In good times, financial markets embrace Capitalism. In bad times, financial markets re-discover Socialism. Currently, the US Federal Reserve is engaged in a dangerous strategy to look after its Wall Street friends.
The origins of the current credit crisis lie in loose monetary policy and excessive capital flows that was turbo-charged by “financial engineering” techniques used by banks. Borrowing bought more borrowing fueling price increases in financial assets - debt, equity, property, infrastructure.
The US central bank’s strategy is clear. [...] de-leveraging and price adjustment can be achieved by creating inflation through loose monetary policy. If asset prices remain at current levels, higher inflation allows values to fall in real terms. Higher inflation also reduces the value of the borrowings that must be paid back allowing the required reduction in leverage.
The strategy is dangerous. Inflation can lead to a significant transfer of wealth from investors to borrowers. Inflation once embedded in the economy distorts economic activity such as investment and savings. The experience of the late 1970s and early 1980s highlights the difficulties in recapturing the inflation beast once uncaged. Paul Volcker, then Chairman of the Federal Reserve, bravely increased interest rates to stratospheric levels to squeeze inflation out of the financial system.
The banks continue to privatize gains and socialize losses. Socialism for Wall Street will prevail, once again.
Satyajit Das: Socialism for Wall Street
Credit derivatives expert and prolific author Satyajit Das calls a spade a spade:
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