Left Flank

Jerome a Paris and a «US central banker friend» help us to understand why the Bush administration is so desperate to see the Bernanke-Paulson coup plan passed quickly. It's all about hiding the damage before the adults find out.

The theory here is that the Fed has destroyed its balance sheet by taking on increasingly large chunks of non performing assets (the «toxic waste» made from mortgage-backed securities and the like) in exchange for loans of «real» cash to banks that may still end up not repaying them.

It is effectively «broke.» This is not what is supposed to happen to a central bank, which can print money without restriction, so let me explain what this means: it can no longer help the banks in a non-inflationary way. In order to take on more toxic collateral from the banks, it would need to actually print money, which would immediately be visible and would be seen as very inflationary. Instead, by getting government to take on more public debt, the impact is diluted in a much larger pool (public debt, rather than cash).

So this is a desperate gamble by Paulson and Bernanke to avoid the run on the dollar that would be triggered by direct cash creation.

Obviously, as the market shows (with the euro up by 6 cents since the plan was announced Thursday night, and gold and oil similarly massively up), worries about inflation have not quite been killed, but they have been kept to a manageable scale.

At this point, of course, the goal is to avoid a bigger crash before the election.

Jerome a Paris suggests instead a stimulus package.

...the real worry is on actual economic activity, which is straining under the twin burdens of asset price depreciation (house prices crashing, leading to lower incomes for people, less construction activity and foreclosures) and the credit crunch (business no longer having access to credit to develop their activity). Given that companies and households are also deleveraging (reducing their debts or increasing their savings), or are about to be forced to do so, the real need is to inject actual revenues, ie wages coming from real activity, in the economy, and NOT debt. What government needs to do is to spur real economic activity - as it were, there are whole sectors begging for it, like investment in public transportation or renewable energy infrastructure.

I guess that puts paid to talk, that Henry Paulson is the sheriff policing his former croonies on Wall Street.

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