Tuesday, February 10, 2009

A Review

As I have done some review on your posts and my previous posts, I will not stand as firm as before about the USD and UST positions.

Yet how will the future trend is going is still subject to various "parallel futures".
Instead of doing simple projection, I guess we had better first review what had happened so far and what the government measures are attempting to do. Then maybe we can work out some possible scenarios on how people will respond.

Property cycle was the final straw on the camel's back; nevertheless, property cycle has appeared over decades and never has it be as destructive as the current time. The key issues, I persume, are as follows:
1. Fiat Money system;
2. The incomplete mobility of labour, money, information, and material;
3. Book value accounting system;
4. Risk spreading tools;
5. Prolonged loose interest rate.

All these combined together allows a country to print money without risking inflation as well as substantial depreciation of asset. As long as there are buyers, and as long as
the "lies" can continue, then there will be no problems.

But the realistic world will always tell the final truth eventually. Re-settlement occurs.

Once the accounting principle changes to mark-to-market, people will find that the lies cannot continue. It will trigger the distrust on various tools, including the risk spreading ones. Hence, it will trigger another cycle of depreciation. Cost of capital, despite the government efforts on manipulation, will be in fact risen in accordance with the new risk evaluation. Without further money as fuel, economy will slow down and even recess. Without free flow of labour, money, information and material, equilibrium cannot be reached. The cost paid for maintaining the imbalance will reflect eventually on the fiat money.

Now most of the government measures attempt to
1. Lower the cost of capital,
2. Re-installinig the risk spreading model,
3. Continuing the lies.so as to continue the old system. In other words, none of them are trying to create new value (and hence bring "real" increase on GDP).

However, the trick is hard to continue because risk spreading tools are no longer be trusted. Risk evaluation re-settled at the reasonable level. As a result:
1. Banks are unwilling to loan to both individuals and business;
2. Individuals are unwilling to purchase and particularly purchase on loans;
3. Companies are unwilling to expand and face difficulties on maintaining cash flow.

Under such situation, in order to complete the goal, government can only
1. Force the banks to do loans (by taking over, by providing incentives like guarantee and free money),
2. Force people to consume (by punishing deposit, by providing coupons, by providing more social welfare, by providing coverage on mortgages, and by providing jobs through infra-structural projects).

But each of those can lead to the following possibilities:
1. For the bank parts, it can either lead to
a. no actual increase on loans to direct customers but use the cheap money for buying back some on-the-book safe assets like treasuries and bonds. But the actual rsk is not as low as those tools persume. It will not benefit individuals and enterprises, and in the long term it will put the bank assets at risk.
b. increases on loans due to orders. But meanwhile bad debt will also increase because of loosen standards. Due to unclear vision on the future, the borrowed money will be used on maintaining current business, paying off debts, and short-term speculation. None of them will benefit the economy, and will initiate another wave of first inflation and then bubble burst.

2. For the individual parts, it can
a. save the money for themselves and use the benefit. Consumption cannot be enhanced.
b. use the money for short-term speculation due to unclear vision.

From both situations, the most important part is the vision to the future. Without a clear expectation on the future, any financial stimuli will not result in enhancement on both productions and consumptions. It will further worsen the already unfair wealth distribution as well as the lack of circulating money. Or, it will circulate to short-term projects or government designated projects: both of them will result in first inflation (or even hyper-inflation) and then burst of bubble.

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