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”.

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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.