The Root Cause
October 4th, 2008 by 
reality
How did we get here, and how do we get out? In my view, the root problem was the Bank of Japan’s response to the collapse of its property bubble in the early 1990s. Just as the Fed is starting to do, the BoJ flooded the banks with yen, driving interest rates to zero. The excess liquidity wasn’t absorbable in Japan, so it spilled overseas as the so-called “carry trades” allowed hedge funds and others to borrow yen and swap them into dollars for a total cost of 1% or so. This cheap, easy money drove the demand for securitized debt, which Wall Street was only too willing to supply - for a fee - and Alan Greenspan went along with the plan.
Greenspan’s attempts to manage the economy through the resulting bubbles with, as James Grant says,”Low interest rates, easy money and malleable accounting rules” aggravated the situation. And now we are getting more of the same. It won’t work.
In order to recover, we need to get interest rates back up to the point where they encourage capital formation and provide a substantial return to lenders and investors. We are losing capital. If we want more, then the price has to go up. And that includes the BoJ.
Posted in Fixed Income, International, James Grant, Manias, Rogues and Rascals, Strategy & Scenarios | 
October 4th, 2008 at 11:48 am
If society allows debasement of money, is it a “monetary” problem, or it is a problem with fundamental organization of society?
Blind tolerance of (political and economic) power concentration? Erosion of freedoms? Erosion of private ownership, income taxes?
It is not a society, it is a thong of behaviorally conditioned animals. Live cattle, freely traded on world financial exchanges.
Real money and normal interest rates, and normal behavior, and normal attitude to freedoms of course would be helpful. Only who needs all this?
Sorry for dark mood. Tired of domestic pre-election (to Lithuanian parlament) political absurdity overload, messed with no-need-to-panic, we-are-safe, our-banking-is-strong, there-is-no-crisis official demagogy.
You know, what can be wrong ourdays with commodity and energy importing economy with fixed (to Euro) currency rate and ~17% current account deficit?
October 5th, 2008 at 3:31 pm
I pretty much agree with you that we need to discourage new debt and get interest rates back to historical norms.
However, I’m pretty sure the gov’t is not on the same page. So, I am left to predict reality, and invest accordingly.
I predict the gov’t will borrow more to bail out. Then when interest rates increase because we are issuing so much debt, print $ to pay off the debt. The median income is $50,000, the median house should cost about $150,000.
By bailing out and printing $, things will cost more than what they should be. However, wages will pretty much stay flat - especially with a poor economy.
I believe the most likely financial reality will be significant stagflation; most likely worse than that late 70s.
The $64,000 question is - what’s the best investment strategy for stagflation? Buy 3 years worth of canned food, pay off the house, keep the rest in T bills and wait?