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Sunday October 5, 2008 1:27 am

Big Trouble in Little Washington

According to President Bush this bailout is a good deal for Main Street.  He assures us that the tax dollars invested will pay for themselves and then some.  Oh really?  That’s the definition of a good investment. Well, if this is such a good investment why aren’t private investors rushing in to snap up these assets and companies at bargain prices?  Hint: Because they aren’t good investments!

Adding the $700 billion to the rest of the actions taken recently (Bear Stearns, AIG, Fannie Mae and Freddie Mac, FHA rescue bill, and the rest) the total balloons to a whopping $1.8 trillion, and counting!  Where is this money coming from?  Unfortunately for us, it’s coming out of thin air!  Anytime the government spends more than it receives in tax revenue, they engage in deficit spending. This is accomplished by the Treasury Department auctioning Treasury Securities on the open market. These are the same securities that China has purchased to the tune of $2.2 trillion. With me so far?

The new securities being auctioned have exactly the same result as the printing of new money; it’s the inflation of the money supply pure and simple.  Under normal circumstances, these securities are purchased by investors, both foreign and domestic, but in this case, they are being swapped for stock and the Mortgage Backed Securities that are now next to worthless.  When there are more dollars in circulation trading for the same amount of goods and services what happens?  That’s right, prices rise. Anytime new money is created, the first receivers of that new money enjoy the benefits of spending it at the dollar’s current value. By the time that new money makes it way through the economy, the dollar’s value has decreased. Are you a first receiver of ANY of this money?  Nope, me either!

The goal of all of this bailing is to stabilize credit markets.  What the heck does that mean?  It means that the Federal Government wants to re-capitalize (filling the coffers up again) the lending industry so they can resume lending money.  This will only make the problem worse!  What happens when banks loan money?  Here’s how it works.  Let’s say you deposit $1000 dollars (a short term deposit) in the bank. The bank can now take that money and loan a portion of it to another bank customer. Let’s say they extended an $800 loan to another customer who then deposits those funds in the same bank.  You know have two accounts, one for $1000, and one for $800. Two people now claim ownership of the same $800 dollars.  This is how the fractional reserve banking system works, and this credit expansion inflates the supply of money still further, in this example, to the tune of $800 dollars.

Unfortunately, it doesn’t stop there; the bank can then loan out a portion of the second customer’s $800 deposit, and so on and so forth.  This is why bank runs kill banks, they don’t have the money! In a fractional reserve system banks can increase deposits by up to %1000 through credit expansion.

The increase in the money supply by the Federal Government and the further expansion of credit by the banking industry will produce inflation on a scale we haven’t seen for quite some time.  The market needed to make corrections after the bubble burst, and it was doing just that. Stocks, companies, assets (including homes) that were overvalued began to adjust. This was a necessary correction.  The Government wants to reverse this correction and prop up overvalued assets and failed ventures with new money.  This will turn a short term (yet still painful correction) into a decade (or more) long mess.  Be prepared to suffer sticker shock on a continuous basis for the foreseeable future.  The only viable option to this crisis was to do nothing.

Once the again the Government is catering to F.O.G.’s, no that’s not Frick’n Old Guys, it’s Friends of Government!

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