Monday, December 29, 2008

Fools at the Wheel

The biggest risk to the world economy is the men who pull the levers of power in the government and the financial system. They have considerable ability to get things wrong while trying to put things right. Most depressions are caused when unexpected events are exacerbated by political and financial leaders. The credit crunch is the result of foolish responses to previous troubles. The capabilities of our political leaders have not improved with time, so they still have massive ability to stuff things up.

The Federal Reserve is currently pumping credit like a thirsty man at a dry well. The Fed knows nothing else, but boosting credit is just more of the same; more of what created the credit crisis in the first place. Massive credit creation may limit the worst of the immediate damage, but it will spawn terrible problems for the future. Current policies will leave a lake of liquidity. When confidence conspires and leverage ramps up again, the world economy could spin into hyper-inflation.

The central banks are now pushing the banks to do more lending, but this is naive. Their solution is the same as the problem. Reckless lending got the world into a mess, so more lending will not save it. A new borrowing binge and spending spree will not restore the economy.

Bush’s $700 billion rescue package for the banking sector may restore banking confidence, but it will not resolve the problem, because it rewards weaker lenders with new capital. In free market, the competent and wise people who prepared for hard times usually take over the assets of the reckless and incompetent. This time the reverse is happening. Governments are taking from the prudent people and businesses that built up wealth and giving to the careless, foolish and bungling banks. That cannot be good for the economy.

The American financial system is seriously flawed. It will eventually collapse when God has had enough of American shenanigans, but until that happens, it will lurch from minor crisis to minor crisis and from power to more power.

Bernanke and Co Ltd are throwing the kitchen sink at the global credit crisis, but they produced the crisis, so it is unlikely that they understand the solution. That does not matter, as wrong solutions often appear to be efficacious, and appearances are all that count in the political world.

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