Page 3 of 3 CHINA AND THE GLOBAL CRISIS Denial as the storm gathered
By
Henry C K Liu
(TALF) Term Asset-Backed Securities Loan Facility - $200 billion
(GSE) Government Sponsored Enterprises and (MBS) mortgage-backed securities
Program - $600 billion From the Treasury:
(TARP) Treasury Asset Relief Program - $700 billion; $330 billion expended
Exchange Stabilization Fund to guarantee principal in money market mutual funds
- $50 billion
Treasury direct purchases of MBS since September - $26.5 billion
Citigroup (Treasury+FDIC guarantees) - $238.5 billion
From the FDIC:
Guarantees for Banks - $1.9 trillion From Other Sources:
Automakers - $25 billion; $25 billion more pending
Consumer credit - $50 billion (out of TARP)
(FHA) Federal Housing Administration - $300 billion
Fannie Mae/Freddie Mac Nationalization - $350 billion Grand Total: $7.362 trillion
A government plan to sop up hundreds of billions of mortgage securities spurred
a bond rally that yanked 30-year home loan rates down half a percentage point
to about 5.5% in the final week of November. The supply of unsold homes is near
record highs. Buyers fearing job loss, or betting on even greater bargains, are
unlikely to commit now to one of their biggest investments. Private sector
employers cut 250,000 jobs in November, the most in seven years and the latest
sign of recession fallout. US unemployment rate is expected to rise to 6.8% in
November after setting a 14-year high of 6.5% the prior month.
After committing over $7 trillion into the finance sector, the market continued
to fail and the economy heading downward. If just $2 trillion of the $7
trillion the government has so far committed for the financial sector were to
be channeled directly to the unemployed, each worker would receive $200,000
(the equivalent of four years at average wages) to tie them over their jobless
phase to kick-start the economy.
The same amount would support for one whole year 40 million middle-income
families with an annual income of $50,000. If government funds were directed
towards people rather than institutions, consumer demand will revive
immediately and companies will sell again to make profits. The recession will
end within 18 months.
But alas, the measures taken by the US government thus far were all designed to
save the financial system and its institutions from the penalty of excessive
risk rather than to help the economy and its people from the pains of
recession. The net result of this top-down approach will be to punish the
economy with a lost decade while feeding the cancer of a dysfunction financial
system held together by unsustainable debt.
Still, the market-oriented US leader felt the need to adhere ideologically only
to a top-down solution. The priority must be to save the dysfunctional
financial system and its wayward institutions, while the public must wait for
the presumed trickling down benefits, if any. A decade-long depression will be
the result.
The leaders of the G20 have a collective responsibility to face the reality of
the crisis to save the world economy from total collapse instead of meekly
following misguided US rescue measures of adding more liquidity to a crisis
created by excess liquidity.
The Farce of International Coordination
President Bush then reported the "good news" of international coordination:
In
Europe, governments are also purchasing equity in banks and providing
government guarantees for loans. In Asia, nations like China and Japan and
South Korea have lowered interest rates and have launched significant economic
stimulus plans. In the Middle East, nations like Kuwait and the UAE have
guaranteed deposits and opened up new government lending to banks.
In addition, nations around the world have taken unprecedented joint measures.
Last month, a number of central banks carried out a coordinated interest rate
cut. The Federal Reserve is extending needed liquidity to central banks around
the world. The IMF and World Bank are working to ensure that developing nations
can weather this crisis.
None of these lip-service measures by
other governments can be expected to have any significant impact on rescuing
the US big domino if the US continues to follow a strategy of adding more
liquidity to a crisis of liquidity trap which occurs when the nominal interest
rate approaches zero, and the central bank is unable to stimulate the economy
with conventional monetary measures. In a liquidity trap, market participants
forego higher returns on physical or financial investments to flee to
short-term cash accounts, exacerbating an economic downturn and leading to
deflation.
Helicopter money
Fed chairman Ben Bernanke subscribes to Milton Friedman's prescription for a
liquidity trap by bypassing financial intermediaries to give money directly to
consumers or businesses, invoking the imagery of dropping money from
helicopters. In essence, it is form of inflation targeting to reverse
deflation. Helicopter money can only be dropped covertly to avoid ideological
conflict and only to institutions deemed too big to fail. To inject liquidity
into a distressed financial system, central banks during a financial crisis
sometimes buy gold at above market prices or buying preferred shares and
convertible bonds as hidden money to distressed firms.
Bernanke in a speech to business leaders in Austin, Texas on December 1, hinted
at the possibility of further central bank relief for a stubbornly sagging
economy with the purchase of Treasury notes and bonds to bring down long-term
rates. Bernanke's comments immediately stirred further buying of longer-term
Treasury bonds, pushing the yield of benchmark 10-year Treasury notes, already
at a 31-year-low, to 2.719%.
The National Bureau of Economic Research announced on the same day that the US
has been in a recession since December 2007, a year ago, already longer than
all recessions since World War II. A long downturn is projected by many
forecasters. The Dow Jones Industrial Average dropped 680 points, or 7.7%, to
8,149.09, the 12th biggest one-day percentage drop and fourth-sharpest point
loss since the DJIA was launched in 1869.
The fall interrupted a five-day rally of 1,277 points, or 17%, caused
previously by the announcement of a new $200 billion program to buy consumer
debt and small business loans by Treasury and the Fed. Treasury Secretary
Paulson announced that the Treasury has committed all but $20 billion of the
first $350 billion Congress has authorized for Troubled Asset Relief Program
(TARP).
Inflation targeting does not work if economic turmoil is caused by the bursting
of a debt bubble created by monetary inflation, which could only be cured by
allowing the bubble burst to liquidate the misallocated investment made during
the bubble boom. The debt bubble burst has left the US with a national
insolvency problem of insufficient income to support bloated asset price
levels. US ideology of market fixation normally limits the solution to come
only from market corrections. However, when market correction causes systemic
market failure, market ideology is cast aside to make room for practical
emergency measures to revive a market system hit by cardiac arrest.
Still, under this market ideology, government assistance is not allowed to be
applied directly to distressed individuals who are innocent victims of a
dysfunctional debt regime to help them increase their income to transition to a
new viable financial regime in a new economic system. It can only be applied to
distressed institutions deemed too big to fail. Yet nationalization of
insolvent private institutions facing weak demand so that they can continue to
survive massive losses in a market economy will only bankrupt the entire
nation, bringing down all citizens with it.
What the US economy needs in this crisis is not inflation targeting but income
targeting. Let's hope the new Obama administration has the sense to implement
immediately a massive income policy when it hits the ground running on January
20, 2009.
Next: China the road to recovery
Henry C K Liu is chairman of a New York-based private investment group.
His website is at http://www.henryckliu.com.
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