osewalrus (osewalrus) wrote,

Why Your Average American Should Care About the Financial Collapse.

We are, of course, way beyond subprime now. We are into the commercial bad loans and the loans that were marginal but fell off the tipping point when the interest rates went up and even the loans that were basically sound until the double whammy of inflation and curtailed consumer spending began to hit.

But that's not why people should care.

It's not even for the market collapse. Unless you were planning on retiring, the hit on your 401K is not catastrophic in the short term. Nor is the collapse of pension funds heavily invested in the market.

It is the collapse of liquidity. Or, more simply, there is no money in the market.

At any times, businesses and people need to borrow money. Even if you are paying it off regularly, being smart, not accumulating debt on foofie consumer goods, and all that other good stuff, both businesses and consumers need ready access to capital in order to maintain and expand their businesses. Liquid capital in the system is like a fine lubricant, keeping the engines humming. Businesses use financing to upgrade equipment in logical anticipation of profits, to expand business lines, to hire more workers to increase productivity and output. Consumers rely on loans for education, for home repairs, to buy houses or get their cars fixed.

When capital gets tighter, interest rates go up and we see these activities decline. That's how the Federal Reserve manages an "overheating" economy. But it needs to be done gradually to avoid shock.

What we have is the collapse of capital markets in a way that sucks liquidity out of the markets suddenly and unexpectedly. This condition is aggravated by the panic over who will get hit next, which prompts hording of capital. Without capital, even businesses that should (in an economic sense) expand cannot. Consumers cannot make purchases that are rational. The cycle continues unless broken by some other stimulous.

Free market economists had hoped that th global market would take the place of the federal government in cushioning the extremes and providing additional stimulous to break the cycle. The hot economies of India, China and Brazil could become new markets for our goods and services. Their finacial institutions could provide liquidity. (Free market economists are somewhat indifferent to the political consequences of this.)

But free market economists forgot about transparency. In deregulating U.S. markets, we eliminated needed transparency that ecnourages investment. No one wants to invest in a money pit. We got one round of major foreign financing that kept us afloat last year. I am not convinced we will see the same sort fo infusion this time, given that foreign investors have lost their certainty that the U.S. government will not allow huge institutions to fail and that the dollar will remain the premier currency. But I could be wrong. Old conventional wisdom dies hard. Newly rich investors in Russia and other oil-rich nations grew up believing in the value of dollars and may still cling to that. But even this is not an inexhaustible supply.

Good news for McCain/Palin, however. The worst effects are yet to come, and probably won't hit until after November 4.

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