To save the economic and financial future of America, the US government is taking over the financial system by changing the rules and becoming the backstop for all the junk in the current financial system. While this may save them in the near term I think it is going to put America in a big black hole for the next decade or more. What’s more America’s global influence will mean Australia, Europe and Asia will feel the impacts just as much. This makes it especially important to understand what is happening in America, even if you have no direct invesment there. Here is a quick recap of the key elements of the latest mega-bailout plan – which is equal to more than $2,000 for every man, woman and child in the United States.

1. The Treasury Department will guarantee the assets in money market mutual funds to reassure savers and investors. Probably the only sensible component of the plan. This is money that is quite safe, but the treasury’s reassurance will make people feel much better about their holdings.

2. The SEC is temporarily banning the short selling of almost 800 financial stocks (Australia has gone one step further and banned all short selling). Short selling is a bet the stock will fall. It is legal but has been blamed for worsening the crisis by putting added pressure on. Most market traders see this is a knee jerk reaction which doesn’t address the root cause of the crisis. But, there are no rules now, except the ones the Fed and treasury create.
   

With all the bailouts to date and the most recent mega-bailout, here are some of the long term problems being created for America and the global economy:

• Inflation: While the Fed has about a trillion or so dollars currently on its balance sheet, it is likely the cost all of the bailouts will be much more. In order to get more funding, more money will be printed by the Fed and added to the money supply. Economics 101 says that this will lead to inflation as the purchasing power of the currency declines. This will mean the US dollar will fall (see below) and make Australia imports to the US less competitive.
• Too much government authority: The $700 Billion rescue plan gives Treasury power unchecked by courts – so who is overseeing the overseer? With all this economic, regulatory and political power do you think the government will easily give it up? Particularly under a pro-government control democratic administration. Further, if the government is so good at managing debt, then why does America already have the highest national debt in recorded history? The proposal is “a clear abdication of all oversight and fiscal authorities to a Secretary of Treasury that has bungled this crisis from the beginning,” said Joshua Rosner, an analyst at the independent research firm Graham Fisher & Co. in New York. “This is Marxism. And I mean Groucho not Karl.’’ The Australian government is also slowly having more influence on financial markets, but thankfully our financial system is much more sound and better regulated.
  



• National debt: American national debt will be a problem for years, if not generations to come. One of the reasons the treasury had to make moves now was pressure from foreign banks in China, Korea and Japan who own a significant amount of MBS. When foreign governments and banks can start putting pressure on the US because of the growing amount they owe, then they are slowly but surely losing control of their economic future.
• Bye-bye US dollar and hello $150 oil: With inflation, slower economic growth and uncertain financial markets the US dollar is set to lose a large portion of the gains made over the last few months. Long term the trend for the greenback is down, which coupled with global demand and limited supply will mean $150 in the not to distant future (It was already back above $100 this week). This means higher fuel prices in Australia too, despite a likely appreciation in the Australian dollar.

• Losing the mantle of the world’s premier economy: Japan went through an eerily similar scenario in the early 90’s when their financial institutions collapsed. It has been more than 15 years and they are still recovering from that crisis. America may be more resilient and actions were taken sooner rather than later, but it could take until 2015 or later to recover the bailout funds and get the financial system back to being world class. By then the emerging super powers India and China will have made significant ground and it could too late for America to take back the mantle of the worlds number one economy.
• Bad examples for future management: Unless some serious regulatory and structural changes are made most of the management of these bailed out companies will get off with a relatively minor rebuke. Yes, they may not get their big bonuses but most of them had already made their millions before the financial crisis really struck. So don’t feel too sorry for them while they have a couple of years off in their yachts and holiday homes. A number of them will return to Wall Street in a few years as “consultants” when the dust has settled to very cushy jobs as this crisis and the faces behind it fade into memory.

There you have it. My view on things as they currently stand and unfortunately not a very rosy picture painted. What are your thoughts – do you agree/disagree? What further impacts do your foresee for Australia?