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Fed Provides Borrowed Matches For Fire

By: Murray Nickel

September 6th, 2007

Picture this: you find your son playing with matches in your house. "Son, that's a mighty dangerous game you're playing - you could burn the house down. Oh, I see you're almost out of matches, here use these ones I've borrowed and by the way, I'll take the blame on your behalf should anything go wrong".

Would you say and do that? Not likely! The chances of your house burning to the ground would jump drastically.

So why has the Fed done exactly that? Bernanke has said "that's a dangerous game you finance guys are playing with credit and derivatives. Oh, I can see you're running out of credit sources, here use this credit that I've borrowed from tax payers and my Asian friends . let me take your junk collateral in return, and if anything really nasty transpires I promise to step in and help again. But I don't want you to worry. I'll take the lions share of the pain since I would then hold your last lot of speculative investments as collateral that's of questionable value".

Mr Bernanke needs to go on a course teaching grown-ups behavior management for children!

I fully expect the behavior of banks and others to get worse, not better.

Is it just me, or can others see the irony in trying to calm a debt bubble by adding more debt into the hands of those who have so clearly mismanaged its distribution to-date. Yes I know "debt" is unfashionable - "credit bubble" sounds so much more pleasant, but hey, let's call it what it really is.

So is there an answer to our woes? Sadly, there is no easy one, but there is an obvious choice. Here's my understanding of the situation, if one looks at the big picture: add all US Public Debt (national, state and city-level debt), plus Social Security and Medicare commitments, and you get a figure so large that at current GDP levels of growth, you could tax every earning individual in the US at 100%, and the debt and obligations would continue to grow.

In this situation I can only think of two options:

* Do "something" to get GDP growth over 10% p.a., and keep it there year after year. At the same time drastically increase taxes and default on those Social Security commitments. Hardly an election-winning strategy! Or,

* Default on an international payment - one just big enough to ensure that the US Dollar plunges, thus making the remaining debt worthless (oops, sorry our Asian "friends"). In this way US citizens don't carry all the pain as it gets spread far and wide around the globe - and especially in far away Asia. And the political fallout need not be great, at least initially: just target a major lender without a democracy, begin tit-for-tat bickering with them that escalates over time into positioning them as a "public enemy". Then when you pull the plug there'll be a resounding cheer from voters.

Well, from most of them. A few might see the consequences of a plunging dollar: the kind of hyper-inflation followed by deflation cycle that Germany endured in the 1920's. Followed by a global economic depression.

As I mentioned, there's no easy fix, but if I was facing the choice of my country's citizens carrying all the immediate pain with no guaranteed successful outcome, or spreading that pain globally knowing the world economy should digest the elephant more readily, I know which choice I'd make. Add in the political implications and it's a no-brainer.

When any bubble bursts, it's a bit like an avalanche: once the ball starts rolling and growing in size and momentum, the whole mass accelerates into a catastrophe with surprising speed. The debt bubble is no exception, so don't rely on Mr Bernanke and his banking friends with their boxes of matches to save you: they'll end up much more focused on saving themselves!

Article Source: http://www.articlesinsight.com

Murray Nickel is a mathematician, statistician, and professional trader. He offers a free trial of trading signals for market indices and index ETFs, spot Forex, and spot Gold. He also mentors traders aiming to excel at trading global markets.

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