Although the U.S. Government has thrown an estimated $8.5 trillion so far into bailout measures and credit stimulus, this huge sum has yet to produce even a mote of tangible success. The goal for nearly two years has been to stabilize home values, but instead they have continued to fall.  Policymakers and economists must be perplexed by this, even if beleaguered homeowners are not.  Maybe the latter have remained gimlet-eyed because they’ve received only bailout crumbs to date. Whatever the case, at a time when households have become properly obsessed with repairing their balance sheets, who could blame them for being suspicious of Big Government’s so far fruitless collusion with the corrupt likes of J.P. Morgan and Goldman Sachs?

Even so, a government rescue of individual homeowners cannot be ruled out. Our friend Jim Willy of GoldenJackass.com thinks it’s inevitable, and he expects the Government to attempt it in 2009 by way of a new Resolution Trust Corp that would put a floor under home prices. The agency would channel enough printing-press money to lenders to allow them to write down mortgage receivables significantly.  We’ll concede that such a plan might extricate homeowners from an otherwise bottomless hell-hole of deflation. However, we do not see the enactment of such a plan as inevitable, since letting homeowners off the hook with an ocean of printing press money would simultaneously wipe out lenders on the other side of the mortgage equation.

On that day, bond markets would collapse along with the dollar, and only hoarders of physical bullion would likely escape ruin.  On that last point, we agree completely with Jim. But there is one point on which we disagree – i.e., the matter of whether the global financial system is experiencing deflation, or, rather, what Jim calls “liquidation.” He sees liquidation as part of a process leading inevitably to hyperinflation; we see liquidation as the essence of deflation itself. If we are right, deflation has become too powerful to arrest and will run its course no matter what countervailing tactics are tried. The only alternative scenario we can imagine would have the Government assume virtually all debts, public and private, and then monetize them directly via unlimited Fed purchases of Treasury bonds, bills and notes.  Although that would lift the burden of debt from homeowners with skip-and-go-naked finality, it would also gut savers and lenders for a generation, along with their institutional conduits, most crucially the bond markets.

$4 Trillion Stop-Gap

Under the circumstances, Jim’s RTC II would seem to offer no more than a stop-gap against deflation. He estimates that as much as $3 trillion to $4 trillion of printing press money would be needed to arrest the real estate market’s collapse, but we doubt that even twice that sum would do the trick.  At peak values, U.S. homes in 2007 were “worth” perhaps $20 trillion (click here for the source of that estimate),  and it would arguably require write-downs of at least half that, or $10 trillion, to even temporarily stabilize home prices. But just how much stability could we expect that to buy in the context of a global deflation that has already sucked perhaps five to ten times that amount – including more than $40 trillion in stock-market valuations -- from assets other than real estate?

No question, homeowners would breathe a sigh of relief if their mortgage debt and monthly payments were halved. But keep in mind that whatever positive impact that might imaginably have on the real economy – i.e., on capital investment – it would be negated by the corresponding ruination of savers and lenders, of the U.S. currency system, of the banks and the bond markets.

Bottom line, the deflation that Jim Willy would treat dismissively is in fact many orders of magnitude larger than any inflationary countermeasures our political leaders are likely to attempt.  In the end, nothing short of outright and deliberate hyperinflation will reverse the deflationary tide.  Obama the Populist might risk it, but surely he knows what each of us knows even now -- that there is no chance that a hyperinflationary settlement of debt would put the economy quickly on the road to sustainable recovery. Better times would come eventually, as they always do, but destroying the dollar would likely set the process back by at least a decade, and perhaps by as much as a generation.

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-- Posted Monday, 29 December 2008 | Digg This Article