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I ran across an blog post that includes an article called Sucked into the Green Zone, by Andrew Redleaf (Dec 2008). It presents an interesting perspective on how government-backed borrowers are crowding others out of the market:
http://robbservations.blogspot.com/
Here's an excerpt:
When a massive and sudden deflationary credit collapse hits a modern economy, borrowing becomes extremely expensive for everyone—almost. The government, and certain government backed institutions, will still able to borrow at pre-deflation rates. With money plentiful and cheap on one side, the government’s side, but scarce and expensive on the other side of the room, assets will flow toward the government’s side of the room like water flowing downhill. Over time all ‘normal’, not government-backed, asset holders who can borrow only at high rates would lose everything they own to those who can borrow at the government rate. If government backed entities can finance an asset at 5 percent, and everyone else in the room is obliged to finance it at 15 percent, and if this condition could long endure, ultimately every asset in the economy would be owned by the government backed crowd.
Thus, just as in an inflation, by precipitating a sudden catastrophic deflation the government not only shifts wealth from one citizen to another, the government itself can massively confiscate assets.
At first this seems odd, since the government itself is massively a debtor, and deflation is generally held to be bad for debtors (as inflation is generally held to be good for them). Is it not for this very reason that governments are tempted to inflate the currency, so that their own debts can be wiped away, paid off with cheap currency of its own issuance?
All true. But our deflation—let us call it the deflation of the Red Zone—is the creature not of a long term shortage of currency, as for instance the US saw frequently in the 19th century, but a catastrophic credit collapse. A credit collapse, as the very word implies, is preeminently a crisis of trust. A lone trusted borrower in the midst of a financial terror can borrow and lend at an extraordinarily favorable spread, putting assets on its balance sheet at amazing bargain prices. This is exactly what the government is doing right now—even though it is trying to give the spread away by tossing money to its favored banks. Right now, the only US debtor with access to still functioning credit markets is the U.S. government. Because only the Treasury can borrow, only the Treasury, or those on whose behalf it consents to borrow, can lend, or buy.
A deflation arising from a catastrophic credit collapse can thus be described simply as a condition in which the spreads between risk free, or Treasury rates, and all other rates, or risk premiums, are radically out of proportion with real economic risks. (Or at least those real economic risks apparent before the collapse. The longer credit markets remain dysfunctional, the more the real economic risks will increase to match the increase in risk premiums.)
If such a condition could persist forever, only the state would own any assets, which is why the estimated price of the bailout keeps rising. The government is borrowing, lending, and buying in an attempt to keep the system afloat, but it is not closing the spread between risk free and risk premium paper. Perversely, by driving down risk-free rates it is actually widening the spread.
-- continues --
http://robbservations.blogspot.com/
Here's an excerpt:
When a massive and sudden deflationary credit collapse hits a modern economy, borrowing becomes extremely expensive for everyone—almost. The government, and certain government backed institutions, will still able to borrow at pre-deflation rates. With money plentiful and cheap on one side, the government’s side, but scarce and expensive on the other side of the room, assets will flow toward the government’s side of the room like water flowing downhill. Over time all ‘normal’, not government-backed, asset holders who can borrow only at high rates would lose everything they own to those who can borrow at the government rate. If government backed entities can finance an asset at 5 percent, and everyone else in the room is obliged to finance it at 15 percent, and if this condition could long endure, ultimately every asset in the economy would be owned by the government backed crowd.
Thus, just as in an inflation, by precipitating a sudden catastrophic deflation the government not only shifts wealth from one citizen to another, the government itself can massively confiscate assets.
At first this seems odd, since the government itself is massively a debtor, and deflation is generally held to be bad for debtors (as inflation is generally held to be good for them). Is it not for this very reason that governments are tempted to inflate the currency, so that their own debts can be wiped away, paid off with cheap currency of its own issuance?
All true. But our deflation—let us call it the deflation of the Red Zone—is the creature not of a long term shortage of currency, as for instance the US saw frequently in the 19th century, but a catastrophic credit collapse. A credit collapse, as the very word implies, is preeminently a crisis of trust. A lone trusted borrower in the midst of a financial terror can borrow and lend at an extraordinarily favorable spread, putting assets on its balance sheet at amazing bargain prices. This is exactly what the government is doing right now—even though it is trying to give the spread away by tossing money to its favored banks. Right now, the only US debtor with access to still functioning credit markets is the U.S. government. Because only the Treasury can borrow, only the Treasury, or those on whose behalf it consents to borrow, can lend, or buy.
A deflation arising from a catastrophic credit collapse can thus be described simply as a condition in which the spreads between risk free, or Treasury rates, and all other rates, or risk premiums, are radically out of proportion with real economic risks. (Or at least those real economic risks apparent before the collapse. The longer credit markets remain dysfunctional, the more the real economic risks will increase to match the increase in risk premiums.)
If such a condition could persist forever, only the state would own any assets, which is why the estimated price of the bailout keeps rising. The government is borrowing, lending, and buying in an attempt to keep the system afloat, but it is not closing the spread between risk free and risk premium paper. Perversely, by driving down risk-free rates it is actually widening the spread.
-- continues --
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