'Pumping station' or bust

Last week I discussed two key points in dealing with the U.S. financial crisis: The first was that U.S. Treasury Secretary Hank Paulson's plan to buy up bad assets is not the priority; a liquidity facility is. The second was that a "wolf-pack" psychology will prevail without a "pumping station" of liquidity to which troubled financial institutions can run and work out their assets and liabilities without fear of cash running out.

I said this pumping station must be on the order of $5 trillion for the United States alone and $10 trillion to include Europe and the rest of the world.

The U.S., nonetheless, passed the $700 billion buyout bill Oct. 4, only to find out from market reaction that the bill is not what is urgently called for. Worse, America is sending a wave of fear to the rest of the world. Now the Europeans have fallen into the wolf-pack syndrome. And this time it is not individual financial institutions at stake, but countries. Now that Ireland promises to guarantee all deposits, fear is spreading to other European countries that their own systems are not as generous.

In the 21st century, a run on the bank a la 1929 takes place in cyberspace. We witnessed two weeks ago how 10 percent of the $300 billion in deposits at Washington Mutual were drained electronically in one week. Had the savings and loan stopped its electronic banking service, a classic panic on the street would have resulted. Since it could not simply shut down the system, it ran to the government for help, but to no avail. If it had had access to the liquidity pumping station proposed last week, it could have worked out the problems and probably come out alive.

Cyber-runs on banks are what is probably happening in Britain now, as people transfer money to Irish banks and, believe it or not, to Northern Rock, a now nationalized (and hence safe) haven, as reported by BBC. A cyber-run on a bank is like a neutron bomb. You don't see it on the street, but it can kill financial institutions in days rather than years.

Although German Chancellor Angela Merkel opposed establishing a pan-European rescue package at the European summit over the weekend and accused Ireland of being self-centered, it took her only one day to change her position and announce not only the rescue of Hypo Real Estate but also plans to extend protection to everyone in Germany.

Now that the crisis psychology has spread throughout Europe, it is even more important to establish an international facility to provide liquidity — an emergency room. There must be enough money gathered there so that people do not feel it is a shallow oasis.

We should not let the Americans try to figure out what to do by themselves, because what they do immediately will impact the rest of the world. For example, in Japan we have piled up over $1 trillion in U.S. government securities (USGS). If Uncle Sam prints a massive amount of fresh greenbacks in the name of the rescue, it will devalue USGS. This is something the U.S. must recognize and face squarely, because some 45 percent of all USGS and, for that matter, greenbacks, are held by non-Americans. Declines in the value of the dollar or USGS will severely damage assets held by "wealthy nations."

So, it is in the best interest of the "have countries" to chip in to provide liquidity, rather than watch the dust settle with Americans using their mint.

This also means the U.S. needs to reconfigure its entire foreign policy. The Bush doctrine is characterized by the fight against terrorism. It seems that the rest of the world is now fighting financial terror that has spread from Wall Street. In establishing a new framework of economic and financial peace, the U.S. will have to repair relationships not only with China and Taiwan but also with Russia and Persian Gulf/Arab nations, whose help is essential in setting up the proposed liquidity facility.

Neither U.S. presidential candidate seems very familiar with the economy or the market, but it is by far the most important issue for the Americans and the rest of the world.

If America cannot come up with proper leadership in this field, it is high time for Europe and the rest of the world to take the helm — to establish the liquidity pumping station with $10 trillion in reserve. The wolf pack is staring at the next victim, the weakest of the cohort.