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Generational Dynamics Web Log for 13-Dec-07
Central Banks around the world announce an "unprecedented" joint plan to end the credit crunch.

Web Log - December, 2007

Central Banks around the world announce an "unprecedented" joint plan to end the credit crunch.

There were simultaneous announcements on Wednesday by the US, Canada, the UK, Europe, Japan, Switzerland and Sweden to provide liquidity to banks at a lower interest rate and under easier terms than usual.

The BBC and others have described the new plan as "unprecedented."

What was particularly interesting is that all of these central banks are injecting liquidity in the form of US dollars into their local banking system. This is because banks have been hoarding dollars more than other currencies. The other central banks will obtain dollars from the Fed through a repo (repurchase) agreement.

Statements were issued simultaneously on Wednesday by the Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Swiss National Bank, Bank of Japan, and Swedish Riksbank.

The Fed statement refers to the establishment of a brand-new Term Auction Facility (TAF) program. Using whatever securities they have in their portfolios as collateral, banks will be able to bid for dollars to be offered at a series of TAF auctions. The dates for the TAF auctions are as follows:

$20 billion to be auctioned on Monday, December 17;
$20 billion to be auctioned on Thursday, December 20;
Unspecified amounts to be auctioned on January 14 and 28.

The statement adds:

"Experience gained under this temporary program will be helpful in assessing the potential usefulness of augmenting the Federal Reserve’s current monetary policy tools--open market operations and the primary credit facility--with a permanent facility for auctioning term discount window credit. The Board anticipates that it would seek public comment on any proposal for a permanent term auction facility."

In my August article, "Bernanke's historic experiment takes center stage," I described how open market operations and the discount window work. The TAF, if it's successful, would add another major tool to the Fed's arsenal.

Still, let's face it, this is desperation -- a desperate act to try to pump up the leaking credit bubble and keep it from collapsing.

They're talking about $40 billion this month -- that's nothing compared to the writedowns that are occurring.

Even the most hopeful mainstream estimates are that there will be a total of $500 billion in writedowns, resulting in $2 trillion more in lost credit, as I described last week in my article, "Questions and answers about the 'credit crunch'."

So even assuming these optimistic amounts, $40 billion is still a drop in the bucket.

You know, the first of these TAF auctions is on Monday, just three days away. So we may know by then whether these auctions will "save the world."

Everyone seems to think that with a little Fed "magic," everything will go back to the halcyon days of 2004 to August 2007, when bad news was always good news, and the market had no way to go but up.

But that's absolutely impossible, for three reasons:

The credit bubble has gotten too large to be sustainable. It has to deflate just because of its sheer weight.

The generations of people who survived the 1929 crash and the horrors of the 1930s Great Depression are gone now. Today's leaders are Boomers and Generation-Xers who have never seen anything like a generational stock market panic and crash, and don't even believe that it's possible. At some point, millions or tens of millions of Boomers and Xers will panic and try to sell off their stocks, resulting in a new generational panic and crash.

Even ignoring the possibility of a panic and crash, the Boomers and Xers who used the debauched and depraved forms of credit that gave rise to the huge credit bubble are now considerably more risk-averse than they were. A couple of Fed interest rate reductions will not reverse this generational change in attitude to risk-aversion.

Now let me return to the remark by the BBC that this plan is "unprecedented." Maybe a few of the details have changed, but this kind of international cooperation to save the world is not unprecedented.

If you haven't read the fascinating story of "The bubble that broke the world," then now is a good time to do so. It's the story of what happened in 1930 and 1931, when the world's central bankers got together to save the world from financial collapse. In fact, it was this joint plan that led to the creation of the Bank of International Settlements.

The problems then were the same as they are today. The 1920s bubble had created huge amounts of money in the form of a credit bubble, and after the 1929 crash, that bubble started to leak.

It was bad enough in the US, but it got worse and worse in Europe. Central bankers in Britain, the US and France got together with a plan to prevent the financial collapse of central Europe by injecting huge amounts of liquidity into the European banks. It worked for a while, but not for long.

On May 11, 1931, the Credit-Anstalt bank of Austria failed. This triggered mass panic and bank failures throughout Central Europe, and generated a worldwide banking crisis. On July 13, the German Danatbank failed. Foreign investors in Germany quickly withdrew their capital from Germany, heightening the crisis, leading to the complete collapse of the German economy. By the end of the year, there were over 6 million unemployed, and the resulting social tension gave rise to Communism and Naziism.

So, the new international "TAF" plan is not unprecedented. It was tried before, and it failed. Now it's being tried again, for the same reason as in 1930-31, and it's going to fail again, for the same reason as in 1930-31: There isn't enough money in the universe to prevent the credit bubble from collapsing. (13-Dec-07) Permanent Link
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Generational Dynamics Web Log for 13-Dec-07 Central Banks around the world announce an "unprecedented" joint plan to end the credit crunch.

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Generational Dynamics Web Log for 13-Dec-07
Central Banks around the world announce an "unprecedented" joint plan to end the credit crunch.