I post on another forum much different from this one. Its not even market releted.
But the subject came up about the economy.

I asked a person that I respect what would he do if he were in charge.

He gave a very interesting response. I was just wondering if some of you could give insight on his beliefs. Here it is:







So this seriously is a question that could take an entire book to answer. So I'm going to throw a lot of what I think, without backing every thing up with details. If you have detailed questions, I will try to explain my thought process.

The first step is, you gotta completely throw politics out of the equation. The economy does not react to politics like people think. The economy doesn't tank overnight or get fixed overnight. It could take years to decades for a policy to work itself through the system... good or bad. So with that said, I'm not blaming any President or party. So if you completely throw politics out you get a blank canvas of an economy.

My other belief in the system is this. The only goal of fiscal and monetary policy is to control inflation and prevent deflation. The Govt can not go broke. When the Govt spends it creates money when it taxes it destroys money... and this all plays in to inflationary control. The Fed controls monetary policy, basically the demand for money (aka liquidity).

So basically in 2008, we lost $14 trillion in wealth (aka paper wealth... since money can not be "lost" by the private sector), 6.2 million jobs, wall street collapsed by over 50%, banks failed, and the entire system came to a halt. This we know, this is proven fact of the effects that happened in 2008. So the question is now what.

First off, a fiat system requires trust... people HAVE to trust that their money in the banks is there when they need it. The worst possible thing that can happen is people not being able to get their money. So because of the repeal of Glass-Steagal you had these major depository institutions merging with investment banks creating monster banks. And they were all involved in these financial vehicles dealing with subprime mortgages. The kicker was, just like the homeowner taking out a loan to purchase the house, they were purchasing these pools of mortgages with debt themselves. Everything was done with debt. AIG didn't have the money to cover the insurance they were offering, they just had enough to cover the expected risk of the securities they were insuring. So there was very little money actually involved, it was tons of paper being passed around through the entire system that had no backing what so ever except the "home value". I put that in quotes because this was a projected home value based on equations that home prices do not actually fall and haven't in decades.

But, what they didn't realize is after a while, what was backing the mortgages wasn't the same quality as the mortgages from the previous decades. So they were running on a faulty assumption of home prices. So we can talk about this aspect forever, but I'll move on.

Alright, so now if the Govt takes absolutely no action... what happens? First thing to realize is the mortgage industry is very capital intensive. It requires a lot of up front cash for banks, with a 20-40 year window to recoup that cost. So you had tons of investment banks using short term debt to purchase long term assets. The banking system didn't have money to pay off the short term debt it used to purchase these assets. They needed to be bailout out. If you didn't bail them out, the system would have completely collapsed as a domino effect would have went throughout the system as banks couldn't pay off their debts, which means lenders who had debt couldn't pay off theirs, etc. So the first necessary step was bailing out the banks.

So now what? So now households lost a quarter of their net worth. That is MASSIVE!!! I mean that has depression written all over it.

So now another domino effect happens...

1) People lose their jobs
2) People lose their wealth
3) People start saving to pay off debt and to prepare for the worst
4) Banks stop lending because they are crammed with toxic assets
5) Because of the above four, businesses start to suffer from lack of demand and lack of credit

So if the Govt or Fed doesn't do anything to prevent this, we go directly in to a deflationary spiral of depression. As more and more people default on their debts, there is less and less money for banks to lend. As more people save, there is less money for people to pay off their debts. As more jobs are lost their is less money to consume. So if no action is taken we are stuck with incredibly large amounts of wasted capital and debt that can not be paid. It is a destructive force of nature that can completely destroy an economy. With out money the system fails.

So now the big threat is deflation. Every one says "Why are dropping prices bad"!! Deflation is one of the worst things that can happen in a debt driven society dependent on flow of money. Deflation basically makes holding on to money profitable. They say inflation is a tax on idle wealth, as in it forces people that don't want to lose purchasing power in the future to do something with their money. Deflation is the opposite... if prices are projected to decrease in the future, there is no incentive for anyone to spend money. So everything the Fed tried to do was prevent deflation. That was what we learned in the Great Depression and throughout history. Money HAS to flow for the debt system to work. And as people save and banks don't lend, money stops and the system continues to collapse.

So no matter what was done in 2009 regardless of who was President, the system was going to re-balance itself regardless. The 6 million people who lost their jobs and the millions of people in homes they couldn't afford, were all going to suffer. So much wealth had evaporated, so much housing value lost, you are looking at a restructuring phase for years and years to come. So what can the Govt do?

Cut taxes? That doesn't work very well when people don't have jobs and need money immediately.
Lower Interest Rates? This is usually a normal move but because the 2000 recession rates were already cheap. So the Fed couldn't do much more about drop them to about 0.

But low interest rates didn't matter to banks because they had enough problems on their own. So what next. Banks aren't going to lend until they are solvent with each other. So the Fed's come up with QE1 and QE2

Both of these were meant to stack banks with liquidity. Basically get rid of their toxic assets and create a more lending friendly environment. But to protect an absolute onslaught of cash flooding the system they created an IOER, basically paid the banks interest on their excess reserves which made them able to hold on to excess reserves and not have to sit on idle money. Because remember, no one wants to sit on idle money. So now banks are flooded with cash to lend. They still don't lend because A) people aren't trying to borrow and B) the economy is still re-balancing.

What next? The Fed supposedly tried to take care of the credit issue. And it still didn't really work. The Fed has nothing left in their arsenal. If they raise interest rates, they make credit even harder to attain.

Up next is fiscal policy. What are the Govt's options? This is where politics come in to play the most. What if the Govt did nothing? Well, since people can't borrow from the banks, they now can not pay off their loans. Since people aren't spending, there is less money circulating the system for businesses to acquire or for people to acquire to pay off debt. And you get back in to that deflationary spiral you didn't want to get in, in the first place.

So the Govt's only real option is stimulus. Basically employ people, it's a bandaid to close the spending gap that is created by a recession. It allows people to downgrade with out defaulting on their loans or for businesses to have new demand to stay afloat. There is literally no logical evidence that a stimulus hurts the economy, unless the money exceeds productive output. A stimulus is not meant to create permanent jobs or to be the life saver of the economy. I mean think about it mathematically. People lost $14 trillion of wealth and you put in a $800 billion stimulus spread out over 2 years. The calculations show we are going to lose $1.2 trillion a year in productive output, meaning we have $400 billion a year to patch that gap. That leaves $800 billion a year in re-balancing that must occur. So the $800 billion stimulus was literally just 2% of GDP. As this guy from Harvard says, we needed a MUCH bigger stimulus. In the realm of $2 trillion.

The other option is what type of stimulus, in the form of tax credits or direct Govt spending. Obama chose 2/3rds tax credits and 1/3 Govt spending. This was stupid because people didn't use their tax credits to spend, they used it to save or to pay off debt. So you had just $200 billion actually going through the economy. That is why the stimulus had very little effect on the unemployment rate, is because it literally didn't create money that flowed through the system like it should have. That is why this Reagan adviser is saying that the Govt should have spend directly in to the economy. Employ the newly unemployed, let them pay off their debts, let businesses get some knew demand to work for, etc. Everything else is purely political. All this talk on debt, and China, and debt ceilings... is all purely political. The Fed and the Govt pulled out all the possible tricks to try to keep the economy from deflation... and to an effect it worked, but it didn't succeed. Obama crushed himself by not pushing for a much larger stimulus. But at the time, the economy wasn't expected to be in that bad of shape. Every month, the prospects got worse and worse and worse. It was brutal.

So long story long, if I were Obama, I would have spent about $1.2 trillion on direct Govt spending, employing people to build roads and **** like that... and another $600 billion in tax credits to those with incomes up to $200,000. That would have at least closed the gap a bit, and created a much bigger bandaid for the system. The problem people have of course is politics... with out politics, the economy was going in the ****ter regardless of what was done. The Fed and Govt are limited in what they can do. And we know from empirical evidence on what happens when you do nothing!!! The economy goes BOOM!!!

Well this is a fairly accurate representation of Keynesian economics. All it is dealing with is supply of money. Supply of money is only one small part of the issue. Two factors are not included here. #1 The effect of debt overhang (totally ignored) #2 Demand. Stimulus improves demand over the short term, but long term it just pulls demand from the future.

Look at chash for clunkers... greatly improved the auto market for maybe 6 months, but then it was even worse afterwords. Look at the new home buyer credit. Was great for home buying, at least until it stopped. Home buyers on average have now lost all of the credit and home values are still dropping.

To improve things, you have to get rid of debt while at the same time improving demand. This is almost impossible to do, hence why we are screwed.




I am sure even you know stimulus is not the answer. If it was all we had to do to get rich would be have non stop stimulus plans by our Government. We could just print our way to prosperity.

Lets imagine you are a business owner. You start with your own capital and build a good base for your company. So you decide to get some credit. Your business rapidly grows. So then you get greedy and decide to take out even more credit. This time your business doesn't grow quite and fast and you added tons of debt. So you try again. At some point if you are not careful, the money you spend on interest payments will start rising faster than your business is growing. This is a great way to go broke if you are not very careful.

While nobody was looking but a few thousands were talking about it (appraisers petition, calling CONcritters, faxing petitions, writing mis-Representatives, too many truthful analysts to mention) the largest chunk of the available bail-out effort went to those at the top of the pyramid.

Taxpayers have witnessed a crime and stayed around long enough to get charged with it.

Quote:

'Minsky, however, argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government - or what he liked to call “Big Government” - should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work.

http://www.boston.com/bostonglobe/ideas/....

What seems strange is that the Minsky solution sounds a lot like picking up the pieces after everything is destroyed. It also sounds like KD's suggestion to the government to prepare I forget how many millions 3-hots-and-a-cot.

"We can share the women we can share the wine,
'We can share what you've got of yours 'cuz,
'We've done shared all of mine."

- Jack Straw (the Taxpayer blues j/k), Grateful Dead