Why it can’t work–Crikey fol­low up

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In my col­umn in Crikey yes­ter­day (see below) I promised to pro­vide some “back of the enve­lope” cal­cu­la­tions on why the Paul­son plan can’t work.

It’s not my usual stan­dard or style of analysis–just a sim­ple text-only flow­chart map­ping out of the pos­si­ble con­se­quences of a US$2 tril­lion bailout, financed by either bond issues or print­ing money–but a promise is a promise, so here it is. Since the images are quite dif­fi­cult to read, I’ve attached the Pow­er­point file as well.

Pow­er­point Flow­charts

Images from the two relevant slides

The Plan with bond issuance, as it will probably be carried out

Inci­den­tally, one thing I noticed sim­ply by chance when tak­ing a humour break to read Doonesbury’s Daily Dose was the fol­low­ing state­ment on it’s “Say What?” link:

“It’s not based on any par­tic­u­lar data point. We just wanted to choose a really large number.”–Treasury spokes­woman on the $700B bailout fig­ure

What is not sur­pris­ing is that fact. What is sur­pris­ing is that some­one admit­ted it in pub­lic. The so-called experts don’t have a clue–and of course don’t for­get, their total inabil­ity to see this com­ing is in part why this cri­sis occurred in the first place.

I sub­se­quently found that the source of this breath­tak­ing piece of hon­esty was an arti­cle in Forbes Mag­a­zine.

Crikey Column–“Paulson’s Plan is like bailing the Titanic with a thimble”

The Paul­son res­cue plan looks mas­sive at first glance — US$700 bil­lion of gov­ern­ment money will be spent buy­ing the shonky bonds that Wall Street sold to Main Street (and fool­ishly also kept on its books, hence the effec­tive extinc­tion of US mer­chant banks in the last month). Surely that will bring the cri­sis to a halt?

If only. While $700 bil­lion sounds like big bikkies, it’s chicken feed com­pared to the scale of out­stand­ing pri­vate debt in the USA of $41 tril­lion. Some of that is legit­i­mate debt-money bor­rowed to finance pro­duc­tion rather than spec­u­la­tion, and lots of it has gone “up in smoke” in the sub­prime melt­down; but what is left still dwarfs the size of this res­cue.

And there’s the rub. While the res­cue might keep what’s left of Wall Street sol­vent, and could pro­vide a boost to Main Street’s econ­omy, it will be dwarfed as the Great De-lever­ag­ing begins, as Amer­i­can fam­i­lies and cor­po­ra­tions, by choice or by bank­ruptcy, start reduc­ing their debts rather than pil­ing them for­ever higher.

That has already begun. In Sep­tem­ber of 2007, pri­vate debt was grow­ing at a rate of $4.75 tril­lion a year; nine months later, that growth rate had dropped to $1.8 tril­lion. That rep­re­sents almost a US$3 tril­lion reduc­tion in demand, which is a large part of the rea­son that US asset mar­kets have tanked, and the real econ­omy is mov­ing rapidly into reces­sion.

Some “back of the enve­lope” cal­cu­la­tions I’ve done imply that, even if the res­cue pack­age totalled $2 tril­lion, and even if it were financed entirely by print­ing money (rather than sell­ing newly minted Trea­suries), the best it could do would be to boost aggre­gate demand by 5%. But the col­lapse in pri­vate bor­row­ing could cut aggre­gate demand by 30%.

The ben­e­fi­cial impact would be neg­li­gi­ble if, as is almost 100% cer­tain, the “res­cue” were funded by sell­ing Trea­suries to the pub­lic-Michael West’s col­umn on this in yesterday’s SMH was spot-on.

So this res­cue won’t bail out the Ship of Fools, but it will make the Amer­i­can Ship of State even more insol­vent than it already is (aggre­gate US gov­ern­ment debt is now run­ning at 53% of GDP). As Michael West con­cluded yes­ter­day with pro­found under­state­ment, “Amer­ica is in trou­ble”.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • Emil

    Phil,

    I can’t remem­ber the source, but, appar­ently we are get­ting a hous­ing index next year to be traded on the ASX that will be short-able. 

    I just hope it is in time before the defla­tion starts so I can place my bets!

    Can you explain the $20,000 deposit insur­ance?

    The other thing that will be inter­est­ing will be the impact of the first home savers accounts. Once money goes in there, you can’t touch it for four years and then when you do touch it, it can only be to buy a house. 

    My guess is that this will take money out of hous­ing as well, thereby deflat­ing the pool of money for pur­chas­ing hous­ing just as the first home own­ers grant increased it. A lot of peo­ple will jump on board this pol­icy. I imag­ine by next year the rules will change and they will allow peo­ple to take the money out before the four years is up. Does any­one know if any econ­o­mists have done any research into the impacts of this?

  • BrightSpark

    Ken

    but prob­a­bly not until the next elec­tion when they dis­cover eco­nomic ratio­nal­ism.”

    What do you mean by this? Do you mean eco­nomic opin­ion which is ratio­nal, or Eco­nomic Ratio­nal­ism which I believe is based on Neo-clas­si­cal garbage?

    A few other obser­va­tions

    I have read lit­tle about the for­eign bor­row­ing sit­u­a­tion. This is needed by Oz and the US just to keep the rest of the eco­nom­ics going. This means we need to bor­row more than $32Bil­lion per year if we can. If we cant we have depres­sion and astro­nom­i­cal unem­ploy­ment. Surely this is also part of the hous­ing bub­ble prob­lem.

    The $4bil­lion bail out seems to have been pre­ceded by other repo financ­ing by the RBA

    All I can see is a con­trol sys­tem which is totally out of con­trol. The pilots are back in the cock­pit they have turned of the alarm and are now pan­ick­ing. The ground is approach­ing rapidly.

  • Phil

    Emil,

    Here is the link to the arti­cle explain­ing the deposit insur­ance. http://www.news.com.au/business/money/story/0,25479,24375006–5013952,00.html

    It’s good news to hear that the ASX is get­ting a short-able hous­ing index, though I won­der if there are more ways to profit from the hous­ing defla­tion than just to short secu­ri­ties and an index.

    I don’t know if there has been per­formed any econ­o­mist research on the issue you men­tion. One of the best pieces of research done so far is by Nigel Sta­ple­don, for­mer chief econ­o­mist at West­pac, and eco­nom­ics lec­turer at UNSW. In his recently fin­ished PhD the­sis, he con­structs a hous­ing index, like Robert Shiller of Yale has done. Whether they are com­pa­ra­ble, I don’t know. Either way, his the­sis pro­vides a plethora of sta­tis­tics and hous­ing analy­sis that you may find inter­est­ing, although it is a tough read. http://unsworks.unsw.edu.au/vital/access/manager/Repository/unsworks:1435

    One of the worst things politi­cians have done with our tax­payer funds is the home­owner grants. These days $AUD7000-14000 is a tiny frac­tion of the price of hous­ing these days, requir­ing that own­ers mort­gage them­selves to the hilt. This reminds me of the Howard baby bonus of $AUD3,000, a polit­i­cal stunt which may make it more likely that young, poor women have babies which will end up being a greater bur­den on our social wel­fare in the end any­way.

    Throw­ing more money onto hous­ing now is just try­ing to delay the day of reck­on­ing.

    No doubt that Swan and Rudd want to keep the hous­ing party going as smoothly as pos­si­ble, but in the end they can’t defy the inevitable col­lapse due to the burst­ing of the hous­ing bub­ble. No doubt their reac­tions will be like that in the U.S.: “we didn’t see it”, “how could we know”, etc.

    BrightSpark,

    Can you explain the forex sit­u­a­tion as it cur­rently stands? If you have any links to arti­cles, papers, etc, that would be appre­ci­ated.

  • BrightSpark

    Phil

    I have been watch­ing the cur­rent account and bal­ance of trade for the last 30 years.

    I recently found rel­e­vant data on the RBA web­site.

    The files are excel files and I have plot­ted some graphs. I am try­ing to work out how to make them acces­si­ble from this blog. 

    The CAD is cur­rently ris­ing expo­nen­tially with a nat­ural time con­stant of about five years while the GDP is is ris­ing expo­nen­tially with a nat­ural time con­stant of about 15years. It had to hit the wall soon.

    As I under­stand it the CAD must be cov­ered by over­seas “invest­ment” in the form of either debt (writ­ten in a for­eign cur­rency or $AU), or equity (sale of Aus­tralian assets. The accu­mu­lated CAD over this period exceeds $1tril­lion but the debt is at about $620 bil­lion
    or 56% of GDP. This appears to have been mul­ti­plied by bank “secu­ri­ti­sa­tion” into the wider com­mu­nity.

    I fig­ure we now need at least $32bil­lion per year to ser­vice this, that is if we can find $32bil­lion of assets to flog . The banks bor­row the debt and they have been feed­ing this into the var­i­ous Ponzi schemes poi­son­ing not only real estate but also our super­an­nu­a­tion. Now just as the US has, we have also run out of peo­ple to pay the inter­est bill.

    The Neos have been say­ing for years that because it is “pri­vate debt” it is not a prob­lem. The gov­ern­ments (both par­ties) has been tak­ing tax off of us and not spend­ing it to keep the Neos happy (fis­cal sur­pluses). Now the Neos want the gov­ern­ment to take over the bad debt to solve the prob­lem?? They must be stu­pid and they must think that we are stu­pid.

    It was because of the high CAD that Paul Keat­ing made the “Banana Repub­lic” speech, the CAD was then 7% of GDP. The CAD is now 8% of GDP and going hyper­bolic. No one men­tions it now! More lies!

    Some details are on the fol­low­ing report from ear­lier this year.

    http://www.news.com.au/business/story/0,23636,23322662–462,00.html

    I will post the graphs soon.

  • opti­mist

    Buf­fet has said he would buy all the secu­ri­ties at mar­ket value … if he could raise the credit.

    http://money.cnn.com/video/#/video/news/2008/10/02/news.romans.100208.cnnmoney

  • mike says it was planned

    To pay

    back just

    ONE

    of those Tril­lion dol­lars.

    @ $1 Mil­lion a day: 2,739 Years
    @ $10 Mil­lion a day: 274 Years 

    @ $100 Mil­lion a day: 27.4 Years

    @ $ 1000 Mil­lion a day: 2.74 Years 

    Offi­cial national debt of the US is of now is at least TEN Tril­lion dol­lars

    (maybe 11.5 Tril­lion).

    Unof­fi­cial national debt of the US is $56 Tril­lion.

    $56 Tril­lion repaid @ $1 Mil­lion a day: 15,000 Years 

    (give or take a few hun­dred years). 

    If the Bank is on fire you can’t put the fire out with money.

    You get the idea… Bye bye dol­lar.

    Hey Jack…What’s a Quadrillion ?

    What is the value of the deriv­a­tives traded annu­ally in US ?

    In excess of 1 quadrillion.….notional amount.….…unless.……they all go bad then.….it’s back to one quadrillion.….OWED!!

    Assum­ing the aver­age Yan­kee FRN is .06 mm thick then when stacked one upon the other would reach 2/3rds of the way to the sun.

    Assum­ing that if they are that close to the sun then, maybe the yan­kee dol­lar caught fire!!

    The fuse has been lit.…and is headed for earth at the speed of light.

    Bet­ter stock up and head for the hills.

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