The Imperfect Situation

Felix Salmon does a good job of analyzing the illiquidity/insolvency issue. I still believe, though, that the entire situation will turn basically insolvent, simply because there is too much interlocking debt producing illiquidity amidst Deposit Investors. About a year ago, I made some mention of the Stock Market Crash of 1929 being a over-leveraged Market failing because of Market Calls (at least I think I did). The Situation today does not directly threaten the Stock Market, because the leverage was not carried by the Market, but by financial institutions who had no business leveraging non-Collateral loans. The problem of illiquidity comes from legitimate business lacking Operating Capital through financial institutions being caught short of Cash.

Understand that Production potential still remains because Consumption Demand holds relatively constant. How long this Condition will hold force depends on the ability of financial institutions to clear up this mess. Another Problem arises in that Government has little ability to intervene, as the Treasury would have to issue greater Note issuances to capitalize Government contracts, and Fed purchase of Treasuries would raise their Pricing as Domestic Demand has rejoined foreign subscription. A recent appearance of EU subscription of American bad paper may seem like a panacea, but repayment of this debt is mandatory–else EU will be drawn into the illiquidity trap; while the delay of the Crunch will lead to inefficient clearing by American financial institutions. Inadequate clearing of the bad debt is the true threat to the Economy, and delays in that process will adversely affect the Production cycle. lgl