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This might be the turning point in the global financial crisis, when bold action puts us on the road to recovery

8 August 2011

This could be the turning point in the global financial crisis (GFC) that began in Fall 2008.  Much like the August, when Mexico’s financial crisis (the climax of the long Latin American debt crisis) forced the Federal Reserve to loosen monetary policy, igniting the long disinflationary growth period that ran (with two light interruptions) until 2007.

We might see this soon on a global scale if a market firestorm forces the major Central Banks into large-scale and coordinated action to stabilize the world economy.  A change of policy in the ECB would be necessary, as it’s current policy is an incoherent mixture of tight and loose.

If governments remain paralyzed, or attempt to cope individually with a global event, then we might see ugly results.  (later addition:  Not good to start a recession with weak household balance sheets and 9%+ unemployment).

There will be people cheering for us to lose, advocating inaction with confident assurances that nothing can be done.  Let’s hope our leaders do not listen to them.  Schumpeter was wrong when he said that “A depression is for capitalism like a good, cold douche.”  (Douche in German means “shower”, but it is still bad advice.)

To see the full coverage of the GFC, go to the FM Reference Page Financial crisis – what’s happening? how will this end?

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7 Comments leave one →
  1. 8 August 2011 12:14 pm

    For anyone who might like to know exactly what the FED is, and what they state they do, it might be worthwhile to read this post, which is from their own words, and straight from the horses mouth: {edit: The Federal Reserve System: Purposes and Functions.
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    FM reply: Yes, like most Fed publications this is clear and well-written.

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  2. Pluto permalink
    8 August 2011 4:41 pm

    The Milpub is having this same discussion right now. They are not yet as hopeful as Fabius Maximus. They (and I) feel that the government will only deal rationally with the crisis after every single bit of political advantage has been milked from the occasion. Given the current circumstances, that’s going to take a while.

    I would also add that numerous pet economic theories (such as US government tax cuts predictably stimulate the US economy) will also need to be popped (probably repeatedly) by hard cold reality. FM speeds this process by continually reminding us that our economy doesn’t necessarily work the way we wish it did.
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    FM reply: During the past two months I re-read the FM website. I was right on an astonishingly wide range of subjects — accompanied by comments ranging from disagreement to catcalls. But I was wrong about the most important subject. I was too optimistic about the politicaly deterioration of America.

    So the people at Milpub might be correct about their a dark forecasts, probably more dark than they realize. Most of the people I’ve read making such forecasts I’ve seen have no idea about the possible consequences of continued deterioration.

    My guess is that the economic outcomes will be better than those folks expect. But he political changes ahead will be worse than they expect. Perhaps much worse. This will be one of the major topics of the FM website during the coming weeks.

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  3. 8 August 2011 4:49 pm

    FM: “A change of policy in the ECB would be necessary, as it’s current policy is an incoherent mixture of tight and loose.”

    In your view what would that change look like?
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    FM reply: They have to decide what Europe should become when it grows up. They can stay a group of small nations, or unite to become a great power. They are at a fork in the road. Steering a middle course hits the tree in the “Y”, guaranteed disaster.

    Staying together would mean massive aid programs to the PIIGS (most of which have already made most of the necessary reforms), combined with EU assumption of policy control over those “states” who have totally mismanaged themselves (e.g., Greece). The current policy of imposing EU tight money, with austerity plus aid to the PIIGS — just pushes those areas further under water. It is guaranteed to fail.

    Staying together would be making the case for doing so to their people and obtaining their consent, rather than attempting to unify on the sly. That course has failed, and IMO was never feasible.

    Strong leadership might bring them together, fulfilling a dream on which Europes elites have worked since WWII. If not, they can break up. Both paths are doable; both involve pain and effort. Note that effective unification on the scale required came to the US only through the Civil War, and to France through the Revolution.

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  4. 9 August 2011 4:10 am

    FM offered: “Staying together would be making the case for doing so to their people and obtaining their consent, rather than attempting to unify on the sly. That course has failed, and IMO was never feasible. Strong leadership might bring them together, fulfilling a dream on which Europes elites have worked since WWII”

    Very similar (and most of what you offer, too) to what I hear from elder French and Dutch friends. They call it a failure of the Demogogues but possible never the less due to strong popular desire since the end of WWII.
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    FM reply: Thank you for this information!

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  5. Matt D permalink
    10 August 2011 10:56 am

    What sort of action are you seeking from the Fed and other central banks? Interest rates are already low.
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    FM reply: That’s a great question. But I’m out of time to reply; I will try to get back to this later in the week. Three quick points:
    * Rates are only one tool in the arsenal of central banks.
    * The ECB cannot take bolder steps without authorization from Europe’s elected officials. It’s foremost a political issue, not a technical one.
    * To oversimplfy, current ECB policy is tight monetary policy (suitable for Germany) plus aid to the PIIGS. This combo will almost certainly fail.

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  6. jay howard permalink
    18 November 2011 4:33 pm

    Now it is November. As the above poster stated, austerity and tight monetary policy will fail. The only way to get out of the mess in Europe is to first default, and secondly, for the member countries to federalize. The US has many problems but the requirement of the states to balance their budget is a huge part of our strength. The EU allows member states to run up to 3 percent deficits. Even this is unacceptable. As long as any deficits are run, the ultimate result is what we see in Greece. As a federal entity, deficits can be run and money doled to the member countries/states, but not each one separately running deficits. Europe has not come to grips with the fact that they are no longer sovereign nations. They will not in time either. The Euro will break up and you will see Germany partner with Russia as the rest flails around helplessly, ultimately turning to the US or China for help. Sadly, the US is in no position to help anyone. As Brent Skowcroft said “As a result of the policies of the Bush Administration the United States can’t even fight a war that lasted just 3 days without borrowing the money from China.”

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    • 18 November 2011 5:44 pm

      I do not agree with the overall framing of this.

      “Europe has not come to grips with the fact that they are no longer sovereign nations.”

      What is the authority for this belief? Can you point to national referenda? Votes by the national legislatures? They agreed to certain forms of collective policy-making, but none of the Treatys creating the current mongrel-like structure ceded sovereignty by member nations.

      Nor is there anything in the current global structure that makes small nations dysfunctional, especially within common trade federations.

      European unification offers many advantages. But they still have a choice.

      Like

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