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That was an important post by WiseBear, because it illustrates the seriousness of the current turmoil, and how it will remain prevalent in the near/medium future.

Unless liquidity and confidence improves soon then the Central Banks will be forced to cut rates and leave them low. They will have no choice, they HAVE to keep the financial markets running effectively. Currency concerns and inflation will no longer be major issues.

The question then remains: will this work?

IMO, there will be an initial large bounce in the equity markets, and the usual suspects on CNBC and Bloomberg will claim vindication.

But, will the commercial Banks be prepared to lend again to high-risk funds/institutions/hedge managers? That is the trillion dollar question.

If this monetary policy instituted by the Central Banks fails to work then economic growth will grind to a halt, all liquidity will disappear and financial markets will fail to work. Investment banks and hedge funds will fail in spectacular style, and the global economy will enter a long period of stagnation.

This correction is necessary - even the institutions know this - but has the debt boom gone too far for interventionist monetary policy to work?

We will see, but it will take months, not weeks, before it fully plays out.

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That was an important post by WiseBear, because it illustrates the seriousness of the current turmoil, and how it will remain prevalent in the near/medium future.

Unless liquidity and confidence improves soon then the Central Banks will be forced to cut rates and leave them low. They will have no choice, they HAVE to keep the financial markets running effectively. Currency concerns and inflation will no longer be major issues.

The question then remains: will this work?

IMO, there will be an initial large bounce in the equity markets, and the usual suspects on CNBC and Bloomberg will claim vindication.

But, will the commercial Banks be prepared to lend again to high-risk funds/institutions/hedge managers? That is the trillion dollar question.

If this monetary policy instituted by the Central Banks fails to work then economic growth will grind to a halt, all liquidity will disappear and financial markets will fail to work. Investment banks and hedge funds will fail in spectacular style, and the global economy will enter a long period of stagnation.

This correction is necessary - even the institutions know this - but has the debt boom gone too far for interventionist monetary policy to work?

We will see, but it will take months, not weeks, before it fully plays out.

Good post.. and welcome BTW :)

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That was an important post by WiseBear, because it illustrates the seriousness of the current turmoil, and how it will remain prevalent in the near/medium future.

Unless liquidity and confidence improves soon then the Central Banks will be forced to cut rates and leave them low. They will have no choice, they HAVE to keep the financial markets running effectively. Currency concerns and inflation will no longer be major issues.

The question then remains: will this work?

IMO, there will be an initial large bounce in the equity markets, and the usual suspects on CNBC and Bloomberg will claim vindication.

But, will the commercial Banks be prepared to lend again to high-risk funds/institutions/hedge managers? That is the trillion dollar question.

If this monetary policy instituted by the Central Banks fails to work then economic growth will grind to a halt, all liquidity will disappear and financial markets will fail to work. Investment banks and hedge funds will fail in spectacular style, and the global economy will enter a long period of stagnation.

This correction is necessary - even the institutions know this - but has the debt boom gone too far for interventionist monetary policy to work?

We will see, but it will take months, not weeks, before it fully plays out.

What will happen of the BOE sits back and does nothing, which seems to be the stance it wants to take?

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What will happen of the BOE sits back and does nothing, which seems to be the stance it wants to take?

The Central Banks are sitting back at the moment as they are (desperately) hoping that the Commercial lenders and borrowers will achieve some stability, and that liquidity is restored to the markets.

It won't happen, the "fear and revulsion" in the debt market is too high.

At the moment, the Central Banks consider it someone else's problem. If the market stops functioning, it becomes their problem. Forget any stated mandates or policy aims.

The Fed, ECB will then cut rates - hard. The BoE will have to follow. No options left. There is plenty of scope for downward movement of IR's. What else can they do?

Then it will be down to a handful of Risk Assessors at the big Commercial Banks. They will advise at board level whether to resume lending to the debt and derivatives market.

If they decide the risk is too high, all bets are off. Traditional monetary policy/theory will have failed, and the financial markets will be in new territory.

All IMHO of course.

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It's odd that central banks would reduce IRs - although I can see exactly why they might see it as their only option. But the whole crisis is tied to debt built on cheap IRs and lending. Wouldn't reducing IRs be like trying to put out a fire by pouring petrol on it?

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Then it will be down to a handful of Risk Assessors at the big Commercial Banks. They will advise at board level whether to resume lending to the debt and derivatives market.

If they decide the risk is too high, all bets are off. Traditional monetary policy/theory will have failed, and the financial markets will be in new territory.

All IMHO of course.

If they decide risk is too high, what would be the effect of this?

There is a lot of news out there about this but little information about the possible outcomes

Edited by madasafrog

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Liquidity trap and a resulting asset-driven deflation, in all likelihood. 90's Japan.

OK thanks for that. For someone who has limited experience in this, could you explain more (no jokes about crayons or pictures ;) )

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The Central Banks are sitting back at the moment as they are (desperately) hoping that the Commercial lenders and borrowers will achieve some stability, and that liquidity is restored to the markets.

It won't happen, the "fear and revulsion" in the debt market is too high.

At the moment, the Central Banks consider it someone else's problem. If the market stops functioning, it becomes their problem. Forget any stated mandates or policy aims.

The Fed, ECB will then cut rates - hard. The BoE will have to follow. No options left. There is plenty of scope for downward movement of IR's. What else can they do?

Then it will be down to a handful of Risk Assessors at the big Commercial Banks. They will advise at board level whether to resume lending to the debt and derivatives market.

If they decide the risk is too high, all bets are off. Traditional monetary policy/theory will have failed, and the financial markets will be in new territory.

All IMHO of course.

I've always said it's a political decision as to whether this ends in deflation or hyperinflation but it appears I'm wrong.

The power is with the banks' risk assessors and board.

The next is what would they prefer?

Hyperinflation makes all paper assets worthless but you get to keep your property while deflation makes cash king.

I think the bankers would prefer deflation as they ultimately create and control the money supply.

Either way it's going to be one hell of a crash!

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It's odd that central banks would reduce IRs - although I can see exactly why they might see it as their only option. But the whole crisis is tied to debt built on cheap IRs and lending. Wouldn't reducing IRs be like trying to put out a fire by pouring petrol on it?

The central banks now want to get "bad" debt out of the system. That is why they will not step in and bail out the sub-prime lenders and highly-leveraged hedge funds.

"Bad" financial practises (such as CDOs, ABS, MBS, and other "dodgy" commercial paper) must be seen to be "bad" in reality - the institutions who made vast profits out of these in the good times must be seen to suffer. There will be alot of pain.

But "old-fashioned" debt is what makes the global economy tick. Banks and corporations HAVE to be able to lend and borrow money. Without it the system would collapse.

The system must be purged of these "innovative" financial products which, let's remember, are a very recent development (approx 1998 to 2005).

The central banks will cut interest rates, but in return they will expect to see the commercial banks return to more traditional lending practices - ie. no more high-risk hedge-funds, the end of ridiculously over-leveraged corporate buy-outs, no more subprime lending, more cautious private equity.

The markets will be made to learn a lesson, and then the system will recover (this is the theory at least).

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OK thanks for that. For someone who has limited experience in this, could you explain more (no jokes about crayons or pictures ;) )

a savers dream if you have a depression proof job.... lots of job losses, working longer hours to keep your job, wages and prices falling year on year for 2->20 years (in japans case), people still cant afford houses because they don't have jobs, salary's has fallen so falling asset prices (houses) are as good as a lead balloon. People are also scared about buying property because they are dropping in price, they will be cheaper next year, and next years smaller salary wont pay the mortgage!

It could happen we would all be hurt, only the very rich (possibly including landlords) would be safe. Getting out of the negative cycle at the end could be very tricky, hence it lasting up to 20 years?

Edited by moosetea

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OK thanks for that. For someone who has limited experience in this, could you explain more (no jokes about crayons or pictures ;) )

Let's imagine things get really bad really quick and the Fed cuts interest rates to 1%, and provides unlimited funds at this rate.

A big commercial institution such as Citibank will now have vast amounts of cash to lend at low rates, but it must still pick and choose who it decides to lend to.

Good investments will get the cash. Bad ones won't. It's all risk assessment.

In the last five or six years the banks had low lending standards. From now on they will have high lending standards.

If respectable international companies (with low debt) want to borrow money, no problem. The 5 times leveraged hedge fund or subprime mortgage lender will get a different answer.

Liquidity trap is real, not theory. It happened in Japan in the early 90s, hard to break out of too.

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Let's imagine things get really bad really quick and the Fed cuts interest rates to 1%, and provides unlimited funds at this rate.

A big commercial institution such as Citibank will now have vast amounts of cash to lend at low rates, but it must still pick and choose who it decides to lend to.

Good investments will get the cash. Bad ones won't. It's all risk assessment.

In the last five or six years the banks had low lending standards. From now on they will have high lending standards.

If respectable international companies (with low debt) want to borrow money, no problem. The 5 times leveraged hedge fund or subprime mortgage lender will get a different answer.

Liquidity trap is real, not theory. It happened in Japan in the early 90s, hard to break out of too.

So what does this mean for property prices?

I'd guess that higher lending standards would trump even a 1% base rate and so house prices would fall.

This leads to negative equity, more losses and higher lending standards.

Those with lots of cash could pick up a bargain but is it a bargain if prices are falling.

As 90's Japan as mentioned above.

Very scary.

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The central banks now want to get "bad" debt out of the system. That is why they will not step in and bail out the sub-prime lenders and highly-leveraged hedge funds.

"Bad" financial practises (such as CDOs, ABS, MBS, and other "dodgy" commercial paper) must be seen to be "bad" in reality - the institutions who made vast profits out of these in the good times must be seen to suffer. There will be alot of pain.

But "old-fashioned" debt is what makes the global economy tick. Banks and corporations HAVE to be able to lend and borrow money. Without it the system would collapse.

The system must be purged of these "innovative" financial products which, let's remember, are a very recent development (approx 1998 to 2005).

The central banks will cut interest rates, but in return they will expect to see the commercial banks return to more traditional lending practices - ie. no more high-risk hedge-funds, the end of ridiculously over-leveraged corporate buy-outs, no more subprime lending, more cautious private equity.

The markets will be made to learn a lesson, and then the system will recover (this is the theory at least).

I like it. Nicely laid out argument, but I'm no expert. But I still like it.

May I politely ask what your credentials are, are you involved in finance yourself ? I'm not doubting you but it's nice to get some idea of where people are in the 'financial knowledge' chain or how well positioned they are in it. There are varied posts on this forum from a variety of people and for someone like me (who, I can honestly say, is right at the bottom of the 'financial knowledge' food chain) it's just nice to know where the wiser, well formed arguments come from.

Cheers :)

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I like it. Nicely laid out argument, but I'm no expert. But I still like it.

May I politely ask what your credentials are, are you involved in finance yourself ? I'm not doubting you but it's nice to get some idea of where people are in the 'financial knowledge' chain or how well positioned they are in it. There are varied posts on this forum from a variety of people and for someone like me (who, I can honestly say, is right at the bottom of the 'financial knowledge' food chain) it's just nice to know where the wiser, well formed arguments come from.

Cheers :)

He's an estate agent.

During the day he tells people there are no problems and prices will rise 10% next year :)

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Let's imagine things get really bad really quick and the Fed cuts interest rates to 1%, and provides unlimited funds at this rate.

A big commercial institution such as Citibank will now have vast amounts of cash to lend at low rates, but it must still pick and choose who it decides to lend to.

Good investments will get the cash. Bad ones won't. It's all risk assessment.

In the last five or six years the banks had low lending standards. From now on they will have high lending standards.

If respectable international companies (with low debt) want to borrow money, no problem. The 5 times leveraged hedge fund or subprime mortgage lender will get a different answer.

Liquidity trap is real, not theory. It happened in Japan in the early 90s, hard to break out of too.

The fact it has previously happened to Japan shows that its not just theory and therefore a possible outcome. Will be interesting to look at the similarities between the UK and Japan in early 90's.

Thanks for putting into layman terms. Bravo.

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Let's imagine things get really bad really quick and the Fed cuts interest rates to 1%, and provides unlimited funds at this rate.

A big commercial institution such as Citibank will now have vast amounts of cash to lend at low rates, but it must still pick and choose who it decides to lend to.

Good investments will get the cash. Bad ones won't. It's all risk assessment.

In the last five or six years the banks had low lending standards. From now on they will have high lending standards.

If respectable international companies (with low debt) want to borrow money, no problem. The 5 times leveraged hedge fund or subprime mortgage lender will get a different answer.

Liquidity trap is real, not theory. It happened in Japan in the early 90s, hard to break out of too.

Surely if they dropped to 1% you would be looking at a massive unwind of carry trade, possibly even a reverse. The Dollar would become worthless over night, China etc would stop buying US paper and possibly dump any $$ reserves they have and you would end up with hyperinfaltion? Time to buy some more Gold? or am I reading this wrong?

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The fact it has previously happened to Japan shows that its not just theory and therefore a possible outcome. Will be interesting to look at the similarities between the UK and Japan in early 90's.

But isn't there one important difference to Japan? Japan still had a huge export industry all the time, and the banks were/are lending Yen, only they get sold and put into foreign investments. If the US and the UK and much of Europe go into meltdown, there is not that much export, and would the created money be exported in a Japanese way? What I mean is, even if we go Japanese, won't the outcome be a completely different, much worse one?

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Darn! GF beat me to it. I'm stuck with a 'me too' post. :D EDIT: Actually LordLister beat me to it, oh well.

Basically 'what he said', if US hammered their rates down to 1%, the wheels are likely to come off (rapid unwinding of carry trade, lots of dollars let loose on the market) and inflation would possibly rocket as USD (and GBP) became toilet paper currency.

Edited by ChrisM

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Surely if they dropped to 1% you would be looking at a massive unwind of carry trade, possibly even a reverse. The Dollar would become worthless over night, China etc would stop buying US paper and possibly dump any $$ reserves they have and you would end up with hyperinfaltion? Time to buy some more Gold? or am I reading this wrong?

This is a good question.

I believe the US would get hyperinflation as viewed internally (higher prices in nominal dollars) but the rest of the world would see it as deflation (crashing dollar) - Just like Japan actually.

However countries with little to offer the world and with no way of paying off their debts wouldn't bounce along the bottom like Japan but would collapse totally.

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The system must be purged of these "innovative" financial products which, let's remember, are a very recent development (approx 1998 to 2005).

The central banks will cut interest rates, but in return they will expect to see the commercial banks return to more traditional lending practices - ie. no more high-risk hedge-funds, the end of ridiculously over-leveraged corporate buy-outs, no more subprime lending, more cautious private equity.

The markets will be made to learn a lesson, and then the system will recover (this is the theory at least).

All of this has reminded me of the situation when the electricty market was deregulated in California.

Enron (amongst others) managed to abuse the system and they deliberately brought about rolling black-outs so that they could make huge profits from over-inflated prices.

So I think the answer is regulation - perhaps of the credit rating agencies - don't expect the banks or hedge funds to put their house in order themselves.

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Surely if they dropped to 1% you would be looking at a massive unwind of carry trade, possibly even a reverse. The Dollar would become worthless over night, China etc would stop buying US paper and possibly dump any $$ reserves they have and you would end up with hyperinfaltion? Time to buy some more Gold? or am I reading this wrong?

Just to clarify:

If liquidity in the markets doesn't improve over the coming weeks, the Fed and other central banks will have to cut rates to kick start the lenders in to action.

They may start with a 25 or 50 base point cuts, but once they start it has to work. It's no good just getting a few days or weeks respite then the system seizes up again. They will have to cut and cut again to get confidence back into the market. Drive out the fear. If it ends up at 1% (or whatever) then so be it. The system HAS to keep working.

If everything is smooth after a 0.25% or 0.50% cut, then the debt and derivative problem wasn't as serious as many imagined, and the market may have simply had their wake-up call just in time.

However, if they believe the situation is as bad as people fear, then rate cuts will have to happen quickly. Will the Fed allow a major hedge fund group or investment bank to go under? Personally I doubt it, as too many others would follow.

Interest rate cuts will of course hammer the dollar/pound/euro, but what value do those currencies have if the banking system in those countries has ground to a halt.

That will be the dilemma for Bernanke et al, at the moment they hope it doesn't come to that.

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Surely if they dropped to 1% you would be looking at a massive unwind of carry trade, possibly even a reverse. The Dollar would become worthless over night, China etc would stop buying US paper and possibly dump any $$ reserves they have and you would end up with hyperinfaltion? Time to buy some more Gold? or am I reading this wrong?

Just as you start thinking 'the b8strds are going to lower IRs and try keep it going that way' up pops the Carry Trade. I'd forgotten about that beastie in all the credit crunching excitement.

Lowering IRs too much might just have the opposite to desired effect. I.e. you can borrow as many dollars as you want but they aren't worth anything since the dollar has become toast.

I'm going for inflation -> stagflation -> deflation. That should be enough to f@ck everyone over!

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Liquidity trap and a resulting asset-driven deflation, in all likelihood. 90's Japan.

Exactly the same scenario that Gary Schiller outlined on Bloomberg at lunchtime.

The look on the financial-bimbo's face that interviewed him was a picture - almost "you cranky old guy, what did you just say?....."

At this point the channel "took a commercial break". Guess they can't have too much bad news in one day ;)

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