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

Federal Reserve Chairman Ben Bernanke warned Tuesday that the financial crisis has not only darkened the country’s current economic performance but also could prolong the pain.

The Fed chief’s more gloomy assessment appeared to open the door wider to an interest rate cut on or before Oct. 28-29, the central bank’s next meeting, to brace the wobbly economy.

Bernanke said the Fed will “need to consider” whether its current stance of holding rates steady “remains appropriate” given the fallout from the worst financial crisis in decades.

WASHINGTON - Calm gave way to fear in financial markets Thursday, turning a relatively steady day into a rout that pushed the Dow Jones industrials below 9,000 for the first time in five years.
Investors, who had begun the day somewhat optimistic that the government was taking extraordinary steps to contain the financial crisis, turned gloomy under an onslaught of worries about the economy and corporations.
On the anniversary of its closing high, the Dow shed more than seven per cent, or almost 700 points, to 8579.19. The Dow has lost 5,585 points, or 39 per cent, since closing at 14,198 a year ago. The S&P 500, which also fell more than seven per cent to 909.92, is off 655 points, or 42 per cent, since recording its high of 1,565.15 a year ago.

President George Bush appeared in the White House rose garden in an attempt to reassure American voters and investors.

"We are a prosperous nation with immense resources and a wide range of tools at our disposal," he said. "Fellow citizens, we can solve this crisis. And we will."

In the month after October 24, 1929, the Dow had lost about 48% of its value. We are seeing losses approaching those of 1929 and a month has not yet passed since "Black Monday" September 15, 2008!

Markets tanked Thursday, extending the Dow's losses over the last seven sessions to 2,271 points, or 20%, as panicked investors ditched stocks across the board.

Bush Calls for Calm Amid Global Stock Market Panic- Reuters

Warning that "anxiety can feed anxiety," U.S. President George W. Bush implored Americans to remain confident on Friday and promised to restore stability in the face of a global stock market panic.

Let’s begin with the fact that the financial crisis is more or less worldwide. The mechanism that spread the American-made financial crisis abroad was the massive US trade deficit. Every year the countries with which the US has trade deficits end up in the aggregate with hundreds of billions of dollars.
Countries don’t put these dollars in a mattress. They invest them. They buy up US companies, real estate, and toll roads. They also purchase US financial assets....

If the US current account was close to balance, the contagion would have lacked a mechanism by which to spread.

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In place of a liquidity problem, I see an over-abundance of debt instruments relative to wealth. A fractional reserve banking system based on fiat money appears to be capable of creating debt instruments faster than an economy can create real wealth. Add in credit card debt, stocks purchased on margin, and leveraged derivatives, and debt is pyramided relative to real assets.

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The explanation of the Great Depression was not known until the 1960s when Milton Friedman and Anna Schwartz published their Monetary History of the United States. Given the stupidity of our leadership and the stupidity of so many of our economists, we may learn what happened to us this year in 2038, three decades from now.