretty certain, as it indeed played out, to produce losses. The banks had assumed they could simply let the SIVs fail, but were told in no uncertain terms by the debt investors that There Would Be Consequences if the SIVs went bust. Suddenly an off balance sheet exposure was not off balance sheet at all.

    This is the part that I still don’t understand. I remember hearing things like “it would affect the reputation of XYZ if this or that SIV or fund would fail”. What was the threat exactly?

  3. Dean

    There is amble evidence offered in this blog (revised and supplemented on a daily basis) that the financial crisis solutions offered(currently on the table) are at minimum imperfect and at maximum ineffective. I would like us then to concentrate on the next sequential topic of the most probable outcome. Here are the facts:

    there was a deliberate attempt by the current administration to paint a rosy picture of an economy ready to turn the corner (refer to sentiment as manifested in July, August of this year and part of September). This lead to a strengthening of the currency which also temporarily solved a necessary prerequisite for winning elections: low gas prices. We all know by now that this artificial construct has or is about to fail. Before you are tempted in countering this opinion, please refer to the political winds shifting as a result of the economic crisis(aka Paulson bailout). The “all is well” scenario designed to favor a Republican ticket is currently giving away to electorate redistribution in key battleground states seen as favoring the Democratic ticket.
    the Paulson plan is and will remain inadequate to recapitalizing the system. One has to wonder that Paulson and other smart brains in his entourage already know this, perhaps a tacit admission that the problem is far worse than currently imagined.
    There is a significant and very worrisome trend developing of foreign entities refusing to participate in purchases of US Treasury debt; 1/3 of usual purchases. As our troubles become known to the man on Asian and European main streets, financing US debt becomes a much more difficult proposition.
    In trying to reason this through, could it be that (I would appreciate your commentary pro or con):

    Recapitalizing the system would require a coordinated attempt by all Central banks (Trichet hinted of lower rates and the probable October outcomes point to a 50 basis points to a Fed rate cut). Plan B?
    Not enough money in the system to do so.
    Our consumption driven (70%) economy would require another Trillion or so of government spending enacted by the new administration.
    Doesn’t all of this lead to a circular argument as to available choices and remedies? (i.e. monetizing making us a less credit worthy borrower?).

  4. joe

    What to do?
    What to do?

    SOMETHING !!!

    What I like about this particular thread is that it addresses the gap between the capitalist’s solution and the money problem.

    The gap is obviously and sufficiently wide enough to show there is no solution.

    At some point, a handful of folks are going to come to grips with the reality of the absolute and total failure of the debt-money system.

    IMHO, eventually we will all reach the conclusion of the fallacy of using money as commodity, and begin the process to return money to its proper role and status as a means of exchange.

    I recommend all do a quick read of monetary reform pioneer C.H. Douglas on the subject of the proper role of money.

    There is a solution out there.
    But we cannot borrow our way out of this here shtick.
    But the issuance of public credits, as Douglas calls them, we can begin the process of restoring economic democracy and free enterprise to the nation’s and the world’s economic system.

    I will say it again.
    What you have here is the end of laissez-faire, debt-money capitalism as we know it.

    But, we have not yet met the enemy.

  5. River

    Dean…

    The Problem Is:

    ‘The “Freidmanites” thought they understood the (post-crash) policy mistakes that led to The Great Depression. They believed the “Roaring Twenties” was the “Golden Age of Capitalism.” [The Friedmanites believed] The great bust could have been avoided with a simple ($5bn or so) banking system recapitalization. As we are witnessing today, the issue is not some manageable amount of new “capital” to replenish banking system losses. Instead, the predicament is the massive and unmanageable amount of new Credit necessary to, on the one hand, sustain a mal-adjusted Bubble Economy and, on the other, the Trillions more required to accommodate a gigantic speculative de-leveraging.’

    Since the Sec Treasury and Chairman of the Fed realize that there is no way to come up with a solution to accomodate housing prices continuing to deflate, they are attempting to reflate housing prices by allowing institutions holding mortgages to mark them to some fantasy value. By injecting ‘seed’ assets into some big banks and allowing those banks to mark mortgages to fantasy, the Fed and Treasury are hoping to implant a ‘virus’ of fantasy mortgage prices that will spread to all institutions holding deflated mortgages and thus to the private sector of home owners. IF this strategy works the system might be reflated and be saved from meltdown. Will it work? I don’t have a crystal ball, but after examining the factors involved I do not think so. I believe Doug Noland was right when he said ‘I have a very difficult time seeing a way out of this terrible mess.’

    Of course, there is the alternative view: That the Fed/Treas know that this rescue attempt is bound to fail but it is a huge life ring to their pals.

    In any case there was little choice. Some attempt had to be made, no matter how futile…Like sandbags against a rising river…People feel they must do something even if they know the effort is wasted. If they did nothing, imagine the fury after the crash!

    I think the $700B was ammo wasted and it will be sorely needed later when the going gets really tough.

    http://www.prudentbear.com/index.php/commentary/creditbubblebulletin?art_id=10125

  6. Anonymous

    For those who remember the mock documentary film “Spinal Tap”: the MLEC is Paulson’s “Jazz Odyssey.”

  7. Dean

    River and Joe:

    Agreed.

    I have occasionally come across Doug Noland and the spike in his federal Reserve Credit chat is very telling. Paulson is smart enough to know that the current bailout is simply window dressing. The full extent of the crisis will become known post November 4th.

  8. Anonymous

    And the good thing for the Paulson plan vs MLEC is the funding source for the assets. Instead of selling CP (for which there is very little demand), the Paulson plan involves selling bills (for which the whole world is lining up). Masterstroke…

  9. Erich Riesenberg

    This is the problem you and many have been pointing out the whole time, paying above market or paying at or below market.

    By the by, perhaps you commented, Section 103 (f) specifically calls for the Plan to help banks hurt by the preferred stock of Freddie and Fannie, which clearly calls for purchase above current market price for those assets. Seems they realize their mistake.

  10. Anonymous

    Are there any legal principles a taxpayer can invoke if the price paid for mbs paper is manifestly too high?

  11. Anonymous

    “the Fed and Treasury are hoping to implant a ‘virus’ of fantasy mortgage prices that will spread to all institutions holding deflated mortgages and thus to the private sector of home owners.”

    trickle down bailout? Cleary the idea that they can hold the line on more foreclosures by removing the ever rising stockpile of GSE foreclosures and of course HOPE Now nonsense and buying up worthless paper to steady the SFR market is the great illusion.

    Easy credit has lead to a housing glut the inventory will take years to sell off with the gov’t eventually owning whole neighborhoods and subdivisions.
    The return of easy credit doesn’t solve the problem!

  12. John Meyer

    The light bulb just turned on for me Yves! The “Maginot Line” analogy is pure genius! Too bad the analogy cannot be extended – in our current situation its the Nazis that occupy our government and are looting the treasury in anticipation of a hasty retreat come 4 Nov. No friendly troops anticipated. Just collapse.

    John M

  13. Kafka

    Admittedly I am a dope and can only do simple math but I know when you borrow today to pay back tomorrow with contingent revenue streams, eventually the shell game ends. Let’s see, the U.S. Government 07 tax revenues were about $2.3 Trillion comprised of about $400 Billion in corporate taxes and $1.9 Billion of income taxes (numbers could be off). Approximately, 50% of the income tax revenues were generated from the top 5% income earners from which a substantial portion of those profits were derivatives of the stock market, don’t look like those dudes will fare very well in 08 and beyond. As for the corporations, many will have losses this year and be requesting tax refunds from loss carry backs (I think financial services represents something like 30% of corporate income). Assume tax revenues remain constant in 08 at $2.3 Trillion, how the U.S. government can continue to be the lender of last resort with its $11.5 Trillion (soon to be) national debt, $7 Trillion GSE debt guarantee obligation, $60 Trillion present value entitlement obligation and rolling presumptive annual deficits of $700 Billion from the budget and $700 Billion from trade deficits is beyond this simpleton. Since tax revenues will likely decline from 08 and forward, should the U.S. government be loaning money to anyone? I would be more concerned about who will continue funding the U.S. voracious deficit spending needs with its massive debts and declining revenue stream. Remember, the U.S. economy is 70% debt financed consumption based, 30% of GDP is fake, about $16.5 Trillion of financial services debt exists, credit spreads are at unheard of levels (over Sigma 6 deviations), real estate will likely revert to the long term mean best case scenario….it seems more likely to me that the $700 Billion will be blip since the Politico heroes have already thrown about $1.5 Trillion at the problem they claim did not exist to begin with and the dollar will devalue and Treasury rates will rise.

  14. doc holiday

    My latest quest is to research the Treasury yield curve, which is linked to that tsunami of easy credit that goes back to 2002. It is interesting that the yield curve has remained in a steep state for 6 years and that this recession has not impacted the shape, thus the Treasury is using synthetic leverage and non-existent credit to prop up the long-term, while they flood the short terms with money that is linked to massive future obligations that can’t be repaid!

    There is a massive tsunami wave shortage of global cash, because there was a tsunami wave of synthetic credit.

    More later, but it seems no one gives a crap as to the mechanics of this. Anyone curious?

  15. Krakpotkin @ newcombat.net

    The privatization of the Paulson Plan that was sold to the Congress is a betrayal of the public trust.

    And by reminding us of MLEC you’ve provided something of a missing link as to how/why it’s happening.

    Is it too late to stop Paulson, Sachs from railroading this into the private sector’s broken pricing machinery?

    “What’s To Be Done?” asked Lenin.

    Deluge your Senators and Reps with missives …?

    http://newcombat.net/Conversation/2008/10/05/paulson-plan-gets-privatized/

  16. Matt

    I wonder…if Mr. Paulson thinks that demand for treasuries will crash, he may be using TARP as an excuse to sell a whole lot of them while there is still demand. If this is true, then the details of what he is going to do with the money over the ensuing months is less relevant, and subject to renegotiation.

  17. lrm21

    Yves as always you are spot on on your analysis.

    Like the shell shocked french who are standing watching the Nazis march down the Champs Elysees we continue to discuss how we got here.

    I think the course of action for many americans and those who are truly opposed to the direction of this country is where do we sign up for the resistance.

    Either we flee the invaded homeland or we form the resistance. I am talking as euphimism of course. Although further lack of political action by those who know in the hearts how dangerous the situation is, may at some point lead to a more active resistance.

    We are no longer in control

  18. donna

    Of course it won’t work. Paulson’s attempt to monetize things that aren’t worth anything will fail badly, and we’ll just be that much more in the hole.

    But, he will have kicked the can down the road, and it’s one more thing another administration will eventually have to solve.

    By then they all will have collected their winnings and left the casino, though.

  19. badanov

    Ms. Smith’s comparison to the 1940 German invasion is apt as far as I understand it.

    The Maginot Line which was established to prevent a second German attempt to cross that area with its forces would have been a devastating force multiplier for the French had the Germans decided to commit its forces there.

    Instead, the French anchored more than half of its forces behind that line, while,when the Germans crossed the border near the Netherlands,the rest of the French army along with with British Expeditionary force moved forward to counter that move, even as a huge German armored force was moving through the Ardennes and then into open country to cut off the forces near the coast.

    So was relying Maginot Line responsible for the German sucess in case Yellow?

    No,in fact the Maginot Line did its job: It prevent German forces from moving through that area, as designed. The fact that reliance on the line by the French General Staff was an error of maneuver and operations. The basic concept was sound had the Germans decided to use that route.

    What caused the German success in May 1940 is that they simply outmaneuvered Allied forces.

    As it was the German forces, especially the Luftwaffe suffered tremendous losses from the invasion and the subsequent occupation tied it own valuable forces for years after the invasion of the Soviet Union.

  20. Kafka

    At the end of the day, you can apply all the econometric analysis you want, the math is simple, you can’t beat a “liquidity trap”, all the rhetoric and analyses on the planet will not solve one the most massive liquidity traps in history. Perhaps more debt will defer or smooth out the insolvency issues for a time but more debt can not and will not solve the liquidity trap which necessarily requires a reversion to the mean. And all you lovers of Buffet ought to go read his simple article on Squanderville from 2003 (which apparently the bottom feeder is now ignoring for his own financial gain), more production, less consumption and less debt are the only answers; which I do not see ever happening especially if you listen to your Politico heroes.

  21. Anonymous

    October 5, 2008

    Anecdotal real estate values from the hinterlands:

    I’ve found it amazing how the bailout nonsense has blown off the subject of current real estate prices, the core indicator of how low in value bank mortgage portfolios have gotten. You know the stuff Paulson & Co. are going to pay 100% of face value for in order to “save” his Wall Street buddies. Sorry, but what would be once considered sarcasm has now been upgraded to the “way things really are”, particularly here in “Truth Land”, aka Naked Capitalism.

    First report: Seasoned mortgage broker friend says that formally $400k to $500k houses in the greater Sacramento, CA area are now selling in the $200k to $250k range a solid 50% drop in value with no bottom in sight, and this is not an “economically depressed” area.

    Second report: Long time friend attended bank REO’s (real estate owned) auction in Sacramento two weeks ago with 420 houses on the block with bank reserves on sale prices. Friend bid $130k for 4 year old, 4b 3b, two-story house, and was the high bidder, but price didn’t meet bank reserve. Bank quickly took the deal anyway in after auction negotiations, and offered liberal financing. Current County assessor value (?), $320k, roughly a 60% drop in assessed/market value.
    So when our Gov, Uncle Arnie, says that California may also need “bail out” money he wasn’t just
    woofing.

    On the bases of the old accounting principle of Li-Fo, last in, first out, I would say that most of the so called “toxic debt” comes from the rock and roll real estate balloon areas of California, Las Vegas, Florida, etc., and I am suspecting that values have fallen in those areas as they have in Central California.

    My “plan” of the morning for Paulson & Co.: Just give his buddies the %$*# $700 billion and let them keep and deal with the toxic waste, on and off, their balance sheets. That way the “asset
    managers” now “liability managers” that Pauly-Baby is going to hire, and the perceived to be “no-
    conflict-of-interest” Wall Street firm guys can spend the Winter jetting back and forth from their
    Caribbean Islands, and St. Trope, in their G-6’s, and we ordinary, Main Street, taxpayers would then
    save a ton of money in the process.

    Earl L. Crockett
    Heading to beach for regeneration and absolution,
    Santa Cruz, CA

  22. SlimCarlos

    >> At the end of the day, you can apply all the econometric analysis you want, the math is simple, you can’t beat a “liquidity trap”…

    This is just ribbish. Of course you can beat a liquidity trap. All the Fed has to do tomorrow is say it will pay par plus 10% for anyone w/ a funky IOU in his pocket. Then the Administration announces a $5t infrastructure re-build. Tnen the Fed cuts rates to 0% and revises its outlook to "further easing".

    You don't think this will get the money flowing again?

    Of course, the currency gets destroyed, but that will happen anyway….

    Speaking of destroyed currencies, I read on the Iceland thread that Iceland will now have trouble buying fuel. So a question to the deflationists out there: is the price of fuel in Iceland going up or down? (This as per the thread on Friday re Merrill call for $50 oil.) Second question — what fundamental reason is there to suggest that the same thing won't happen in the US?

  23. Kafka

    I will say it again dude, you can not beat a liquidity trap. You can print more money but the effect will be moot. The economy is 70% debt financed consumption based. 30% of GDP is fake. Adding another $5 Trillion to the debt burden will not fix anything assuming anyone would lend after the massive devaluation of the dollar you just created. Studies show it currently takes $5 of borrowing to create $1 dollar of GDP (which has no inherent profit after interest). What is rubbish my friend is suggesting more massive borrowing in a debt financed consumption based economy will provide any result other than wheel barrels full of dollars. You can’t beat a liquidity trap, prices must revert to the long term mean best case scenario.

  24. SlimCarlos

    >> Adding another $5 Trillion to the debt burden will not fix anything assuming anyone would lend after the massive devaluation of the dollar you just created.

    What debt burden? I am not saying the Fed will *lend* money, I am suggesting it will give it away, no strings attached.

    You're right, this will preclude the US' ability to borrow and spell the death knell for the dollar. But that's the whole point. The debt is denominated in dollars. No more dollar, no more debt. See?

    Liquidity traps are avoided all the time, but always in smaller countries with "expendable" currencies. Many of you think it can't happen here. But most of the Street the bubble could expand forever too.

    Here is a chart of the Icelandic Kronur: http://www.exchange-rates.org/history/ISK/USD/G/30

    Now, is the price of oil going up or down in Iceland? Seems to me the correct answer here is "up", quite a bit up, in fact.

    This theory that banking crisis = deflation is preposterous on the face of it. One can't get out the front door without tripping over counter examples.

    Why the mental blockage here?

  25. Kafka

    Dude, you are talking about printing over $8 Trillion and another $2 Trillion per year at least(after inflation and devaluation) to fund the budget deficit. In a 70% debt financed consumption based economy that means ball game over and riots in the streets. I will say it again, you can not beat a liquidity trap by printing money and survive. What part of hyper inflation do you not understand?

  26. SlimCarlos

    >> What is rubbish my friend is suggesting more massive borrowing in a debt financed consumption based economy will provide any result other than wheel barrels full of dollars

    I should say that I agree that this won't help revive the economy, as least as we knew it. I agree that this will result in a hyperflationary mess. I agree.

    I would nonetheless say that this way out is preferable to a deflationary contraction. The deflationary contraction will extinguish everything in its path, including productive sectors of the economy. An inflationary wipe-out will kill off the consumption-oriented sectors (i.e. those responsible for the problem) yet leave relatively unscathed the parts you want saved. For example, farmers will do just fine in a inflationary wipeout. Ditto for, say, coal producers.

    But my main point is that this will happen anyway. Resistance is futile. It is always the currency that goes.

  27. SlimCarlos

    >> I will say it again, you can not beat a liquidity trap by printing money and survive.

    Actually, that is not what you said the first time. What you originally said was that "You can't beat a liquidity trap." Now you've added the rejoinder "and survive".

    So we now agree you can beat a liquidity trap? If so, all that left to discuss is the meaning of “survive”.

    You say we will see “ball game over and riots in the streets.” I totally agree. There will be riots in the streets and certainly the ballgame as we know it is over.

    What I put back to you is this: Why is this so exceptional? This happens in other countries all the time. Most paper currencies go to zero. What’s really amazing is that the US Dollar has lasted as long as it has.

    Question: Would it be fair to say that, apart from differing scales, the disease plaguing Iceland is the same disease plaguing the US? If so, would you place all of your savings in the Kronur now? If not, why not?

  28. Kafka

    Dude, if what you describe happens, then the liquidity trap will have won. I would suggest there is little difference in a 70% consumption based economy between a deflationary correction and hyperinflation in real terms. Your analysis seems to me like the one that brought the U.S. to this point to begin with, borrow with no regard to repayment as long as the fake GDP numbers keep increasing, now instead of borrowing, you are suggesting debasement of the currency to achieve your results, simple math provides it can not work, you can not beat a liquidity trap eventually even the best ponzi schemes must end. Schumpter knew what he was talking about. I have been betting on dollar devaluation for years which is inevitable no matter what happens.

  29. Kafka

    Dude you do not seem to get it, Iceland has something like 300,000 people and an economic environment not even comparable to the U.S., comparison is meaningless. There will be riots in the streets if the dollar debases by a mere 50% more. You can not beat a liquidity trap, hyperinflation is not victory dude but defeat.

  30. Anonymous

    Everyone keep an eye on Paulson/Bernanke. There are ways to challenge their activities.

    First, administrative law requires Treasury/Fed and other agencies to submit public comments in order to issue final regulations, whether initially issued as proposed regulations or as temporary regulations. Treasury/Fed has discretion to disregard comments; however, they often bend to political pressure.

    Second, if Treasury/Fed attempts to enforce a regulation against a taxpayer/regulated entity, a taxpayer/regulated entity can sue in tax court or for a refund elsewhere to have the regulation invalidated as illegal.

    Third, citizens could try to persuade Congress to exert pressure on Treasury/Fed not to provide handouts to banks. There are situations in the past where Congress has pressured Treasury/Fed to withdraw industry handouts.

    Fourth, citizens could lobby the the General Office of Accounting to use its authority to investigate actions by agencies to protect against fraud, waste, and abuse in order to investigate Paulson, Bernanke, Cox and anyone else that giving corporate handouts.

  31. SlimCarlos

    >> Dude, if what you describe happens, then the liquidity trap will have won.

    What do you mean "the liquidity trap will have won"? Huh? I can assure you that if the US goes Weimar (as it surely will), there will be no shortage of liquidity!

    Please explain your riposte.

  32. Kafka

    Dude think about what you just said, going Weimar beats a liquidity trap, read some Socrates and apply logic, going Weimar is the end of the Country and its economy as a direct result of the liquidity trap the Debt Dealers created.

  33. SlimCarlos

    >> Dude you do not seem to get it, Iceland has something like 300,000 people and an economic environment not even comparable to the U.S., comparison is meaningless. There will be riots in the streets if the dollar debases by a mere 50% more. You can not beat a liquidity trap, hyperinflation is not victory dude but defeat.

    I am sorry, but the size of the economy has no bearing on the prognosis. Fact is, Iceland sipped from the ladle of easy credit whilst the banking sector went on a crack binge. Ditto for the US. The economics transcend scale. For you to simply asset that "Oh, that's different" is hardly a powerful argument.

    But if you want "bigger" examples, how about Russia of 15 years ago, Argentina (once one of the most prosperous countries in the world) several times, Brasil several times, Italy and France and Greece and who-knows-who-else throughout the middle of last century and, …, the US in 1934 (!!), this to help dig its way out of the last big credit crunch.

    Now you say "It can't happen here." I respond by saying "Dude, how can it not?"

  34. Anonymous

    “There will be riots in the streets if the dollar debases by a mere 50% more. You can not beat a liquidity trap, hyperinflation is not victory dude but defeat.”

    If the Fed runs massive inflation / dollar devaluation, there will be riots because the global wage arbitrage will prevent wages from keeping up with inflation/devaluation, so people’s standard of living will fall. The only way to inflate without riots is to drive up US wages, which probably would require tearing up trade agreements / treaties in order to shut down global wage arbitrage.

  35. Anonymous

    “Hyperinflation is a reset event, the liquidity trap won. You can’t beat a liquidity trap.”

    It is easy to beat a liquidity trap if you are a politician representing middle / lower class wage earners with liabilities and no financial assets, and maybe some real property. You run inflation to burn away their debt, and you destroy trade agreements to boost wages. This destroys liabilities of the lower class / working class, and increases their wages relative to housing prices.

    Win win for everyont except the rich investors holding debt, but if they aren’t part of your voter block, tough c#!p.

  36. SlimCarlos

    >> Dude think about what you just said, going Weimar beats a liquidity trap, read some Socrates and apply logic, going Weimar is the end of the Country and its economy as a direct result of the liquidity trap the Debt Dealers created.

    I did say that Weimar beats liquidity trap, but only in passing. The main focus of my posts here were to contend that your assertion "You can't beat a liquidity trap" is just plain incorrect. You have conceded as much and now seem to be logrolling your position into, if I may paraphrase: "A liquidity trap is the preferred outcome", which is quite a different position indeed.

    This inflation/deflation debate recalls this old saw:

    Fire and Ice

    Some say the world will end in fire,
    Some say in ice.
    From what I've tasted of desire
    I hold with those who favor fire.
    But if it had to perish twice,
    I think I know enough of hate
    To say that for destruction ice
    Is also great
    And would suffice.

    Robert Frost

  37. Dean

    Gentlemen:

    Some decorum Please. Yves becomes displeased when arguments break out in the Naked Blogosphere.

    There is a certain rumor Yves can and will withhold postings until normalcy returns. Given the unstable market conditions, lack of guidance by Yves for any time interval will equate to catastrophe.

  38. Anonymous

    I have tired of people saying that there is no way out of this “terrible mess.” Yes, there is a way out. It called the healing power of time and care. We screwed things up; now we have to take our medicine. This too shall pass. It will be very, very painful, but as long as we accept that sooner rather than later, we can begin the reconstruction process.

  39. Anonymous

    One thing I do know. I’ve been buying gold nonstop over the last month. Best case scenario going forward is no overall meltdown and a lot of inlfation. Other otions are worse and provide even more reason to own gold.

  40. SlimCarlos

    >> Some decorum Please. Yves becomes displeased when arguments break out in the Naked Blogosphere.

    Are you referring to the discussion between Kafka & myself? I would think that this is a healthy debate and certainly I am not offended by anything Kafka has said.

    But I see you are saying that Yves does not like "arguments" — really? What are these pages for then if not debate?

    Please advise.

  41. Anonymous

    Hyperinflation would destroy the banks that Bernanke exists to protect. The Fed can deal with deflation, they’ve done it before.

    If FDR didn’t print – and he didn’t – then nobody is going to.

    Wiemar comparisons are preposterous.

  42. Yves Smith

    For the record, ad hominem attacks are a big no no. And content free fulminating isn’t too good either, although most readers are smart enough to breeze by that sort of thing.

  43. SlimCarlos

    >> If FDR didn't print – and he didn't – then nobody is going to.

    Yes, he did. He devalued the dollar by about 44% when he re-pegged the currency from 1/20th an ounce Au to 1/35th an ounce Au.

    >> Wiemar comparisons are preposterous.

    So would have been predictions that money center banks would have fallen like dominos as they have.

    Go buy the Icelandic Kronur if you think bank crisis are good for a currency.

  44. Kafka

    Dude, u b cool but let me b clear, when I say you can not beat a liquidity trap I mean some sort of reset event needs to take place before the healing can begin and the reset event will likely be very painful for all involved. Deflation, which is what I believe will occur is not gonna be fun and if for what ever reason the reset occurs through inflation that will also be painful as the commoners have not had an increase in earnings in over 10 years and many more banks will likely go bust. I think many are of the belief that if Treasury spends $700 Billion on a plan they can barely articulate or provide any factual support for including math; presto, things return to normal but for the unintended consequences of the stress created in the Treasury Debt markets which would perhaps be manageable if $700 Billion solved the problem, that would be beating the liquidity trap. My point is for this liquidity trap (I know we can argue about the technicalities of what a liquidity trap is) $700 Billion is going to be a drop in a bucket already filled with $1.5 Trillion of liquidity (to no effect) and real estate will continue to decline in value (revert to the long term mean as it must) with much pain attached to the pending recession and rising unemployment. The course now being taken by the Fed is essentially the Japanese solution and you know how well that has worked; and Japan was a production based economy with decent savings (the inapposite of the U.S.). I like your energy dude so let me know where I have gone wrong.

  45. SlimCarlos

    >> Dude, u b cool but let me b clear, when I say you can not beat a liquidity trap I mean some sort of reset event needs to take place before the healing can begin and the reset event will likely be very painful for all involved.

    I agree. There will be a "reset event." Question is, will it be via inflation or deflation? You say tomayto, I say tomahto.

    I am of the inflationary school because historically the currency is the weak link. The only counterexample that is ever cited is Japan. But I would argue that Japan was an example of a banking crisis in an otherwise pretty solid economy with strong export earnings and robust household savings. The US is a banking crisis amidst a true bubble economy with debt in every sector. Additionally, it depends on external funding just to keep the lights on.

    I don't believe there has ever been a country thus described whose fiat currency has not turned to dust. Can you provide me with a counterexample?

  46. SlimCarlos

    Kafka,

    Hey, if you want to see the strongest argument yet for hyperinflation, go check out the graph at the top of Doug Noland’s piece this week. I’d post it here but don’t know how. Shocking, the graph, that is.

  47. Yves Smith

    A definitional point that might clear up the debate. Hyperinflation occurs at levels well below Weimar Republic cash-in-wheelbarrows scenarios. It is considered to be operative when inflation itself starts distorting economic decisions and activities. No hard and fast line, but I recall reading that 20% inflation per annum is a good working definition.

  48. SlimCarlos

    I see the wheelbarrow thing, Yves. They will flood the system with money, a small fraction of which will “get to where it is needed” whilst the rest spills into the general economy, wreaking havoc as it goes, like that tidal wave that hit Thailand a couple of years ago.

    Maybe a Volker-type comes along and puts the brakes on, but it’s now so far beyond where we were in 1980 that this difficult to imagine.

    Very few cusrrencies have survived as long as the dollar. It’s been a good run. But now it is over.

  49. Kafka

    Dude, I get it, I am just unsure what the result will be. I believe real estate will decline by another 20% as for food , energy and other commodities I am 50/50 either way. Bloomberg tonight came out with a deflation article and I am very familiar with Noland. I am not smart enough to prognosticate but I am short the dollar long term, short 10 year Treasuries, short debt financed consumer product companies, short selected insurance companies to the extent possible (or their derivatives) and loving the volatility of currencies in the short term using the magic of charts and trends. As for the fiat currency, I am unsure about dust but long term my view aint good and I can think of no comparable economic example to what is occurring. I do know history teaches us that all great empires which rely on War, debt financing and services to prop up their economies, end.

  50. Anonymous

    I posted in comments on Mish’s site and CR that this was just the SUPERSIV all dressed up weeks ago and no one seems to be actually reading any comments. Everyone is just running in to shout at the internet.

    It was pretty obvious that Hank has a hammer and everything looks like a nail. Recycling a failed idea of a year ago should have condemned this idea but the federal govt. thinks they can polish a turd. All hail the Congressional Turd Polishers!

  51. SlimCarlos

    @Kafka,

    Good chat. Let’s cach up on the flip side, on perhaps a fresher thread. This one is getting long a da tooth.

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