The financial system is undergoing a period of deleveraging that cannot be stopped. For example:
- Barrons is running an editorial entitled “The Crash Must Come: Intervention can’t stop the business cycle”.
- The Economist writes, “Once started, the process [of deleveraging] is hard to stop.”
- The Financial Times quotes the Bank of Tokyo-Mitsubishi in saying, “There seems little what the authorities can do to reverse the process of deleveraging that is taking place with financial institutions all contracting their balance sheets at the same time”.
- Satyajit Das writes:
Ultimately, “all the king’s horses and king’s men” cannot prevent the de-leveraging of the financial system under way.
Like a giant forest fire the de-leveraging process cannot be extinguished. Thoughtful actions can create firebreaks that limit preventable damage to the economy and the international financial system until the fire burns itself out.
The process of deleveraging cannot be stopped, but the government is trying to stop it anyway. Instead of allowing an orderly deleveraging process, the government is actually trying to prop up the leverage.
For example, instead of requiring banks to deleverage, the government is reducing their cash reserve requirements so they can increase their leverage to loan money they don’t have through fractional reserve banking. See also this.
And – even after Greenspan confessed that derivatives were dangerous (and see this) – the government refuses to rescind them or take any other real actions to contain the nuclear fallout from such “weapons of mass destruction“. Instead, the government is trying to prop up the derivatives market by various means.
By trying to put out the raging deleveraging forest fire, the government is actually fanning its flames and making it more dangerous. And even in those areas where the government appeared to put out the fire, there are hot coals just beneath the surface that are already erupting back into flame (as just one example, inter-bank lending rates are back up).
Instead of clearing out the flammable debris which could ignite next, the government is letting it accumulate . . . a recipe for another financial crisis.
As with other aspects of the government’s actions, the attempt to stop the inevitable deleveraging process is only making matters worse.