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ABC news reports today a fresh bank rescue plan could come from the US
administration as early as Monday. This indicates
economic crisis in the United States is deepening and whatever stimulus or rescue plans enacted in the past months in
an attempt to save American economy have not taken effect.
The economy is ill, seriously ill. No one seems to have a
panacea to cure or even to treat it. Fed apparently had used up all its
possible means when the interest rate was aggressively cut to nearly
negative. Tough tasks now all come down to the treasury's shoulder.
Unfortunately, treasury's massive interventions in the financial system
could expose country's broad economy to a number of foreseeable risks. Dollar devaluation
and consumer market inflation will be the greatest concerns in a big
picture.
It is a gamble, a huge gamble. Like no one could predict the outcome of
that 700 billion dollar "stabilization act" last year, less than none
today will be able to assure the new bank bailout plan, if coming out, are
not going to make the bad situation even worse. The reason for saying this is
simple. When a doctor uses a medicine to treat a patient for several
months but sees patient's condition getting worse and worse, can he
convince you by saying he did have used a right medicine but dosage was
not sufficient?
The broad economy, comprising of real economy and the financial sector,
just like a human body. The real economy is heart, skeleton, lung and
other internal organs while the financial sector functions as skin and
blood. When a body is sick and has severe rash symptom, doctors must first
diagnose the root cause and then treat it with appropriate internal
medications. If they intend to remove the rashes one
by one through surgical procedures, the result is doomed to failure.
Someone may argue, how about a cancer? But I am telling you, our economy
has not been down to a fatal level. Nevertheless, rashes could be
fatal to a human body if they were not immediately treated in a proper
way.
Toxic assets are rashes. Buying out toxic assets from troubled banks
equal to cutting rashes off an ailing body. The root cause for the
rashes is inside real economy.
The real economy has always been crutched by the willingness of spending
from average consumers. The most serious and urgent problem we are now
facing is exactly lack of consumer sentiment. According to University of
Michigan survey, the Consumer Sentiment Index actually reached bottom in
April 2008, nearly one year from today, six months before the financial
market was finally crashed, and has since been remaining at the similar
level. This extended trough of the consumer confidence has caused a
great deal of casualties in the broad economy. Apparently, It will be
difficult for confidence to recover without significant improvements in
job market including income levels of average households.
Many have been arguing that massive bank bailout plans will help banks
to clean up massive toxic assets and improve their balance sheets so
they can start lending again. This classic capital theory hopes
government injected funds will trickle down from the credit market to
businesses and eventually create jobs to benefit average
consumers.
Unfortunately, this recovery model is not going to work, because:
1, Logically, an improvement in a bank's balance sheet
doesn't mean the bank will start lending again.
Banks are no fools. They have learnt a hard lesson in this crisis and
surely will rather be conservative in lending operations. Yes, they will
lend, but they can only afford to lend to the businesses that can come
up with solid business plans. When market demands show great weakness
due to low consumer sentiment, where will "solid business plans" come
from? and how could a business assure the lender its abilities to repay
the loans?
I have considered getting bank loans to expand my marble business, but I
really got lost when pondering on where the business can expand to.
Wholesale business is saturated as all retailers are suffering as much
as we are. Retail sales keep declining, a warehouse full of products are
anxiously waiting for their new owners. Commencing massive marketing
campaigns to expand client base? A good idea. But I had to give it up
after finding out from Google Keyword Tools that search volumes
associated with stone industry had dropped sharply in February comparing
to the 12 month average. Then I thought about renovating my own house
and persuading my warping two still employed workers to renovate theirs.
That would stimulate my business little bit and make a small
contribution to country's economic recovery. Unfortunately, bank
says can only approve couple subprime mortgages for us.
Not just me, even those financial institutes like AIG that have been
bailed out in the first round aren't sure where to spend taxpayer's
money other than treating their executives with some lucky bonuses.
Recent reports said many TARP banks had kept their TARP money in vaults
since they received it. Some even wanted to return it to avoid
government regulations.
2. Psychologically, further bank bailout will negatively impact
consumer's sentiment further.
Based on the Consumer Sentiment Index from University of Michigan, the
first financial bailout plan cleared Congress on October 4 did not lift
consumer at all. The index for the October, 57.6, remained near a
historical low of 51.2 recorded in May, 1980. This strongly suggests
that the average consumers did not approve the bailout as effective
means to rescue the economy. I have to doubt a new round of the same
type of bank bailout will affect the consumer confidence differently.
When consumer's sentiment stays where it is now, the broad market demand
will not improve on its own. Consequently, an economic recovery can only
stay in some ideological dreams. It is foreseeable that the staggering
amount of bailout money from already suffered taxpayers will flow around
the financial sector for some time and evaporate eventually.
Moreover, the AIG's bonusgate emerged recently doesn't help the
consumer's sentiments in any sense. Whether TARP would bail out
banks or their executives has been a heated debate since its existence.
Executives seem to have won a knock out victory in this round.
3. Practically, the outcome of this type of financial bailout is bewildering
and contains great uncertainties.
Let's assume the bailout plans would be effective means to stop this
financial crisis, how many dollars will be actually needed to buy out
all toxic assets available or to be available in the financial system? I
am afraid no one could even make a projection. It is an undoubted fact
that 700,000,000,000 in TARP was an arbitrary number. How about the
future plans? One trillion? Five trillions? Who knows. But I do know
there is a cap - the "gross domestic housing value" of about
twenty five trillion dollars.
Let's assume again all toxic assets in the financial system are removed
and replaced with piles and piles of freshly printed hundred dollar
bills, what is next? I think an answer to this question is pretty
certain - all assets in the financial system will become more toxic than
ever, as inflation alone is going to be sufficient to devalue those
freshly printed dollars at a rate much greater than the "gross domestic
housing devaluation", or GDHD we have shared so far.
4. Fundamentally, bank bailouts will intensify the inequality that has
already been extreme.
The body of capital economy does inherit a potentially harmful cancer
gene. That gene is the extreme inequality. In article
"Real Causes For US Financial Meltdown and Global Recession",
I concluded that the extreme inequality is the rooted cause for the
current global recession and most likely for the great depression
in 1929.
Excessive cash flowing
around in the financial market will inevitably escalate the inequality
problem that is already serious, which in turn could lead to a much more
difficult recovery.
In conclusion, further bank bailout will not rescue the financial
system and could potentially end the recession in a catastrophic way as
a new episode of great depression will follow.
Then, what should government do to end this unprecedented economic
crisis?
In general, government should focus on stabilization rather than
expansion of the real economy by stimulating economy from bottom up.
When a recovery takes place in the real economy, the financial system
will be able to rescue itself. To this end, government must massively
and directly invest in various sectors of the real economy such as
infrastructure, technological renovation, health care and education.
These investments will be costly, so will any economic rescue actions.
Government should be prepared to reverse certain courses by raising
interest rates and tax rates for the top bracket groups to reasonably
balanced levels so to increase treasury revenues and improve Fed fund
supplies.
The US administration has repeatedly praised China's four trillion yuan
economic stimulus package. Are there anything in that massive
package providing useful hints for policy makers in the US to fight
against the global recession? It is predictable that there will be great
ideological difficulties to adopt any economic measures from a socialist
system. However, may all politicians abandon their ideological beliefs
and choose what are the best for the nation in a critical time? I
will talk about this in a separate article.
Related Series Articles on Global Economy and Recession
by Jonathan Wang
Railroad Expansion, Most Effective Way to Rescue US Economy
Consumer Sentiment Lags, Stock Markets Soar - Sign of Depression?
Trillions Dollars Won't Save US Economy, Historical Data Say Everything
Why China is more resistant to the global recession than any western
countries?
Bail Out Banks...Again? Caution, Don't Jail in Economy
What has really caused collapse of the financial market in the United
States?
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