With rumours continuing to circle around main street financial institutions in trouble, the Fed along with other central banks piled in another $200bln worth of liquidity in a vain hope to stem the tide. It certainly worked sparking a massive rally in the US market which was looking very weak indeed.

I wrote 6 weeks ago that the Fed would have no option other than to underwrite the whole financial system. This is exactly what they are doing. The worrying aspect of this approach is that it leads the market to depend on continuing liquidity to provide confidence and prevent what would be happening without intervention, namely a full scale rout with several institutions going under.

This creates extreme moral hazard. Even though many financial institutions have clearly acted irresponsibly and in some cases in other ways, they will not be allowed to fail unless a “deal” is worked out where they will be “acquired” quietly for a nominal sum and so the system stays solidly in place and the illusion is maintained.

F.William Engdahl lays out his thoughts on the origins of this mess. It’s focus is the US over the last 100 years and is interesting to read though he makes some strong accusations about the actions of certain people.  The extent to which small cliques have organised and run the financial system is open to questions but there is no doubt that the US prevailed at Bretton Woods on the strength of pure self-interest.

So what now? Well I would say more of the same. But gravity is a powerful force and its hard to imagine these markets not falling further and more de-leveraging taking place in credit and carry trades. I’ll discuss shortly what a new global currency system might look like because the current one is about to explode.

Well Christmas brought some quiet stability to the markets but the New Year has seen an immediate stampede for the exit. What is so interesting about the current economic malaise is that it’s very hard to analyze with any clarity. No one really knows what is going to happen because we’ve never had a crisis of this magnitude before.

We know the credit bubble has well and truly burst. We’ve seen it before with Japan but that was really a closed market and the response was non existent thus causing a 15 year depression. We have Central Banks who are very keen and swift to act but will their actions just make things worse. Henry Paulson today said a correction was inevitable given the price increases of the last 5 years.

Nice to know the guys running the country are on top of things….crickey! Can anyone explain what a stable economic system looks like. Clearly the current bunch of economic leaders haven’t got a clue.

Ambrose Evans-Pritchard argues that we are experiencing a 1929 type situation. I think he is spot on. The bailouts we’ve seen recently could well become more widespread. If that happens then quite clearly the stock markets will fall another 10%. The impact on BRIC (Brazil, Russia, India, China) will decide whether the global financial system collapses or not.

Immediate rate cuts will be forthcoming from the Fed, BOE and maybe even the ECB. All this nonsense about watching inflation needs to be ignored. Inflation will keep being a problem but its a diversion. 2 years out and land prices could be off by 30% or more.

Investing now is for the brave hearted, foolish and very wealthy following the maxim “The way to make a small fortune is to start with a large one”.

As the Fed prepares for another rate cut, probably 25bps, possibly 50, markets are resilient in the face of what is still a horrendous credit meltdown. With Merrill Lynch reporting a monumental loss last week, it is clear that banks are still clearing away the debris of the last few months and the real impact may not be felt for some time.

Never mind the jokes (you can’t bail out anything with a siv)around the Super SIVs: the great $100bln bailout plan hatched by some genius to support the market. Similar to the rescue plan post LTCM crash, it basically involved the market coming in to buy its own distressed assets. Liquidity is the mantra but holding up the market is the reality.

Everything is under water so its a game of smoke and mirrors. As I’ve said before its a rational response to a difficult situation. The social impact of a complete financial crash is not something anyone wants to see but the longer we put off the necessary surgery the worse it will be.

The credit bubble of the last 15 years is over. The balloon has too many holes in it and its a waste of time pumping more air into it.  Satayjit Das, author of Traders, Guns and Money lays it all out in this paper. Its worth a read.