Japan still hasn't "worked their way out of it." They've been spinning their wheels fo almost twenty years now.

This is unbelievably scary. The trestle bridge is out and the train has no brakes. All Bernanke can do now is blow the whistle longer and more frequently.

This is unbelievably scary. The trestle bridge is out and the train has no brakes. All Bernanke can do now is blow the whistle longer and more frequently.

I have a dumb question:

Everyone says that Volcker turned the economy around in the early 80's by cranking up the rates to historically high levels - 10% or more, I think.

He did that in response to the kind of stagflation conditions that we're veering into now.

So why not do that now? Why not draw the economy to a halt for a few months with rate hikes, let the poison work its way out of the system, then crank back down again gradually after that?

(Or in other words, why isn't the solution that worked in the 80's the one that we should follow now?)

Don't worry. Jesus made sure George W. Bush would be President for trying times such as these.

It's clear that the Fed is going to try to go the Japan route of state-controlled deflation and zombie banks. There a couple of problems with that plan, though.

1) Japan had a very high savings rate for which people could fall back on when credit dried up. Americans have a negative savings rate.

2) Japan had a growing manufacturing base that could continue to add "wealth through work" to the economy. America has offshored most of its manufacturing.

3) Japan built a giant credit/housing bubble that, when popped, was largely contained to Japan. The current bubble is even bigger and world-wide.

The most interesting point about the fact that T-bill interest rates have collapsed is that it illustrates the when the Fed "sets" interest rates, it really only has so much influence. Really, the market controls interest rates, and the market says that every single investment out there, in the short term, will probably be a net loss.

This is deflation, folks, pure and simple.

I agree, lampwick. I'm not an economist, but I would think tightening money supply and cutting spending would be the long-term answer. There would be considerable pain in the short-term, and I don't think any politician nor the Fed has the political fortitude of Carter and Volcker.

Our dear old society has been able always postpone major systemic reform to its love of (nearly) unbridled capitalism by exploiting new resources, new people, or new territory. The Great Depression/New Deal is somewhat of an exception except that we were able to exploit our power as the strongest state left standing in order to still behave irrationally.

In a multi polar world sprouting a somewhat “global� economy, our old, favorite economic fixes are ineffective if not totally unworkable. So Kevin, I too am pessimistic. I do not view our outdated assortment of paradigms to be of much use and I do not see the major players of our political economic system too willing to change the way that they feel they should act.

It does seem that we may be due for some increasing pain as we wallow around in a stupor of our own creation. Still, given enough pain for a long enough time a ground swell for change could grow…..unless…..

What is our current terror threat assessment?

So why not do that now? Why not draw the economy to a halt for a few months with rate hikes, let the poison work its way out of the system, then crank back down again gradually after that?

Because while it worked, it was incredibly painful while we went through it. Volcker was despised and attacked for his actions; the protest with farmers driving their tractors to C Street is infamous. It is only in hindsight that Volcker is remembered so fondly.

I am with you on this. Interest rates need to go up. But it is going to be political suicide for whomever does this. They would much rather give us Japan's Lost Decade than a rerun of the early 80s.

liquidity trap = crying in your beer.

If you believe that the fed's main role is to protect the financial markets more than individuals, then the current approach makes perfect sense. Basically, the banks are being given a window to unwind all their toxic holdings, and any resulting inflation only helps them more by shinking their real losses. Plus, the low rates protect against huge resets in the housing market which would only accelerate foreclosures.

Once the banks are sufficiently unwound, rates can be ramped up. More specifically, the next president will be forced to raise rates to fight rampant inflation.

We don't give enough credit to anime and hentai porn for helping the Japanese economy recover.

One of these somebody will explain lucidly why in all the talk about lowering interest rates to get the economy moving, nobody ever talks about the destruction of income and wealth when fixed income investments don't pay anything anymore. Not only does your income on $1000 drop from $50 to, say, $20, but the present value of that wealth drops big time, too. Doesn't that have exactly the opposite effect? Who's going to invest in new production even at 0% when the potential customers for it have lost what they had? And with a fast-aging population reducing its weighting in equities, isn't that counter-effect only going to grow?

I need to hire somebody who knows economics to write comments for me on these posts- that'll make me look like a total genius.

Urban,
I'm no economics weenie and you do raise a point in that lowered interest rate really puts a dent in the pockets of those who are living/or partially living off long term investments.

But, as I see it, the Fed lowering interest rates and propping up the Bear Stearns purchase was good, because if they hadn't Wall Street AND the banks would implode. And if that happened then all of our long term investments would be gone and so we would have absolutely no income from these.

It's a gnarly problem that is for sure.

How about something a little less painful for the majority of Americans? Seize all assets of everyone with a net worth over a billion dollars and distribute it evenly to everyone making median income or less.

Well it's no worse than any other plan floated so far.

One of these somebody will explain lucidly why in all the talk about lowering interest rates to get the economy moving, nobody ever talks about the destruction of income and wealth when fixed income investments don't pay anything anymore.

Absolutely.

Plus, what got the country in the current trap was overly-cheap credit. When there's not much money to be made in a single loan, lenders have to make lots of loans. The result: people who shouldn't be borrowing get loaned lots of money.

Everyone talks about borrowing and credit as if there's never any downside. Of course there's a downside. (Polonius wasn't just a gas bag: there was a lot of wisdom in his advice to Laertes.)

Krugman did NOT say the Fed had lost control over the Fed Rate. He pointed out that it would likely be unable to lower the Fed Rate all the way down from 2.25% to 0.5% -- that somewhere in between those two numbers, it would "lose control" (in Kevin's words, which are not very apt).

Krugman's point was less scary than Kevin's description, but still worrying.

lose control

The question is, can they lower rates any more and have any impact on the market? Could they raise rates now if they wanted to?

If not, sounds like they are losing control.

The market is seeking safe harbor in short term treasuries. 0% return is acceptable, and even preferrable to loaning money to uncertain credit risks or buying unstable equities.

I suspect that the Fed's guaranteeing of the bad debt of Bear Sterns to insure that it didnt collapse may be the beginning of the real fix. The problem is lending not liquidity. No one wants to loan for mortgages anymore even to good clients and the true nature of how far housing prices will fall has not yet been seen and wont be until the first wave of foreclosed residences hits the market for sale. There will be another wave next year. Banks dont want to loan to each other because they dont know what value to place on a Bank's assets when an unknown number of mortgages are bad.

Meanwhile the interest rate cuts have done two positive things: inspired businesses to invest in new plant and machinery and inventories are going down rapidly which will necessitate more production and soon. Second, it has acted to lower the interest payments on many ARMS and that will help prevent or delay foreclosures.

But the guarantee of Bear Sterns debt is what has really been revolutionary. The Fed is not set up to and historically does not do such things. As far as I know this is a first. It gives international investment banks, and their dependents more importantly, assurances that these institutions wont be allowed to collapse and ruin the entire monetary system, regardless of what values eventually come out on bad mortgages in their portfolios and hedge funds. Many people decry the bail out, but the alternative is far far worse I can assure you.

This may all turn out to be a Savings & Loan style crisis requiring a government agency to sort it all out like the old Resolution Trust, albeit this crisis is on a much larger scale.

Ultimately, the Fed wants to do anything it can to "unlock" the credit markets. Without that, the housing market wont recover, construction related unemployment will soar and become permanent, people will feel poorer and spend less. For an economy based on spending, thats the kiss of death. Lets hope the Fed's revolutionary actions viz the Bear Sterns crisis helps us avoid the catastrophe of Japan over the past 20 years.

kis nails it with far fewer words than I:

"If you believe that the fed's main role is to protect the financial markets more than individuals, then the current approach makes perfect sense. Basically, the banks are being given a window to unwind all their toxic holdings, and any resulting inflation only helps them more by shinking their real losses. Plus, the low rates protect against huge resets in the housing market which would only accelerate foreclosures.

Once the banks are sufficiently unwound, rates can be ramped up. More specifically, the next president will be forced to raise rates to fight rampant inflation"

I hope the underlying snark was clear.

I mean, to a certain extent all of us benefit from saving the financial markets. Bear going under would have created a cascading mess of defaults. Just look what happened to energy trading firms when Enron went under.

But the inflationary concerns of individuals (like retired people losing wealth, in real terms) is totally incidental to the fed's primary goals. Besides, I don't think they are actually worried about inflation right now, but rather deflation. We've had under-reported inflation for years. But now we've lost the ability to use our homes as checkbooks. Spending across the entire economy is about to drop like a %&*$@ rock.

But nothing is going to improve so long as we continue to print money and dump it in Iraq.

Ultimately, the Fed wants to do anything it can to "unlock" the credit markets.

And at this stage it's little more than "pushing on a string". Which leaves the Volcker Solution, or generating pull through US government spending or finding another (foreign) engine to do it.

Robert Rubin on Jim Lehrer praising the Bear Sterns deal as I did. The saddest thing about no Hillary for president is no Rubin for Treasury Secretary again. Maybe Obama could appoint him to head the Fed.

There's good reason to believe that the Fed/Treasury will tolerate a good deal of inflation over the medium term in order to avoid this trap. (That perception is part of the reason the dollar's been hammered.) In addition to helping stave off a liquidity crisis, inflation will also help "solve" the underlying problem of overvalued property prices. Instead of forcing house prices to drop by 30%, which cause enormous, visible, and specific pain, much of which will get absorbed by banks, they'll let the price of everything else rise by 30%, which will have a functionally similar effect for ending the housing price bubble, but instead will force the price to be paid not by the banks but by everyone with a fixed income or holding fixed-income securities -- that is, retirees, the working class, and the Chinese....

"Reagan proved deficits don't matter"

Japan still hasn't "worked their way out of it." They've been spinning their wheels fo almost twenty years now. Posted by: Jenna's Bush

I guess you haven't been to Japan in the last ten years or so.

The thing that changed for Japan, and was changing even before its bubble in the late 1980s, was the economy was moving away from the manufacturing base that built its post-war "miracle." By 1980, Japan's economy was as mature as an economy gets. You weren't going to see 7% annual growth anymore or even 5%. It's unrealistic to think that a fully developed, post-industrial country with a predominately middle-class society will any longer grow like that, unless coming out of a severe recession. Japan was not in a severe recession.

Another way Japan was, is different than the U.S. is its phenomenal savings rate, mostly tucked in the recently privatized Postal Savings Bank. This is what allowed Japan to weather the down turn and why it wasn't the hardship that we will see over the next 18 months to two years here in the U.S., where most of the population is carrying an average of something like $5,000.00 in revolving consumer debt.

If you think Japan is still in a recession, I think you'd better tell all those people who have been building hundred of thousands of new square feet annually in office and condominium space to knock it off.

From what I see, the problem isn't liquidity. It's solvency. Unless the Fed starts mailing out free paychecks big enough to cover all these insane loans--this crisis is going to bring the USA, and possibly the world economy, to a place it hasn't been since 1929.

When you extend massive credit to people without the means to pay back their loans--or that their ability to pay back those loans is dependent on Ponzi-scheme ARM bubbles promoted by Bubbles Greenspan himself...well, what do you expect?

The only good thing that can come from this is that Milton Friedman, Reaganomics, and supply-side, mass media, liassez-faire propaganda will finally be discredited, recognized, and odiously hated for the snake oil it has always been. Deregulation invites criminal and social irresponsibility in pursuit of quarterly profits. Now, in addition to being revealed as a pro-torture, moral pariah through Abu Graib--Americans can also be proud that the Republicans they elected have engineered a blow to our financial system that literally could discredit Capitalism for a generation or permanently. When the Fed is giving out more money to prop up Bear Stearns than Visa raised in its record-breaking IPO last week--is there any other word for it than Socialism For Corporations?

This nightmare could have been avoided, rather easily actually--instead the GOP policy was to keep Bush in office at ALL COSTS, and keep Americans feeling affluent with unverified, irresponsible, subprime NINJA loans (No Income, No Job or Assets). These were then sold worldwide to a world ready to believe that the USA actually had a functioning regulatory framework. The truth is now revealed, and the fun has only just begun. When all the dominoes fall, this country and the world aren't going to look the same.

Wall Street always knew this shit was toxic and dangerous. If you think the money boys don't understand the insanity of making loans to people who cannot pay them back--you are a fool. This was a gambit planned out long ago, with a window for massive profits to the CEO class. So long as the quarterly profit statements were hit and yearly bonuses were paid, no one squeaked.

You should be disquieted Kevin. Years from now, even though you were a public, vocal and relatively balanced/responsible critic for years--you will wonder if you did enough to decry the madness emanating from the White House.

Republicans cannot be trusted with a burnout match. Period. Now you know. In a few years, everyone will know it in their bones--and Bush, Cheney, Greenspan, et al will be lucky not to be in prison or worse.

In the long run, Reality Always Wins, especially the realities of financial fraud and imperialist wars.

I mean, to a certain extent all of us benefit from saving the financial markets. Bear going under would have created a cascading mess of defaults. Just look what happened to energy trading firms when Enron went under. Posted by: kis

False anology. "Energy trading firms" in a nation where most of the energy resources are still publicly controlled or heavily regulated were worse than most of the Internet start ups who were able to attract seed money on the basis of a business "plan." Furthermore, Bear Stearns was the most heavily leveraged financial institution in terms of its sub prime exposure. Bear always lived "on the edge," both in terms of strategy and in terms of respectability.

Energy trading was pretty much a ponzi scheme. International finance contains a lot of dog turds and gossamer, but most if it is back by tangle assets. That was never the case with energy trading where no one really fully controlled or owned very little (for good reason) of the nation's energy supply.

The fastest way to get the U.S. out of a recession is to get our asses out of Iraq as quickly as possible, which is, ultimately, the economic equivalent of pounding sand down a rat whole, and begin massive, coast-to-coast government funded infrastructure spending.

While armament manufacturing does goose an economy a bit, it's really not so different from the sort of pleasure you get giving gifts to a rough four year old - he/she enjoys them for a while then trashes them. Rebuilding bridges, updating the long neglected air traffic control system, investing in energy research, building mass transit, a new CCC - these things employ thousands of people for years at a time, and when they are done they've produce benefits that often last for decades.

Energy trading was pretty much a ponzi scheme.

Wrong. Enron was a ponzi scheme. Energy trading is not.

You do realize that CA, TX, NY, New England, and the Midwest still have very active wholesale electricty and transmission markets? And that natural gas and oil are very heavily traded commodities worldwide? Whether it SHOULD be traded is a different question...while I'm a consultant in this space, I sorta agree with you.

Anyway, the point with Enron re:Bear was that when it went under, it brought down lots of other otherwise healthy trading firms in a cascading series of bilateral contract defaults and cutoff of credit. Only a few of the strongest and smartest survived. I'm sure that is what the fed was trying to avoid with Bear.

But, but ... faux-liberal kept telling us that the economy was great and that it was a shame that that great economic genius Georgie-boy just wasn't given enough credit by that evil mainstream media!

You don't mean to say he was lying to me, do you? [Sob, sniffle...]

Paulson gave the reasoning that Bear Stearns couldn't be allowed to completely fail because the ripple effects would be too severe. That may well be true.

Next up is whether the Fed will stabilize interest rates and whether Bernanke and Paulson together will let anybody big fail.

The more they try to apply pressure to the wound and keep injecting strong medicine (lower interest rates and loans and bailouts) the more the pressure builds up on the economy and eventually when the collapse occurs that pressure will contribute to it being much worse than it could be.

Better is to prevent so much bleeding that the economy dies, but to let some bleeding occur to leech out the impurities. Also, some healthy talk to bring the right spirits to bear on the problem and that acknowledgment of reality will help everyone become more trusting, encouraged and hopeful.

And, for God's sake, keep George W. Bush a mile away from all this. Everything he touches gets torched.

Sorry, too late; the economy has already been bled. The only question is where the infusion comes from--assuming a willing donor is available.

I believe we should also realize about Japan that their domestic politics has historically required an insane amount of domestic political spending (what we would call "earmarks"). The Japanese have built roads and bridges to damned near everywhere in the islands, mostly to placate various local constituencies. Basically, it's been a monstrous WPA and it's been going on for fifty years. They can't build any more roads, highways, bridges or whatever. It also left them with a nasty national debt problem which makes the US debt look comfortable by comparison.

Contrast that with the US, where we haven't spent a gazillion dollars on domestic infrastructure. We could choose to build the roads, railroads, bridges, tunnels and dams across this nation, which would inject major dollars into the economy. Better yet, we'd have something beneficial, tangible and useful at the end of the construction.

M1, the measure of 'ordinary money' (cash & checking accounts), is actually contracting. This is a deflationary indicator.

Prices for the basic necessities can rise or fall independently of the broader measures of the money supply, which is what is inflated or deflated. Since at least the 1990s, most of the unprecedented increase in the broader U.S. money supply went into assets, first stocks, then houses, producing the "beneficial" kind of price rise, that continued to such an extent that they became bubbles (when this happens to ordinary goods & services, it's the "detrimental" kind that the media incorrectly calls inflation). Now, the overall money supply (M3) is growing rapidly as the Fed tries to support the same entities (banks & brokerage firms) that have already benefited most from the public's rush into assets toward the end of each bubble.

Meanwhile, the media will keep misinforming their viewers (nothing new there, huh?) about what's actually happening in the economy & financial markets. They'll keep referring to rising prices as inflation, and if coincident with stagnant wage growth, they'll call it stagflation, like the 1970s, even if the causality is different this time. The media is the primary propaganda tool used by those in power who are trying to "manage" the expectations game. Make no mistake, when you have a currency that is increasingly backed by the ability and/or inclination to do something in the future, expectations are everything.

Personally, I don't care too much about labels. These days, labels are more often used to evoke an emotional response than to convey the facts. Whatever they call it, here's what's coming down the pike over the next 12+ years:
1. For US consumers, prices for the basic necessities of life will keep going up.
2. Wages for most U.S. workers will remain stagnant.
3. Demand - and prices - for discretionary items, especially big-ticket discretionary items like autos will decline in the U.S. Does this mean that the same car will sell for less? Nope. It means that the average car sold will sell for less.

refs.:
http://www.garynorth.com/public/3118.cfm
http://www.garynorth.com/public/images/3118a.gif
http://www.garynorth.com/public/images/3118b.gif
http://www.shadowstats.com/imgs/sgs-m3.gif

I know, I know, lets get the hell out of Iraq.

It's costing us billions and billions, having to prop up Halliburton, Blackwater, Exxon/Mobil and BP's viability, with all the massive taxpayer money and military human lives.

Gee, isn't this what happened in the 70's and mid 80's, after the GOP got done cater exclusively to their "special interest" buddies?

It took the US 10 years to dig out of that GOP recession too. And Repugs all blamed it on the Dems, but of course, as we have seen, the Enron fiasco, the allowing of gasoline price gouging, the California brownouts, the housing travesty walks hand-in-hand with the GOP's complete love for deregulation, the doing away with protective laws so they can give away anything and everything in order to cater to their love of legal bribery and extortion with all their good corporate buddies, while acting ONLY in their own individual self-serving interest, interest that do nothing for the people of this nation except take, and take, and take while leaving ruined financial lives for many US citizens for nothing more than completely self-serving purposes of the GOP. The Repugs have always been chilling indifferent to any so-called real conservative behaviors. If it weren't for the ignorate of the heartland masses, the Repug party wouldn't have any voting members at all, but lately, I think even many of those folks have noticed that Repugs are just one big act of complete corruption.

It is laughable to call Bush a conservative, seeing how fond he is of handing out unbid contracts and firing of anyone in those administration offices that would disagreed with his anti-conservative politics.

Whatever they call it, here's what's coming down the pike over the next 12+ years:
1. For US consumers, prices for the basic necessities of life will keep going up.

"12+ years"? Wow! That's one hell of a crystal ball

Well, of course. Prices always go up over time. But you don't even mention the primary reason, which is because the price of oil will continue to rise as long as this modern world runs on it. Nothing else is so elemental or in such a limited and fixed supply.

2. Wages for most U.S. workers will remain stagnant.

Evidence?

3. Demand - and prices - for discretionary items, especially big-ticket discretionary items like autos will decline in the U.S. Posted by: Elvis

Automobiles in a society with next to no public/mass transit are not a "discretionary item." Jet skis, snowmobiles, 42" flat screen TVs, riding mowers, bass boats, "French door" refers, Harleys, these are discretionary items. The rich, idle or otherwise, don't stop buying boats, planes, Italian or German sports cars, the second (or third) home, trips to Europe, these are "luxury" items.

Back to Pluto or wherever the aliens took you Elvis.

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