Saturday, November 6, 2010

Emergency EXIT

In a recent comment here, JB Peebles links to No Exit, a post by James G. Rickards. The post is most interesting and seems a good assessment of the problem faced by the Federal Reserve. I recommend you to read it, for Rickards' logic is exquisite.

Exquisite and painful. Rickards' conclusion is that there is no way out of the problem. As he puts it, "there is no exit."

If you want to solve this problem, you have to think "outside the box" -- something neither Rickards nor the Fed is doing. The solution is not difficult to implement. Nor is it difficult to understand. It is only outside the range of our normal thinking.

All the while the economy was growing, assets were increasing in quantity and value. But since the Paulson Crisis, assets are decreasing in value and it seems we have too many of them. This is a supply-and-demand thing: When the value of those assets came into question, demand for them fell.

If we had fewer of those assets, the demand for them would be relatively greater. If we had fewer assets, the assets would fall less in value, or the value would stabilize or perhaps even begin to increase again. Supply and demand, plain and simple. And if we could get rid of the "bad" assets, so much the better.

As Rickards notes, "...some of the junkier assets and mortgages will not pay off, ever." Those are the ones we want to get rid of. Actually, those are the ones we are getting rid of, and which the Federal Reserve is accumulating. And this (as Rickards points out) is becoming a problem for the Fed.

These "junky mortgages" are not the only problem. The Fed is accumulating that crap by paying for it with newly printed money. And (again, as Rickards points out) "Critics also raise the issue that this much money printing will result in inflation."

Get Out of the Box, Dammit

Borrowing increases, and loan repayment decreases the quantity of money.

The Fed has to stop doing things by reflex. The Fed has to stop injecting money into the economy, where it will lead to inflation. But the Fed has to solve the problem, and the only tool it has is the ability to print money.

The Fed has been printing money and using it to buy up bad assets to get them out of the economy. What the Fed must do instead is simple: use that money to pay off those "junky mortgages." That makes the bad assets good, and that solves a huge problem.

It also makes the debt go away. By paying off junky mortgages, we reduce the level of outstanding debt. That reduces risk in the economy. And that solves a huge problem.

And paying off those debts makes the newly printed money go away. Loan repayment decreases the quantity of money. By paying off junky mortgages, the Fed destroys the newly printed money and reduces the risk of inflation. And that solves a huge problem.

We can fix this thing before it is too late.

1 comment:

The Arthurian said...

With a few accounting entries, the Fed could wipe out the "bad" assets it already holds.