Can Flood of Money Turn the Tide?
Spending whatever it takes might not be enough.
There is currently confusion between the disease and the cure. The "disease" is the excessive debt, and leverage in the financial system, especially in the US, Great Britain, Spain and Australia. The "cure" is the reduction of the level of debt that is now underway ("the great deleveraging").
The initial phase of the cure is the reduction in debt within the financial system. Some of the debt created during the Ponzi prosperity years will not be repaid. Non-repayment of this debt, in turn, has caused the failure of financial institutions. The process destroys both existing debt and also limits the capacity for further credit creation by financial institutions. Even after recapitalization, the capital shortfall in the global banking system is likely to be around $1-3 trillion. This equates to a forced contraction in global credit of around 20-30% from existing levels.
The second phase of the cure is the effect on the real economy. The problems of the financial sector have increased the cost and reduced availability of debt to borrowers for legitimate business purposes. The scarcity of capital means that banks must reduce their balance sheets by reducing their stock of loans. Normal financing and loans are now being effectively rationed in global markets. This forces corporations to reduce leverage by cutting costs, selling assets, reducing investment and raising equity. This also forces consumers to reduce debt by selling assets (where available) and reducing
"Negative feedback loops" mean reduction in investment and consumption lowers economic activity, placing stresses on corporations and individuals setting off bankruptcies that trigger losses for the financial system that further reduces lending capacity. De-leveraging continues through these iterations until overall levels of debt reach a sustainable level determined by lower asset prices and cash flows available to service the debt.
Since the grand mal seizure suffered by financial markets in September and October 2008, national and international "committees to save the world" have implemented a bewildering and ever changing array of measures to try to forestall economic collapse.
The actions -- dubbed WIT ("What it Takes") by Gordon Brown, the English Prime Minister -- have been focused on trying to stabilize the financial system and maintaining growth in the real economy.
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