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"Liquidity" Problem Solved?


Credit contraction will lead to deflation, shrinking GDP.

The solution to the "liquidity" problem has apparently been found. So giddy are banks, big banks, and central banks about the Federal Reserve's latest device for injecting just enough juice into the system to keep it from collapsing, that the Bank of England is about to do the same (at the behest of HSBC (HBC) et. al.).

I've described a probable path to nationalization/socialization, and unfortunately central banks seem to be following it step-by-step. The Fed has finally admitted to taking off the books of banks troublesome debt - debt in derivative form that's carried at a price that doesn't reflect where it could be sold into a free market.

Because it's still being carried at an artificially high price, it can't be used as collateral and thus banks couldn't lend new money even if they wanted to. So the Fed, and it seems now nearly every other central bank, is now exchanging the banks' bad debts for their pristine debt: "give us the bad debt off your balance sheet and we'll give you treasuries that are on ours".

Unlike the troublesome debt, treasuries can be used for capital (at least for now); thus, the Fed is injecting capital directly onto banks' balance sheets. Where does the Fed get this "money"? It prints it. And that's the cost: a devalued dollar and lower standard of living.

I would like to ask a question at this point. If the Fed is saying it's getting plenty of bad debt to act as collateral in exchange for the good debt, why are banks not taking significant losses when the exchange is being made? By definition there can't be both a fair exchange and no loss incurred, because the root of the problem is that no one will buy the banks' bad debt at the price they have it marked at. The answer unfortunately is akin to closing your eyes at the scary part of the movie… it's just too awful to contemplate.

If the Fed (and in more permanent form some government trust) is becoming de facto landlord to a significant part of the populace, is serfdom far behind? But all this is being presented in the form of innocent looking short-term arrangements that aren't meant to become permanent, even though the Fed has not taken such actions since the Great Depression.

Do you remember 20 months ago when we were being told that "central banks have now mastered the management of an economy"? How far we have come since then in understanding what was really going on?

As the Fed kept real interest rates negative, it encouraged vast bad debts to be incurred. While it was happening, volatility was very low as liquidity, or debt, was being created, and people had money to buy things. Now that the debt is contracting the warts are showing. All those "shysters" never would have had the money to make those bad loans if it weren't for the Fed gunning the money supply and polluting it with debt.

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