Another 350 billion - Doing it wrong again

Yves Smith highlights Martin Wolf's article on the stimulus, which completely demolishes Obama's plan. Wolf Versus Pettis on US Stimulus, Fiscal Deficit (Not for the Fainthearted)

First, there must be a credible programme for what Americans call “deleveraging”. The US cannot afford years of painful debt reduction in the private sector – a process that has still barely begun. The alternative is forced writedowns of bad assets in the financial sector and either more fiscal recapitalisation or debt-for-equity swaps. It also means the mass bankruptcy of insolvent households and forced writedowns of mortgages.

All this would also lead to big one-off increases in public debt. But those increases would probably be much smaller than those generated by a decade of huge fiscal deficits. The aim is to have a slimmer and better-capitalised financial system and a healthier non-financial private-sector balance sheet, sooner rather than later. The troubled asset relief programme should be used for these purposes. It will need to be bigger.

Second and most important, the structural current account deficit has to diminish. The US private sector is no longer in a position to run huge financial deficits as an offset to the demand-draining external deficits. The public sector can do so only for a few years. In the long run, the world economy must be sustainably and healthily rebalanced. This is a huge challenge for international economic diplomacy. It is also an essential element of sound domestic policy. . . .

Smith really sums it up well:

The US has not been willing to inflict pain on lenders and investors, even though over-their-heads borrowers will go bust and deliver losses. But too many holders of the paper seem to derive false comfort from having the losses show up a tad later than they would anyhow.

And Stirling Newberry sums it up this way:

With Bernanke talking again about having the Fed sponge up toxic waste, and needing a Federal fund to do that, and Obama issuing his first veto threat over the next round of TARP money, it seems likely that we are going to do things wrong one more time.


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