Wednesday, October 21, 2009

Financial crisis – the benign interpretation

In this post I will partly play the devil’s advocate, to some extent arguing the case of the cornflake mainstream economist. Partly I will conclude the most benign interpretation of the financial debacle. This little exercise is meant to line out the most positive outlook for the coming years.

Re-capitalisation success
The stock market capitalisation of banks has recovered, to an enormous extent. The Keynesian experiment has in this aspect, at least temporarily, and only looking at capitalisation, been a success. When central bank money is almost free, sometimes financial institutes actually get paid to take money, prices of risky assets do recover and competitors disappeared or are weakened, making money is a relatively simple matter for the strong survivors.

What the bail-outs and cheep money has done is three-fold. It made the “to big to fail” into shopping machines i.e. they could go out buying assets, equities, companies and other financial institutes in a way that otherwise wouldn’t been possible. This is the main basic reason for the stock market recovery. It also lowered the risk somewhat comes to banks basic capital, more capital means they stay in business. And thirdly it has accumulated the financial sector into fewer hands because some banks were saved, some were not. Some banks were so far gone they couldn’t be saved or in such bad shape other banks could buy them up. All in all the competitive edge in this particular area have diminished.

But now, with the recession eased off, we are faced with a couple of problems. Most of the stimulus to financial institutes hasn’t really been put to use, the banks have horded some of the money and some banks have paid back to the state. This means that the recapitalisation of normal markets, getting people to borrow and shop again, have been a semi-failure. This have happened, but not really to the extent intended in the eyes of those in charge. This pose a problem, not only have purchases not been going up as much as the schemers projected, policymakers and central banks have also flooded countries with lots of money which have a built-in danger of future inflation and possible devaluing of currencies. With things fairly stable, the people who brought us this situation now need to, among other things, think about when and how much they are going to raise interest rates in order to keep inflation down and not get an run at the currency. The problem is how to do this without pulling the rug from under the financial market and get another dip in the economy. But not to do this or if they wait too long or don’t raise rates enough pretty soon, we’re possibly facing even worse problems ahead. And so big decisions are to be made by our benefactors, and pretty soon.

What they can hope for is that growth and jobs recover enough to pull us up far enough so when they do drag that rug out from under us, it has little effect. In the real world this is impossible; the math tells us that there is no actual recovery in sight so to withdraw the stimuli and heighten interest rates will have very negative effects. But if we make the benign interpretation and say that we soon can return to a more normal state in the economy, we are still faced with the question: have we really changed anything?

Another, more politically adverse effect, is that bonuses are back and that the shopping spree by large financial institutes has had a demoralising effect on the populace. Few are the politicians and policymakers that what to declare that, thanks to their efforts, the surviving bankers will be buying palaces, while humbler folk worry about their jobs and homes, and face decades of fiscal austerity. Watching financiers – beneficiaries of the most generous public rescue in history – returning to their old ways is the cause not so much of envy as sullen resentment. Why, many wonder, should the rigours of the market apply most brutally to those innocent of causing the catastrophe? And why would normal people, in effect, pay for bonuses and the lavish lifestyle of the rich?

The implications of this cannot be taken lightly, which is why we hear from the elite that they are going to impose regulations, raise taxes or even withdraw money back to the state. At least they need to show constituencies that they actually do something about this poor-paying-for-rich-peoples-mistake, what they do aren’t that important.

And then we have deficits and growing number of percentage measured in GDP that is debt. Some countries have grown towards a total debt accumulation - private, company plus state - of 350% or even more. The US and Sweden stand around 150% of GDP in total debt, which in comparison with many others isn’t that bad. However, the US in particular, has debt obligations that will triple that amount over the next decade or so. The ever souring debt that has grown during this crisis need to come to a halt. Even Keynesians know this. They felt it necessary to add to this pile of liability due to the financial instability and, according to them, they succeeded, the numbers are turning around. But, as said, this debt needs to be repaid, and it means that a growing amount of public spending goes to interest rates and repayment, and so there is less money over to help the needy or to found another stimulus if required.

What it all comes down to, no matter how you look at it, is that things need to start rolling again. We need to produce more, increase productivity and get people back to work. But the problems are overwhelming.

How can we keep credit for investments and shopping available when those actually, at least to a certain degree, need to be withdraw from the market? If they regulate or hinder the financial market too much, they will create more problems, if they don’t they risk their jobs or even violent protests. And how will they re-introduce a flexible and more diverse banking sector when there are fewer and more powerful financial institutes today? And how can they get people back to work when they cannot borrow or print more money to pay for government expenditures in that regard? Can they let the debt-GDP ratio continue to increase and what can they do about inflation versus deflation? The questions and the hardship for the mainstream policymaker are very tough at the moment, and seldom have cornflake economists been so busy coming up with solutions.

Let’s say they come up with some reasonable solutions, let’s also argue that people, to some extent, get back to work, and let’s assume that the market rally isn’t a dangerous fluke and that nothing out of the ordinary happens that can spoil the recovery. In such a situation, again, we are faced with the same question, have we really changed anything? The very essence of this crisis – is it gone or will more trouble come up ahead?

Can you see the status que? This is the best possible scenario; that nothing really changes, more questions arise and there are lots of possibilities for wrong decision-making.

If this is our future situation, what will happen if another crisis emerges? Or, even worse still, such a crisis pops up before a full recovery is here? What then?

I’ve offered an alternative solution before, but that is not really the popular one. So what other “solutions” have lawmakers and leaders, historically speaking, turned to when all else fails?

Well, basically there are two ways to go, often enough we have seen a combination of the two. Firstly they can move towards much more of the same. More socialisation, more regulations, more restrictions, more protectionism, and more debt and more use of the printing machine. In effect more stimuli, more bail-outs and more Keynesianism, but, as said, the questions regarding such endeavour, even if successful again, still remain.

Secondly, and the all time favourite of clueless under fire policymakers, is war.

And yes, this is the benign interpretation...

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