If the banks go into survival mode they will (and in fact are) pulling money out of the commercial paper market. If the commercial paper market dies, then you will start seen a huge number of companies starting to fall from the skies.

Companies have gotten into the habit of borrowing short term to fund long term expenses. If you can get money at 1-2% with a 30-day loan, you aren’t going to borrow money at 6-7% with a 30-year bond. The theory is that as one loan expires you can borrow more money and rollover the short term loan. This all works….

Until you run into a situation in which no one is willing to loan money at any price. At which point companies suddenly go broke. And then the credit-default swap bomb goes off, because when a company goes under, then all of a sudden billions of dollars of payments are triggered….

Right now banks are not lending and the *only* thing that is keeping the short term credit markets from collapse are massive purchases by central banks. They are going to run out of money in about a week or two. If you can’t get the credit markets to start lending, then you are going to see massive corporate bankruptcies and defaults when they are unable to rollover their short term financing. The world economy is going to shut down.

We are in the financial equivalent of the “Cuban missile crisis” where one wrong move and the whole financial system blows up. No one right now is thinking more than one or two months ahead because if we don’t get through the next few days, it doesn’t matter.

The financial system is in the process of crashing and the reason for bailout package is to make sure that there is this huge $700 billion pile of feathers to absorb the impact of what is about to happen. Everything you’ve seen, that’s just a prelude. It’s going to get a lot worse.

The good news is that something is going to get done, and we’re probably going to make it through all of this…. I’m a little surprised and amazed that we’ve gotten to this point in one piece.

So I’m an optimist.

Thank you for your welcome back comment and for sharing with me your posting about my writing. Too bad you didn’t mention our book when you were criticizing it. Trading Away Our Future is readily available (see http://www.idealtaxes.com ).

Some day, you will have to reread Adam Smith to find out what he is really saying about mercantilism. He is saying that mercantilism hurts the world economy as a whole. To him, mercantilism was the concept that accumulating gold should be the goal of economic policy. He was advocating, instead, that the wealth of a nation is its production, not its stock of gold.

You should also look at what Hume actually argued. He said that an inflow of gold drives up prices in the surplus country and drives prices down in the deficit country which tends to correct the trade imbalance.

Hume was correct about the mercantilism of his day, but did not anticipate modern mercantilism. In fact, if the goal of the gold mercantilists were to build their industry (not their gold hoards), they could have practiced the same system that the modern mercantilists practice today by using the gold obtained from trade to buy assets in the trade deficit country.

It’s also too bad you haven’t yet checked Peking University Heng-Fu Zou’s 1997 mathematical treatment of mercantilism, “Dynamic Analysis of the Vineer Model of Mercantilism” (Journal of International Money and Finance). So you would have realized that your consumption argument was a short-term argument. Indeed, Chinese mercantilism enhances present US consumption, and reduces present Chinese consumption. But Zou demonstrated mathematically that the modern form of mercantilism results in long-term gain in consumption for the practicing country, even though in the short run it has less consumption.

The huge factor that you missed entirely in your analysis is the effect of mercantilism upon investment opportunities in the practicing country and the victim country. By holding its exchange rate approximately 40% below where it should be, China makes its products 40% less expensive to American consumers and American products 40% more expensive to Chinese consumers. As a result China gets investment while the United States does not, making Chinese products even less expensive to American consumers, compared to American products.

Seeing as the current US investment slump is causing our economy to go into economic stagnation with the definite possibility of an economic talespin, you really should look into the factors that are causing it.

Howard Richman
http://www.tradeandtaxes.blogspot.com

If this passes, I think I will move to China. Seriously.

“The Fed can always print money on a grand scale. But if it does this, the international funding that the US needs will stop. Thus, the Fed is limited in a very real way. And it is burning through its current balance sheet at a terribly fast pace. As Brad Setser says… […]”

Whatever the Fed’s balance sheet may show today, absconding with untold billions via a massive disinformation campaign/putsch will not remotely resolve the problem. Why? Because the problem exists at the heart of the global fiat based money system that relies on growth that is no longer possible in a world of finite resources.

I submit that what we are witnessing now is a secular change of epic size. Peak debt, the death of which we are currently witnessing came about as a way to make something from nothing. It is no accident that the reach for outsized yield that is at the heart of the advent of all the lethal financial instruments of mass destruction came about after this nation was stripped of its industrial base.

The global Great Depression, which will be the greatest experienced by mankind post enlightenment, is underway and the U.S., particularly Wall Street, is the epicenter of the initial quake. This bailout, as obscene as it is, one perpetrated by rubes and criminals and abetted by cowering fools has as much chance of arresting the onset of the well underway U.S. economic contraction as a one legged pygmy does of bringing down a rogue elephant with a bent thumbtack.

The banks will have the money after the TARP buys their crud. In theory, the banks could spend the proceeds on more crud in an attempt to earn a higher return, but I think that the US authorities would take a dim view of such behaviour!