Not Now John.

Not nah John
We’ve got to get on with the film show.
Hollywood waits at the end of the rainbow.
Who cares what it’s about
As long as the kids go?

Roger Waters

In 1991 the Japanese economy busted after over a decade of booming prices in capital and durable goods. The housing boom is paramount, with mortgages running for as much as 99 years. The only way a famuly could afford to buy a house was if their grandsons picked up the tab. We were told there was no way house prices would go down in Japan because of the lack of available space, but this was not the reason why prices surged. The reason was a credit expansion.

There is nothing wrong in promising to pay for a present good with future goods yet to be produced but we must admit there is some uncertainty in the whole affair. If someone is willing to wait for 99 years to get their principal back (at least the last installment) then that person (and his heirs) must be willing to endure a lot of uncertainty in the process. Now, the fact the debt itself became an asset that could be freely exchanged in the market, might have served as an incentive for people to engage in such transactions, but in the end, those assets must remain with someone willing to hold them and take the risk. Or so it should if there wasn’t a lender of last resort that will either buy that asset at face value outright or accept it as collateral for more loans.

As it turns out, in Japan, there was no one available to keep those assets at the prices required by their owners, that is, the banking system. Instead of allowing their liquidation, the BoJ came in and bailed-out the banks. The irony is that in the US a lot of people scorned the Japanese Way, saying no way this would happen in America. In the land of the brave if a business has to fail it does. They were perhaps naïve, believing the legacy of the Founding Fathers still ruled the country in the 1990’s when, in fact, it has been slowly but surely set aside ever since the moment it was written in paper. Americans didn’t have to wait long. In 1998 the LTCM went bust. We must remember this was a company put in place to arbitrage – or so they thought – “inefficiencies” in asset prices. There is definitely some hubris in the whole affair, investors paying the price for defying the gods of science. Their sin: the pretense of knowledge. But if investors were wiped out, all those allowing them to build such massive positions were not. The financial system was crammed with moral hazard and no effort was made to purge it, quite the opposite.

And this brings us to 2008, Lehman and the supposed need for QE to prevent the meltdown of the financial system. American investment banks held assets of very dubious quality. They represented future promises of payment that were going to be partially or wholly defaulted. In order to keep the value of those assets, the pricing system had to be perverted and prices are a fundamental part of economic coordination. What is being achieved with QE is that similar investments (other than subprime for obvious reasons) will continue to be made. If liquidations had been allowed, the capital goods (and claims on capital goods) held by the banks would have been purchased by investors at prices that would have allowed those same goods to have been put to better (or more economical) uses. QE worked to prevented any possibility of recovery from taking place. It channeled and forced (through taxation and regulation) individuals to finance inadequate capital structures and business plans. Now we face an over-twenty-years-ongoing recession. And that is the best case scenario.

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