Is this Crisis over PDF
With a global perspective and much reason to doubt the quality of the past boom it appears very unlikely that this crisis has seen its bottom.
In a recent exchange with Nobel Prize Laureat Paul Krugman, Prof. Niall Ferguson of Harvard echoes an often heard opinion that Mr. Bernanke’s “knowledge about the early 1930s banking crisis is second to none” and reason to be confident for averting a second Great Depression. The way he chooses his words is very interesting. He doesn’t say “Great Depression” he says “banking crisis”, as if they were two independent issues. Indeed, when one reads Bernanke’s papers it does reveal deep knowledge of the mechanics and liquidity flows in the financial system.
However, I have never found him analyzing the quality of debt in the system or the size of it, or calculating debt and debt services in relation to the nation’s ability to generate cash flows. This seems an odd omission and fatal when the resulting policies implicitly assume that fundamentally all or most debt employed in the economy is sound. Mr. Bernanke’s stance is in essence: if credit runs ahead of debt, i.e. if leverage increases to uncomfortable levels, all the FED needs to do is increase the monetary base (print money) and restore sensible levels of leverage.
Naturally, today it is impossible to estimate the quality of the $50 trillion built up in the US alone. Its collateral, the assets that backed this debt, were to a large extent driven by the very expansion of debt. Importantly, Mr. Bernanke’s detailed observation of the Great Depression doesn’t answer the question whether his policies would have saved the system. One might argue that the collapse would have merely taken a different path. One of Mr. Bernanke’s main observations was that as soon as liquidity was provided to the system, the economy started to grow and countries that were late in abandoning the gold standard emerged later from the Depression. What would have been the effects of a liquidity injection early on in the crisis? As we can observe today, since mid 2007, the FED has more than tripled its balance sheet and the government has taken on a couple trillion of bad assets. After two years of enormous efforts Bernanke has nothing to show for.
Is it really a surprise that after almost two years of such unprecedented action, the economy is momentarily arresting its contraction?
Even on the way down, our economy will remain cyclical.
But let us look at the quality and magnitude of the debt that we have to service with our taxed economy. Ultimately, the taxpayer will have to budget whether it is reasonable to follow current policies, indeed whether he has the financial capabilities to do so. As shown in “Eye of the Strom” the margin of effort is not that large. Even if the paradigm of self-regulating and efficient markets has taken a good beating, many still seem to operate under the assumption that our system is much more efficient than it used to be without the tools of modern finance.
In reality, the all-pervasive and irreverent application of the tools of modern finance supercharged ongoing leveraging, and its mathematical approach to risk dissociated our financial businesses from the real risks in our markets. It encouraged harmful institutional transformations in our financial industry while these businesses were operating with deeply flawed risk management tools for decades.
What got us here goes much deeper than mere lack of capital or transparency. Just as the large banks strayed from their core business—relationship banking— financial markets strayed from their core function—the efficient allocation of risk and capital.
These distortive structures combined with an unprecedented expansion of debt should give reason to pause.
Is it reasonable to assume that after we shifted merely 5% of this debt away from clear sight we are back on track? What is a reasonable assumption for necessary write-offs when past crises had to deal with write-offs anywhere from 10% to 30% under conditions that were much more benign, i.e. with less than half the debt the US carries today and in a world that could always count on the US to come to rescue?
Today, it is the US that needs help, but having been the locomotive for 60 years has created economic weakness and dependence in most of the rest of the world. Some have renewed the hope that Europe or China will take the baton. I would put that in the “very, very unlikely” box.
Reality is that much of the final 7 years of the boom in the US was financed by rising asset prices and built on the consumption of imported goods from emerging markets (China). I travelled extensively in China during the boom years. It was remarkable to observe some 50 cities larger than 1 million population and 30 states, each with a population close to the size of Britain or France, compete for all the overseas investments and economic growth to be had. The $6 trillion invested since 2000 in China were openly visible everywhere and even at the height of the boom one could observe high vacancy rates and volume expansion strategies at the cost of ever thinning margins. As was to be expected, businesses in China and emerging markets projected ahead the enormous growth rates generated from years of export growth and built for that future.
What shall we expect from the fiscal investment package launched in China, which is now commonly but still cautiously hailed as having averted a Chinese economic downturn? The evidence is that the consumer in China doesn’t stand on its own feet, which means China is merely increasing its overcapacities. Amid all the arguments flying around pro and con this position there is one important one that I have always found necessary for a solid case for an independently strong consumer when a country emerges into the industrial world: imports. Generally, when a middle class is forming, imports start to expand more rapidly than exports and the composition of imports shifts towards consumption and services. Neither one is the case today in China that has consistently run a large and expanding trade surplus. Its economy, as have most emerging economies, prospered on export growth driven by an undervalued and pegged currency. Despite new popularity of the decoupling thesis, the economic evidence for this happening is lacking, a temporarily successful spending plan notwithstanding.
As was the boom, so is the crisis a global and globally interconnected phenomenon, unprecedented in size and nature. It will be interesting to observe the various reflexive developments and the time lags it imposes. It would be prudent to observe economic statistics with great caution. Today’s hope that the crisis is over is nothing more than hope and gravely irresponsible on the part of policy makers.
With a global perspective and much reason to doubt the quality of the past boom it appears very unlikely that this crisis has seen its bottom. In fact, it is much more likely that we have only seen the beginning.
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