Sayin' it again...

Regarding the bailouts, sooner or later, the bad paper has to be replaced with good paper (Treasuries). Otherwise they'll continue to poison the entire financial system. Unfortunately due to the realities of fractional reserve banking we can't just evaporate 3 trillion dollars of assets out of the economy without setting up a deflationary spiral similar to 1930-1932. So there will have to be a bail-out. The problem is that the Busheviks just don't seem able to do anything without adding some way to loot the Treasury for the benefit of their cronies, and sent out a poison bill to Congress that basically says, "give us $700B and we'll throw it around anyway we feel like." No Congressional review, no review in the courts, just a blank check to the Bush Administration to just give the dough out any way they please. Even when risking a second Great Depression they can't get rid of that same old crony capitalism instinct to steer money to their cronies.

If you are wondering, I believe the AIG bailout is a very good model for how it has to go down. These institutions get the money -- but the government gets ownership of them and can throw out the bad managers and reform their practices so they don't do this stupid evil s**t again, and then sell off the workable assets and fold the part that's not workable. Any bailout that's going to work long-term is going to have to work like that, else this nonsense is just going to happen again. You can't just throw money at these institutions. You have to take them over and reform them.

Now, a short aside about deflationary spirals and the 1930-1932 scenario. Here's what happens. A bank collapses. Now, let's say that this bank had $200B in assets (it's a regional bank, not one of the biggest ones). This removes $2 TRILLION dollars from the economy if those assets are marked down to $0, because of the marvels of fractional reserve banking (check out the Wikipedia article for that and note that the current Federal Reserve reserve requirement is 10%, which means that $1 in deposits generates $10 in currency in the economy).

Okay, so you have less money in the economy, but the same amount of "stuff". So prices AND wages go down. No big deal, you're making less money but things are cheaper. *BUT* your *debts* have not gone down. You can no longer afford to pay your credit card bills. You default on them, along with 100 million *other* Americans. This causes the collapse of yet *MORE* banks. Which in turn collapses the currency even further so prices and wages go down *again*. Which in turn means that yet *more* debts are unpayable. Wash, repeat, rinse, until all assets in the economy are concentrated in the hands of the 5% of the population that had cash in the bank at the start of this cycle, and the remainder of the population, the percentage that owed money (which is virtually all of us), is utterly destitute.

Now, at that point economic activity has *also* fallen, since economic activity needs cash to lubricate it and a lot of cash has been diverted towards futile attempts to pay unpayable debts rather than buying stuff. Figure that the economy is moving 10% of the goods and services that it formerly moved. Furthermore, food was planted and picked at the older, cheaper value of the food. So the stores are full of food, but nobody can afford to buy it because an orange that costs $1 is now only worth 1c but the store can't sell it to you for 1c and make money because they paid the farmer 50c for it at the beginning of the year (thanks to the futures market). The end result is food riots, crops rotting in the fields, and the real threat of a fascist takeover of the country. Look up Father Coughlan and get back to us -- it was only barely that FDR kept Father Coughlan's cronies from taking over (see: Business Plot) and sending us down the same path that Germany and Italy went down. And that was before twenty-five years of rote recitation of "government is the problem, not the solution" discredited FDR's brand of liberalism in the minds of most Americans -- today, a FDR would not be allowed to be elected (I don't consider Obama to be an FDR, looking at his policy proposals on his web site they appear to be fairly moderate free-enterprise-oriented proposals, not something shockingly socialist like the CCC program that built much of the infrastructure in Death Valley).

In other words, I don't expect the U.S. to go down the path of FDR if we have another Great Depression. I expect a Mussolini, probably some general taking charge to "restore confidence and pride in our government", and the usual stuff that happens when you have a Mussolini in charge. Bad things. Really bad things. You know the drill.

Now, here's the good news. Bernanke over at the Federal Reserve? He is the world's leading expert on the Great Depression and steps that the Federal Reserve could have done to prevent the deflationary spiral that crashed the dollar and crashed the economy. He has been writing papers on this stuff since he was a 22 year old grad student, and has written some of the classics on the subject, such as his 1983 paper "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression". He knows his s**t. Paulson over at Treasury? He's no Bernanke, but he's no idiot either. He is a pretty good economist in his own right, he is smart enough to both listen to and understand what Bernanke is telling him, and if the politicians in Congress take out the license to loot that his cronies wrote into the proposed bill and instead assigns ownership of the institutions that get the money to a new "Resolution Trust Corporation" to be completely cleaned out and re-formed as honest financial institutions without the crooks who issued the bad paper to begin with, his proposal actually will work -- it'll re-capitalize the banking system, it'll get all that poison paper out of the system, and things will start working right again. So we have good people in charge, and they know what they're doing, and what they're doing will work once the looting provisions are taken out of the proposal. I'm guardedly optimistic, and if you know me, I'm not much of an optimist.

Yes, it's discouraging that to make all this work we have to replace the bad paper with Treasuries or else we deflate the currency, crash all the banks, and end up with a new Great Depression. So it goes. See my signature. The American public thought we could get something for nothing, and voted in politicians who told us we were right. Now we get it, good and hard.

-- Badtux the Monetary Penguin
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"Democracy is the theory that the common people know what they want and deserve to get it good and hard." -- H.L. Mencken