Paulson's Pozole

The following is a work fiction (maybe), names are purely coincidental. Someday this truth will come out (maybe) .

Once upon a time, in a land far, far away, there was a big evil dragon who lived in a cave. The cave was located in the basement of a building between 14th Street, SW, and 15th Street, SW, in Washington D.C., and the building is know only to brave knights as the Bureau of Engraving and Printing. Most people dare not whisper the name of the evil dragon, know as: Inflation.

The knights Alan Greenspan and John Snow got out while the getting was good. They did not want to be Chairman of the Federal Reserve and Secretary of the Treasury respectively when the fungo hit the fan.

I felt that by the fourth quarter of 2007 (I said '07, not 08') that we were already in a recession. But every time I saw economic numbers coming from the Bush Administration I could not believe it. I really came to think that by the first quarter of 2008, they were falsifying the numbers. The numbers had to be worse than what the administration was saying.

Then, Paulson, seeing the cave paintings on the side of Lascaux, came up with this idea: Keep interest rates artificially low, always under 4%, but really try and shoot for 2.5%. Then at the same time, loan money (in the form of preferred stock) to the major money center banks who were in trouble, for 5% to 8%.

The idea was (for an old Wall Street guy) to play the spread between Treasury yields (that they were selling to China and friends) and the preferred stock ("loans") dividends. We'll borrow money for 3% and loan it for 6%, and ten years on, we will make money. The banks will survive, the U.S. Government will make money, we won't have to raise taxes, we will save the economy, and all of us will look like geniuses.

If John McCain somehow won the election, they would continue this policy as long as possible. If Obama (or Hillary) won, they would walk away and let him deal with it.

Of course as time went on, Paulson realized that the problem was 1) bigger than he had originally thought, and 2) was moving faster than he anticipated.

What is that hissing sound?

You remember the old Inspector Clouseau spoof where the villain knocks on the door, Clouseau answers, and the guy outside hands him a bomb with the fuse burning? Clouseau takes the bomb and politely says, "Thank you," and then closes the door. Timothy Geithner answered the door.

The problem with this "playing the spread," even had it really worked, would be to hide the true borrowing costs. The real borrowing costs for anything, a house, a business, what ever, would have been the two rates added together. So, instead of 6% or 7%, it would really be 9% or 10%.

'Why?,' I hear you ask. Because the money being loaned was "printing press" money, not "sweat production" money. If the money is earned through sweat and production, and then loaned, it is real money. But, if it is just printed with no real equity behind it, that money will have to be earned (or sweated out) somewhere else and at some other time. Otherwise this is called inflation. Printing press money in not really money until it is earned, down the road, by somebody else.

Remember that ancient parable: "Wealth is neither created nor destroyed, just moved." (or re-monetized in different forms. Taken from the Law of Conservation of Energy: "Energy is neither created nor destroyed.") That means if you print money, somebody must lose wealth somewhere else. Usually this means all of the taxpayers and then citizens of a country. The effect of loaning printed money is it will act like a coiled spring, and the longer you go, the tighter the spring will become, until you can't hold it any longer. Energy and knowledge (used in a wise and prudent manner) move wealth. This is translated as thus: "Someone will pay."

So, Geithner and Obama can do one of two things: 1) Add a longer fuse until the next administration comes along, or 2) let it go off, and then try to clean up the mess and fix things.

How much do you want to bet that the present administration and Ben Bernanke will do everything in their power to keep interest rates as low as possible as long as they are in Washington D.C.? Come on, bet me.

I still hear a hissing sound in the room that is the United States.

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