	Generational Dynamics
	Forecasting America's Destiny ... and the World's

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Generational Dynamics Web Log for 23-Jul-2008
Bad news: America is failing. Good news: America is too big to fail.

Web Log - July, 2008

Bad news: America is failing. Good news: America is too big to fail.

Treasury Secretary Henry M. Paulson Jr. is arduously pushing his bailout plan for Fannie Mae and Freddie Mac, the government sponsored entities (GSEs) that guarantee about half of the mortgages on American homes, worth some $6 trillion.

Paulson is essentially asking Congress for a "blank check" to do whatever is necessary to keep the two companies afloat. "Congress understands how important these institutions are," said Paulson.

The message is clear: Fannie and Freddie are too big to fail.

If they failed, it would be disastrous to the American mortgage marketplace, and would trigger a severe chain reaction of bank failures.

Foreign holdings of non-Treasury American securities <font face=Arial size=-2>(Source: nytimes.com)</font>

Foreign holdings of non-Treasury American securities (Source: nytimes.com)

But there's another reason why they're too big to fail: Almost $1.5 trillion worth of Fannie and Freddie bonds are held by foreign investors. If Fannie and Freddie failed, then foreign investors would lose all faith in the credit quality of the entire US government.

As I've said for several years, it's been clear for a long time that the US government would never be able to redeem all the long-term Treasury bonds that it's issued -- something like $9 trillion dollars worth. However, last weekend's near failure of Fannie and Freddie has made that fact obvious even to normally oblivious investors.

The bailout of Fannie and Freddie would essentially mean that the $6 trillion of their debt would be added on to the US government's debt, which would now owe $15 trillion.

This is causing investors to start asking for the first time: Is America too big to fail.

An article on that subject goes into a great deal of detail to explain why it is:

"The logic for that assurance goes like this: The American consumer has for decades served as the engine of world commerce, using borrowed cash to snap up the accouterments of modern living - clothes and computers and cars now manufactured, in whole or in part, in factories from Asia to Latin America. Eliminate the American wherewithal to shop, and the pain would ripple out to multiple shores.

Globalization, in other words, allowed China and Japan to amass the fortunes they have been lending to the United States."

The article blames globalization for the situation, and implies that it's a rather new phenomenon to be in this situation.

In fact, that's not true. As we've said many, many times, from the point of view of Generational Dynamics, if you go back through history, there are many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

These are called "generational crashes" because they occur every 70-80 years, just as the generation of people who lived through the last one have all disappeared, and the younger generations have resumed the same dangerous credit securitization practices that led to the previous generational crash. After each of these generational crashes, the survivors impose new rules or laws to make sure that it never happens again. As soon as those survivors are dead, the new generations ignore the rules, thinking that they're just for "old people," and a new generational crash occurs.

So there's nothing new about the current situation. What's going to happen next? We can look to the past to get an idea.

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.

However, when you read that story, and compare to the situation today, remember that America was a creditor nation in 1931, but a debtor nation today. The debtor nation in 1931 was Germany, and the creditor nation today is China. Thus, we should expect China today to act like America in 1931, and America today to act like Germany in 1931.

Central bankers in Britain, the US and France got together with a plan to prevent the financial collapse of Germany 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.

The statement "America is too big to fail" is the first step in repeating that process. Countries like China and Japan will realize that America is never going to repay its debt anyway, and so they'll cancel the debt, just as we canceled Germany's debt in 1931. But it won't work for long. How that failure will affect America and world remains to be seen. (23-Jul-2008) Permanent Link
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Generational Dynamics Web Log for 23-Jul-2008 Bad news: America is failing. Good news: America is too big to fail.

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Generational Dynamics Web Log for 23-Jul-2008
Bad news: America is failing. Good news: America is too big to fail.