Capitol Hill Blue Forums Political Issues Finance, the economy & Economics How will the financial crisis develop?

...while the current situation can not be adequately compared to that....

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Does the Weatherman Know Which Way the Wind Blows? · · ·

Soros’s Quantum Holding 75% Cash Leads Hedge Funds Baffled by Instability[/b]

World stock markets have fallen after measures announced by the European Central Bank failed to calm fears about the eurozone debt crisis and more weak economic figures from the US fuelled fears of a sharp slowdown.
Stock markets in London, Frankfurt, Milan and Paris closed around 3% lower.

In the US, the Dow was down 511.93 points to 11,384.51 in closing trade, while the S&P 500 lost 4.8% to 1,200.18, while the Nasdaq Composite plunged 5.1% to 2,556.39.

Earlier, borrowing costs for Italy and Spain rose again to more than 6%.
The ECB left its main interest rate unchanged at 1.5% and it bought eurozone government bonds.
President of the ECB Jean Claude Trichet said it will also allow banks access to as much liquidity as they need until at least the end of the year.
European Commission President José Manuel Barroso urged European Union leaders to reinforce their financial defences.
Mr Barroso made his comments in a letter to EU leaders as the debt crisis threatens to engulf Spain and Italy.

[b]He warned that 'it is clear that we are no longer managing a crisis just in the euro-area periphery'.

On June 21, 1948, the currency reform took place:

Erhard also took action to dismantle the rest of the hated command economy, by abolishing most wage and price controls. Erhard acted as if his plan had already received full approval and endorsement by the Allied authorities—-a brilliant bluff that worked.

Erhard’s gamble amounted to blowing up a dam: The blocked productive capacities of the West German economy were able to flow freely again, to find their natural courses, once the crude irrigation system of controls and mandates had been cleared away. The wild flux would be guided by the price system once again and channeled only by the rigors of a strictly guarded money supply. Harsh measures—-with brilliant results, as historians Dennis Bark and David Gress relate:

Productivity leapt up by 30 percent in the following three months—-six times its increase a year before. West Germany would become once more the engine of prosperity for the Continent.

The political squabble in the United States over the federal debt ceiling has ended, but as the past few days have demonstrated, concerns about the health of the U.S. economy, the world’s biggest, have exacerbated, instead of calming down....
According to latest revisions, the U.S. economy shrunk by 0.3 percent in 2008, instead of the previously accepted “zero” growth. The contraction in 2009 was 3.5 percent, not 2.6 percent as estimated before. Throughout a long four years (2007-2010), the GDP contracted by 0.3 percent. Of particular note are the downward revisions for 2010’s last quarter (from 3.1 percent to 2.3 percent) and the first quarter of 2011 (from 1.9 percent to just 0.4 percent).

Evidently, the American economy, to which many other economies depend on, is in a much worse shape than previously thought....Reminding that Washington will be forced to cut spending as part of the debt deal, Dumas says: “This is the fiercest fiscal deflation applied to the U.S. economy since WWII, and comes at a time of zero interest rates when the offsetting impact of monetary policy is unavailable, and of likely sluggish world trade as China irons out its inflation and Europe deflates.”

“The fiscal crisis is further exacerbated by the compression of tax revenues resulting from decline of the real economy,” Michel Chossudovsky says in a recent article. “Unemployed workers do not pay taxes - nor do bankrupt firms. The process is cumulative. The solution to the fiscal crisis becomes the cause of further collapse.” I think this last sentence sums up the dilemma we are witnessing.

the market apparently understands what politicians don't: the debt deal is a death deal for the economy. Reducing government spending by $2.2 trillion over a decade, as Congress just agreed to do, will kill any hopes of economic recovery. We're looking at a double-dip recession....
...that magnitude of spending contraction will result in 1.5 million to 2 million more jobs lost. That's also about all the jobs created since the trough of the recession in June 2009. In other words, the job market will be thrown back two years as well. We're not moving forward. We're moving backward....
The hand-wringing is all about the "debt crisis," but the national debt is not what has stalled the economy, and the crisis was not created by Social Security or Medicare, which are being set up to take the fall. It was created by Wall Street, which has squeezed trillions in bailout money from the government and the taxpayers; and by the military, which has squeezed trillions more for an amorphous and unending "War on Terror."

There is, however, a bubble in the world economy....evidence points to hedge funds as the bubble that has popped....investors are demanding their money back. The debt-ceiling cliffhanger in Washington may have provoked the redemption calls, and the S&P downgrade might provoke more.
But the reason for the downgrades is that hedge funds have crippled out. Hedge funds can't earn the 15%-20% returns they promise investors in a world of 3% bond yields and 2% gross domestic product (GDP) growth. Investors desperate for higher returns, including pension funds, returned to the hedges during 2010 and 2011, and are now suffering spasms of buyers' remorse.
That prompted an across-the-board liquidation of all assets, including commodities and emerging market equities most favored by the hedges. The nearly $2.6 trillion of hedge fund assets constitute the system's only real bubble: too much money chasing too few returns....
They are stampeding to get out.

The last three big drops in the S&P are circled on the chart. All of them occurred when the Equity Risk Premium was negative - that is, when Treasuries offered more yield than stocks. When a safe asset yields more than stocks, investors have to clap their hands and say "I believe in earnings" in order to hold stocks.

In a sign the US economy faces stiff headwinds for at least the next two years, the Federal Reserve’s Open Market Committee, which sets short-term interest-rate policy, said Tuesday that it expects to maintain exceptionally low interest rates through the middle of 2013.
Never in recent history has the Fed specified how long it intends to keep rates low. Apparently, Wall Street received the news with enthusiasm – the Dow Jones Industrial Average soared 429.92 points Tuesday, after dropping 634 points on Monday.
However, the Fed's announcement was accompanied by a somewhat dark assessment of the economy, which it describes as “slower than expected” and as having greater “downside risks” in the future.
The announcement is something of a two-edged sword. With short-term interest rates virtually guaranteed to remain close to zero for two years, companies know they don't need to worry anytime soon about the costs of borrowing. But the Fed, which has a mandate to keep the economy growing, is also sending a message to the unemployed: Don’t expect much improvement in the near future.