Economic Consequences of the Bailout Plan
I’m not going to go through this in detail, but just quickly hit the highlights then discuss what this will mean for ordinary people and the economy.
Fundamentally it’s the Treasury Secretary to spend pretty much as he chooses, with meaningless oversight, up to 700 billion or the debt limit. In theory it’s "whichever is less" in practice it’s going to be "whichever is more". Add to this the end of mark to the end of mark to market, and the move to mark to "whatever the bank says its worth" and banks are going to be allowed to stay alive no matter whether they’re solvent or not as long as their cash flow doesn’t go so far negative it can’t be papered over the world’s favorite wallpaper, the US buck. Zombie banks plus all the money flooding into trying to stop deleveraging from wiping out said financial institutions means this is a Japanification plan.
Japan had its own bubble back in the 80’s. When it popped the Japanese decide that they would not force banks to write down their losses. Instead they left them on the books. Those of you who are old enough will remember when Japan was the economy of the future, who built the best stuff and were destroying everyone else. After the bubble popped that all ended. The world’s most vibrant economy went into a long economic slump from which it never recovered. This wasn’t a classic depression—there wasn’t a huge immediate contraction. Things just generally got lousy – unemployment rose somewhat, jobs stagnated, no one had a lot of money. The good times never, ever, came back ever again. It was like being caught in a low grade recession, all the time.
That’s what this bill will do in the most likely scenario. The US will go into recession, every once in a while it will seem to pop out, then it will drop again. Because the US has population growth, and Japan doesn’t, the actual numbers will look better than Japan’s, but the feeling of "there are no jobs anywhere" and "this economy sucks" will be pervasive. This will translate into a grinding down of Americans standards of living.
The reason this happens is that all the money that could be used to increase output and productivity or to decrease input problems (by, say, reducing the amount of oil and other commodities used) will be all be being used to prop up the current financial structure. 750 billion dollars, and this is key, is not going to be enough. Folks on Wall Street are already saying so. More money is going to keep flying into the structure to keep it from deleveraging in an uncontrolled fashion, and thus wiping out lots of rich people. I figure they’ll be back for more money in 6 months, 9 max. 3 months wouldn’t surprise me, since Paulson has a lot of incentive to use up his full allowance while he’s still Secretary. After he does so the problem will still exist and the next Treasury Secretary will be back looking for more.
Now, if that money hits the real economy in a significant way, it will lead to inflation, and in my earlier writing that’s what I figured would happen. But on consideration, I think the downturn in the economy combined with the sheer sucking power of the leveraged financial structure which has to be kept from collapsing means that very little of that money is, in fact, going to get to the real economy and what does won’t be sufficient to overcome demand contraction. Simply put, the financial masters of the universe owe more money than exists in the entire universe. So their need is going to be pretty close to endless. 10 years minimum, probably 20. Maybe 30. Who knows… but certainly not a one time injection. If 700 billion was their total losses, they wouldn’t actually need a bail out.
Note that Japanification was always the plan of the "neconomy", or Busheconomy if you prefer. It was always the endgame? Why? Because Japanification makes the winners of the final game permanent. All extra money in the system will be pumped to the people who made the bad decisions that crashed the prior economy, they will stay in power and because there isn’t a dynamic economy left, no one is likely to rise to replace them.
Note also that this money is entirely fictional. We are now into a real "paper" money system. For all that they aren’t actually printing it, this is the modern equivalent of just saying "we need more money? Well, we are the government. Run the presses hot."
For ordinary people this means a long gray suck. The US is in worse condition to handle this than the Japanese were. It has a trade deficit and its government is hemorraging red ink. Foreigners will start lending again, but that’s because they know they’re going to get a lot of the bailout cash, which means their real rate of return on the treasuries is going to be a lot more than nominal (no no, ordinary citizens like you do not get this money. You will, however, pay and pay and pay for it.) Standards of living, which have been essentially stagnant with a slight decrease in the last few years, will start a steep decline. Nominal housing values may or may not fully crash, but if they don’t, you’ll find it very hard to find anyone to sell your house to—the housing club will become one for people who are already in it. Those who aren’t won’t be able to afford the overinflated prices, because only people who can sell at high prices will be able to buy at high prices.
Because the US does not run a balance of payments surplus this is a game that can’t go on forever, as it has in Japan. The US still needs outside money and that money will get more and more expensive and will eventually be turned off entirely. How long? Two to four years is my guess. At that point the US will be forced to go to the IMF (which, arguably, it should be doing right now, when it can use special drawing rights with no catch except a prestige loss.) At first the IMF will lend with no conditions. Then it will lend with conditions. You will not like those conditions. At all. Since Obama will be in office and will be associated with this mess (fairly enough, since he whipped for the bill) the right will run populist right wing and odds are very good that they will win. 2013 will likely see a populist right wing government in the US.
There are some ways this could break down. Running the printing presses hot could lead to runaway inflation (I am amazed that all Chicago school economists are not up in arms over this plan, actually. They apparently don’t believe what they teach.) The outside world could decide to really cut the US off, causing a devastating currency drop on the order of 40% or so. The deleveraging may be so vicious that even throwing a few trillion dollars at it and letting banks pretend that it’s really worth whatever they say it is, doesn’t work, in which case, probably a full fledged depression, since the money to fix things right will have just been flushed down the toilet.
And there are some ways this could be fixed. A lot of economists, like Stiglitz, are betting that Obama will eventually do a real bailout bill. We’ll see. He made no real push to fix this bill at all that I am aware of and his various economic policies have long indicated to me that he is essentially a gentler kinder Reaganite in economic terms, so I’m not so sure. Still, there are solutions, and I’ll talk about some of them in future, as I have in the past. The question is whether there will be any political will to do them. When you can pass a 700 billion bailout for the rich, but putting in real changes in bankruptcy laws to allow folks to keep their houses is unthinkable, it’s clear that the elite consensus is still that the little people are always to be made to pay to clean up their betters mistakes. Until that attitude changes, very little useful is likely to get through Congress.
Everyone will be very interested in this again soon enough. In the meantime I wish you all, my readers, the best of luck and good health. I will repeat my standard advice that the most important thing in an economic downturn, by far, is not so much which securities your money is in, but how good your relationship is with your family, friends, neighbors, and most especially, your spouse.