RCM Comment – Gary Rosenthal:

Examine the Total Credit Market Debt vs. GDP chart below and you will quickly realize why all of the government’s bailout programs are paper tigers and are destined to miss their intended mark by a wide margin. The credit collapse of 1929-30 did not hit bottom until the early 1950s. The strong U.S. economic expansion from the early 1980s until recently was driven by an extraordinary rapid climb in the amount of debt per dollar of GDP. At its peak in 2008 total debt per dollar of GDP was dramatically higher than the peak of 1929-30. In a single snapshot you can see that the U.S. consumer has completely lost his credit worthiness at a time when the banking system has regained its sanity and adopted lending standards not seen since the 1950s and ’60s. In short, until U.S. consumers substantially repair their balance sheets (through savings or bankruptcy) consumer expenditures (and in turn the U.S economy) are likely to be on a downward spiral for an extended period of time no matter what the government tries to do. No amount of government spending will offset the vicious cycle of a collapse in consumer spending and rising unemployment.

The government’s misguided Keynesian answer to declining tax revenues is sharply accelerated spending, unprecedented budget deficits and borrowing and higher taxes. Common sense would tell you that something is completely out of whack with this formula. Who would lend money indefinitely to a government who has completely lost control of fiscal responsibility? The answer is that eventually no one. Thus this program of uncommon sense will eventually be largely funded by the printing press until the U.S Dollar loses its role as a reserve currency with our trading partners. How long will it take the Dollar to lose its place in international finance is anybody’s guess, but the next time gold goes through $1000/ounce it is very unlikely to come back.

MISH’S Global EconomicTrend Analysis:

The chart below from Ned Davis illustrates the real problem: An explosion of debt relative to GDP. In Geithner’s plan, this debt won’t disappear. It will just be passed from banks to taxpayers, where it will sit until the government finally admits that a major portion of it will never be paid back.

Total Credit Market Debt vs. GDP

The above chart is similar to those detailed in Fiat World Mathematical Model. Here is the ending snip on psychology that is at the heart of the matter.

Political Will vs. Consumer Psychology

What happens next depends somewhat on the political will of the central banks and politicians. However, it depends more on the psychology of the borrowers. If consumers and businesses refuse to spend and instead pay back debts (or default on them along with rising unemployment), the picture simply is not inflationary, at least to any significant decree.

The credit bubble that just popped exceeded that preceding the great depression, not just in the US but worldwide. Thus, it is unrealistic to expect the deflationary bust to be anything other than the biggest bust in history. Those looking for hyperinflation or even strong inflation in light of the above, are simply looking at the wrong model.

At some point the market value of credit will start expanding again, but that is likely further down the road, and weaker in scope than most think.
Henry Blodget’s Five Misconceptions are another way of looking at the psychology of the situation. The sad reality is that both Geithner and Bernanke are trapped in academic wonderland with failed models about what happened in the Great Depression and why.

Geithner said “Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.” I agree. Unfortunately, Geithner’s solution is to Zombify the taxpayer instead. What needs to happen is for banks to write off the bad debts. The Fed pleaded with Japan to do just that. Now Bernanke and Geithner refuse to follow that advice.

Bear in mind this insanity is just round 1. When it does not spur lending for reasons stated above, Geithner will be back at it begging for more taxpayer funds to bailout the banks. By the way, is this even legal? Offering no collateral loans is a handout. Many on the Fed, including Bernanke have stated the Fed can provide liquidity not capital. What is a no-recourse loan but capital? Of course the Fed is offering these guarantees via the FDIC.