The Main Economic Policy Challenge

Andy Sing comments in Seeking Alpha:
Last week's 700 plus point drop in the Dow seems like a distant memory and a much bigger sequel looks to be in the works. The world has caught up to the US, and the domestic credit crisis has officially become a global one. Who knew that struggling home owners in Flint, Michigan facing foreclosure due to ARM resets could impact the financial well being of people living in Seoul, South Korea, so heavily and so quickly? The doom and gloom news is pervasive in the media today and here are some that have really got me worried:

Bailout Failure: U.S. stock futures tumbled Monday as the world's financial crisis didn't appear to be repaired by the $700 billion rescue plan. Since the bailout plan was approved the Dow has dropped more than 6%. So if the bailout plan fails to stem the tide, what is plan B? Do we even have a plan B?

A vicious deflationary cycle is about to ensue: Banks worldwide, stung by $588 billion in write-downs related to toxic assets -- especially mortgage-related securities -- will further reduce the flow of credit, strangling growth. That will push house prices lower, forcing additional losses and making banks even more reluctant to lend. As the credit crisis worsens, businesses will find it almost impossible to raise prices. They will then be forced to close or start laying off employees, which will in turn reduce consumer demand and thus create a vicious downward economic spiral.

Full of doubts, U.S. shoppers cut spending. This will be the final nail in the coffin that is the US economy. Consumers have already cut back spending, and further cutbacks coming into the holiday season (which account for more than 50% of retail sales) will mean big job losses and a deep recession in the new year.

Oil drops below $90 a barrel for the first time since February, and commodity prices plunge the most in 50 years. Normally this would be good news and a time to cheer. Unfortunately this is just a confirmation that global demand is expected to slow and as a result the demand for oil and other commodities is expected to fall dramatically. Commodity rich countries like Canada, Australia and South Africa have seen much sharper falls in their markets and currencies than here in the US.


The Straights Times reports from Singapore:
The United Nations called on Tuesday for tougher regulation of financial markets to deal with the 'crisis of a century' and warned the global policy response risked creating a prolonged deflationary downturn.

Adding its voice to those blaming the free-market model of the United States and Britain for the crisis, the United Nations Conference on Trade and Development (UNCTAD) said considerable public intervention was now needed to avoid greater damage to the financial system or real economy.

'The market-fundamentalist argument against stronger regulation based on the idea that market discipline alone can most efficiently monitor banks' behavior has clearly been discredited by this crisis,' it said in a policy brief.

UNCTAD said the global policy response was confused, with US efforts to revive its economy contrasting with reactive, even contractionary, moves in other big countries.

The European Central Bank was providing liquidity but retained a hawkish monetary stance at a time when fiscal policy remained bound by the EU's stability and growth pact, it said.

Policymakers have failed to grasp the full implications of the acceleration of the US deleveraging process - depreciating toxic assets and reducing debt, the weak dollar and the uncertainty of Americans, it said.

'Such forces can have tremendous negative implications for the world economic outlook as a whole,' UNCTAD said.

The painful effects of unwinding unsustainable debt must be compensated for by a policy stimulus from surplus countries such as Japan and some large Eurozone members reducing their surplus to avoid recession or a depression, it said.

UNCTAD said inflation concerns were misguided.

'The risk of a prolonged downturn or depression is far more important, as the slowdown will further reduce commodity prices... Deflation, not inflation, may actually be the main economic policy challenge,' it said.

Nadeem Walayat writes in the Market Oracle:
Global deleveraging is taking place as financial intuitions are forced to liquidate assets such as property and stocks and bonds to cover losses on huge derivatives positions is intensify as evidenced by the Iceland government instructing their financial institutions to repatriate wealth by liquidating over seas assets in defence of the Icelandic Krona as the country faced bankruptcy.

The Prime Minster of Iceland, Geir Haarde, on Monday warned: "In the perilous situation which exists now on the world's financial markets, providing the banks with a secure life line poses a great risk for the Icelandic nation," Haarde said in a televised address to the nation. "There is a very real danger, fellow citizens, that the Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool and the result could be national bankruptcy."

The more forced selling takes place the lower asset prices fall which triggers even more forced selling as derivatives positions both on exchanges and over the counter which nearly always tend to be on margin of as much as X30 exposure against the the capital deployed are hence either being forced to liquidate positions are meet margin calls. Therefore deleveraging is intensifying as the only way to finance margin payments is by selling assets as the traditional avenues for short-term money are frozen.

This also means that the impact of interest rate cuts will be muted as it will not induce the banks to lend more because they will not have any available funds to lend, nor are able to borrow money from other banks at as the interbank market freeze hits a new extreme where the only source for both liquidity and capital is now from the central banks and governments. Any capital injections will be utilised to cover losses and not be utilised to provide new mortgages or other lending as the banks face a wall of defaults on existing loans.

Britain is facing the the PERFECT STORM of DEFLATION as the housing bear market erodes home owner equity by several thousands of pounds every month, and INFLATION in the input and output prices surging to 20 year highs. This has meant that instead of taking action to save the economy, save the housing market, the Bank of England has been paralysed since April of this year into inaction.The fact is the Bank of England did not have a clue of what to do so sought to do nothing as the situation is far more complex than it appears on face value given the previously hidden fact that most of the banks are bankrupt, insolvent !, its just that no one was going to tell the public until they started to go bust, instead the banks coasted from quarter to quarter announcing ever larger bad debt provisions and calls for government tax payers cash in exchange for near worthless mortgage backed illiquid toxic putrid slime that has to smeared itself right across the whole financial and economic system and brought the UK financial system to the brink of collapse and therefore pushing Britain towards a deep dark stagflationary recession.