Page 2 of 2 Illusory dollars for a real crisis
By Julian Delasantellis
Then oil started falling, and it didn't stop, dropping like a stone to under
$40 this week. Here, the punditry was perplexed. What about China, and India,
and all that economic growth that was pushing up demand and prices just a few
months ago? Had the bicycle and rickshaw come back into fashion, so soon?
We now know the truth, and probably the only thing it has to do with China and
India is the bird's nest soup and tandoori chicken take-out delivered to the
desks of the commodity traders at the hedge funds in Greenwich, Connecticut.
All during the great bull move in oil, as in most of the rest of the
commodity sector, hedge funds and other speculative interests were buying
commodity futures contracts like there was no tomorrow. To finance these
purchases, the speculators were taking out huge loans from the banks. Why
shouldn't the banks have been lending to the speculators; it seemed like they
were riding the tail of a very profitable tiger. If that wasn't enough, the
fact that the banks were lending to lots of these speculative interests, who
were all in the market taking very similar long positions, made the
profitability of these loans virtually a self-fulfilling prophecy. The loans
spurred buying, which spurred price gains, which spurred profits for the
speculators, and the whole thing went on.
Until this summer. The deleveraging plague finally reached the lending to the
commodity funds, and the banks, seeking to contract and strengthen their
balance sheets, pulled back on the commodity speculation loans. The speculators
couldn't roll over their long positions from month to month, so they had to
sell; in effect, this was the great world margin call. Most other commodity
prices were also driven down through this mechanism; for many of them, the fact
that the banks were also pulling in their crucial letter of credit financing,
by which the transit and shipment of commodities from producer to consumer was
financed, also exacerbated the big bad commodities bear.
The same dynamic has been seen with another critical price level, the price of
money itself. For years, in the foreign exchange markets, currency speculators
have luxuriated in a very profitable strategy called the carry trade; borrowing
funds in low-yielding currencies, such as the yen, and, as the year went on,
the US dollar, to invest in high-yielding currencies such as the euro and New
Zealand dollar. Starting in late summer, the banks started to cut and pull the
funding lines from the currency speculators. The long euro positions had to be
sold off, and with the market so heavily short the dollar, a snowball rally
started in the US dollar that shocked the world.
The rally dropped the euro from 1.60 against the dollar in July to 1.24 in late
October. This was one of the most anomalous features of this year's financial
crisis - why was the country in such perilous economic circumstances seeing its
currency rise (although at the same time the US dollar was falling against the
yen)? But, in this, as in most everything else this year, the mad logic of a
dysfunctional financial system trumped that of basic economics. In fact, what
happened in the financial system dominated just about everything in the world
this year.
When I was a young sprig taking economics classes - "Oh,no!" you must be
thinking. Not another "when I was young" story! We'll hear enough of those when
we go to the grandparents for holiday dinner - the study of economics through
the lens of the money supply and its fluctuations was called monetarism.
It was not popular at the time; it was mostly confided to a small circle of
Milton Friedman's sniveling, groveling toadies at the University of Chicago. I
don't think that any of my professors ascribed to it; they were all
dyed-in-the-wool Keynesians, true believers in John Maynard Keynes' post-World
War II theories that governments could modulate the ups and downs of economic
activity through either increasing or decreasing spending and/or taxes.
The US government ran a $400 billion deficit in the fiscal year that just
concluded, and is on track to run a $1 trillion or more deficit in fiscal year
2009. Most other industrial countries, even including China (but with the
notable exception of Germany) are busting through their budgetary restraints as
well. Still, unemployment is rising, and will almost certainly continue to do
so in the new year. To paraphrase Ricky Ricardo (Desi Arnez) admonishing his
wife Lucy (Lucille Ball) when she got into a pickle on the old CBS TV situation
comedy I Love Lucy, "Mr Keynes, you got some 'splainin' to do."
Perhaps it is time to take a new look at monetarism, but, as I said above, what
is going on currently is not a standard monetary event. The economy is not
being starved for credit due to a tight Federal Reserve interest rate and/or
money supply policy; short-term interest rates have hit zero, and the money
supply is billowing. The Fed has opened a veritable fire-hose of liquidity onto
the economy; still, the conflagration burns on.
But what 2008 proves is the absolutely central importance of focusing on the
financial system as the intermediary, the transfer mechanism, between the
central banks and the economy. It is in the financial system cave where the
deleveraging beast lurks.
I've explained what is happening many times. Starting with loans on subprime
mortgages, borrowers default. Banks take losses to their capital positions from
the defaults. It is the value of the banks' capital positions that determines
how much in loans the bank can have outstanding - capital declines, so new
loans don't get made, old lines of credit and loans get cut and called. This
further starves the economy of funds, more borrowers default, there are more
hits to bank capital reserves, and down and down we go.
On Capital Hill and in the media, elected blowhards and prettyboy blow-dried
newsreaders squawk on and on about how little (or none ) of the hundreds of
billions, by some measurements trillions, of recent government assistance is
being used to make new loans. Of course it's not; every penny the banks are now
getting goes directly to fill the holes in their Tier 1 capital ratios, ratios
that then get promptly blown out again when more loans go bad.
On a recent conference call, Goldman Sachs suggested that up to 20% of
corporate bonds may default in 2009. That would be an incredibly negative and
unprecedented event; who knows, it actually may be so serious as to drive the
saga of missing Florida toddler Caylee Anthony off the lead in the cable news
shows.
Now, the situation is like one of those alien invasion movies. The world's
conventional military forces have had their keisters kicked from Alaska to
Zambia, so the planet's only hope then seems to be with the US Air Force
dropping The Big One on the baddies. Currently, The Big One is represented by
the huge, $1 trillion or more (probably more, considering the pork add-ons
Congress will most likely apply to the endeavor) fiscal stimulus package Barack
Obama hopes to get passed in January.
Will it work? Well, it didn't in War of the Worlds or Independence Day.
But, like computer whiz David Levinson (Jeff Goldblum) in the latter movie
taking down the aliens with a computer virus when The Big One failed, perhaps
there is a way the threat can be addressed in a smaller, more focused, manner.
A few economic observers, probably foremost among them former Clinton economic
advisor Gene Sperling, have come up with an innovative idea to deal with the
financial system's current travails.
Instead of shoveling seemingly endless hundreds upon hundreds of billions of
dollars to save the existent financial system from its own blithering folly,
riches that the institutions receiving the blessings have absolutely no
intention of using to make new loans, why not, in essence, tear up the ledger
books and start again?
The proposal is for the government to fund new banks. It would probably be too
much for a new bank branch to be put on every street corner and strip mall in
America; this would probably have to be some sort of wholesale bank, using its
capital to buy up new loans from some of America's still well-functioning small
local and regional banks, those that survived due to the fact that they did not
get all that caught up in the securitization and fees model that led the big
banks into the crisis. The star of these small banks, New Jersey's Hudson City
Bancorp, reports that it has been involved in a grand total of only 4 mortgage
foreclosures this year.
You wouldn't have to worry about government money going to New Bank being used
to plug balance sheet holes; New Bank would not have any bad loans causing
balance sheet holes since, of course, it would have no existing balance sheet.
I'd like to see this policy implemented with a triage ethic that diverts the
aid currently going to the big sick old banks to New Bank. Maybe the old banks
can't be saved to once again operate as real, functioning, private sector
entities. Maybe it's time for the dinosaurs to die.
But never let it be said that I'm leaving you all dejected and depressed for
the holidays, for I do have this one bit of holiday cheer. As the government
bailouts and new central bank lending facilities piled up this autumn like
brightly colored leaves, by one estimate, over $7 trillion in new government
spending and Federal Reserve lending commitments just this year, some observers
looked at the huge amounts being thrown at the problem, without a whole lot of
seeming success, wondered what better use could the funds have been tasked to
do.
Global poverty could have been fought, the worldwide scourge of HIV could have
been addressed. Americans could have been provided with healthcare or college
educations or the latest in fuel efficient cars; in Texas, some really
extraordinary secondary-school American football stadiums could have been
built. After all, by some estimates, the "cost" of waging financial war in 2007
and 2008 has exceeded, in real dollars, the amount the United States spent to
fight World War II, the Marshall Plan that rebuilt Europe after it, Vietnam,
and the Apollo moon program - combined.
No, it hasn't - not really. In reality, almost none of that supposed $7
trillion has been real dollars. The Marshall Plan and the Apollo program were
examples of real spending; they were spent on rebuilding railroads and bridges
in Europe, and on pocket protectors in Houston. In contrast, when the
government or Federal Reserve "spends" money on bailouts, all that happens is
that some buttons are pushed on trading desks, government accounts are debited,
and the Tier 1 capital accounts at some bank are credited. None of it's real;
that's why those who say that all this government spending on financial
bailouts will soon breed hyperinflation have it so spectacularly wrong.
None of it's real - except for those losing in all this their house, job,
retirement savings, or, in the case of Iceland, their nation - for them it's
all too real and painful. For the rest of us, why not party happy and healthy
this holiday season? Imbibe with joy and gusto; George W Bush said this year
that all these problems were the result of Wall Street getting drunk, so why
can't you (as long as you have a sober designated driver, of course)? My most
heartfelt holiday wish for all of you is that you get over your hangover a lot
sooner than they are doing with their's.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
(Copyright 2008 Asia Times Online (Holdings) Ltd. All rights reserved. Please
contact us about
sales, syndication and
republishing.)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
