by Jerome a Paris
Sat Mar 8th, 2008 at 01:01:48 PM EST
The western financial system is caught in a trap. On the one hand, there is an urgent need for clearing prices to be established for impaired assets to restore confidence; on the other hand, if this is done in a mark-to-market world, there is a risk that some banks will run out of capital.
(Gillian Tett, Financial Times)
The global economy is facing twin shocks. Natural resource markets are delivering a supply shock of 1970s dimensions, while the financial system is delivering a shock comparable to the bank and thrift crises of the 1988-1993 period.
(Tim Bonds, Barclays Capital, in the Financial Times)
One of the most extraordinary things today is that we are facing two simultaneous crises at the same time. To some extent, they are linked, as the growth in China or elsewehre that pushes commodity prices up by making obvious the resource constraints we are beginning to face was to a large extent fuelled by the financial capitalism-driven globalisation. But they are now having completely opposed consequences, as far as inflation is concerned, with emerging markets demand continuing to push prices up, while the credit crunch is savagely cutting into economic activity and causing across the board asset price drops.
What we are really seeing is a quite brutal change in the relative values of goods and assets. For years, we had debt-bubble-fuelled increase in asset prices (mostly real estate and financial assets) and stagnation in goods prices, caused by the downwards pressure from China and the wage stagnation engineered by financial capitalism's requirements.
Now that process is partly going into reverse. Oil and commodity prices are feeding into goods price inflation, while the credit crunch signals the end of the the dizzying valuations of assets. One category is inflating, and another is deflating. And wages and pensions (ie living standards for most people) are caught in the middle.
But, making things even more complicated, the dollar, ie the unit of money that is supposedly neutrally providing the information on these relative valuations, is itself caught in the middle. The debt bubble was really a massive devaluation of the dollar versus financial assets. It was also a devaluation of wages, which was made tolerable to the general population by the parallel devaluation of consumer goods. Now, both the commodity price increases and the credit crunch are a reversal of that whole process, but as it is inflicting pain on rich Americans, ie the politically powerful, they are not about to let that happen if they can avoid it, and they are trying very hard to ensure that their assets do not lose their relative value. The way for them to do that is to continue to weaken the dollar, in the expectation that they can manage inflation better than others, and that their asset values will keep up with the price of goods and wages, thus entrenching the current (favorable) wealth sharing arrangements.
But the twist for them is twofold: first there are now other players in the asset game, with different priorities (oil producers want to protect the purchasing power of oil as well as that of financial assets; the Chinese want to protect their growth prospects and thus the stability of the system. Second is the fact that there is another anchor of value available today, the euro, which is untainted by either bubbly policies or lax central bank. Attempts to devalue the dollar will be visible immediately in its exchange rate against a credible alternative for all monetary functions (as opposed to, for instance, gold, which is a viable store of value in inflationary times, but is not practical for trade or accounting).
Beyond the battering to American pride of no longer being the dominant economy around, a fall of the dollar has political consequences in that the economy of the US is, right now, heavily dependent on borrowing from abroad to keep running. It could suddenly become dependent on what the lenders in stronger economies elsewhere want.
Which brings us back to our first crisis - the consequences of global growth, and the fact that the lenders are a combination of, on one side, the owners of the commodities that have fuelled the global boom, and on the other hand, the producers of the cheap goods that kept that Western population sated - and also the largest new consumers of those commodities. What both groups share are huge financial claims on the US economy - expressed in dollars. But they are also large consumers of goods - expressed in euros, and of oil and commodities.
Right now, the financial markets, mostly based in New York and London, areoblivious to these complexities, and are in full panic mode, with very unpredictable consequences for everybody:
The markets have become ``utterly unhinged,'' William O'Donnell, a UBS AG government bond strategist in Stamford, Connecticut, wrote in a note to clients today. A lack of liquidity has ``led to stunning air-pockets in price levels.''
``Everything is telling you the financial system is broken,'' Simon, whose Newport Beach, California-based unit of Allianz SE manages the world's largest bond fund, said in a telephone interview today. ``Everybody's in de-levering mode.''
Basically the gears of capitalism are pretty much grinding to a halt," said Mirko Mikelic, portfolio manager for Fifth Third Asset Management in Grand Rapids, Michigan. "What started as a little subprime problem has kind of morphed into a bigger problem for the bigger economy."
Any optimism that the market might escape further violent swings has become increasingly rare. BNP Paribas said: "While deleveraging has taken an accelerated path since the beginning of the year, we believe that this is only the beginning of a trend which will look to unwind the excesses of the last few years."
In recent days new horrors surfaced from the hedge fund world. As credit spread have risen, highly-geared funds have come under increasing pressure from uneasy investors who want their money back, and brokers terrified on counterparty risk.
Willem Sels at Dresdner Kleinwort said: "Price changes, multiplied by leverage, leads to redemption risk and margin risk, which ultimately also leads to unwind risk. This creates a technical sell-off as the unwinds happen in a bearish market."
(FT Alphaville Blog)
For the oil producers and the emerging economies, the financial crisis is not a major issue, because they have not been exposed much to the supposedly sophisticated bits of the financial world, having parked most of their money in so-far-safe US Treasuries, and they have not lost their shirts there. But they do worry about attempts to inflate away the crisis.
And they are in a strong position to impose their views, as therelative importance of the two crises has yet to sink in:
The financial markets require a recapitalisation of the banking system, with estimates ranging from $300bn to $1,000bn.
The broad story [in commodity markets] is of depletion. Most of the easily obtainable resource deposits have already been exploited and most usable agricultural land is already in production. Natural resource discoveries, where they continue to occur, tend to be of a lower quality and are more costly to extract. Meanwhile, the dwindling supply of unutilised land faces competing demands from biodiversity, biofuels and food production.
Predictably, the scale of response to each of these crises is in inverse proportion to their respective magnitude. In the US, the credit crunch has elicited an instantaneous fiscal package to the tune of $168bn, or 1.2 per cent of nominal GDP. In contrast, the latest annual budget appropriation for renewable energy spending is just $1.72bn - 0.01 per cent of GDP.
(Tim Bonds, Barclays Capital, in the Financial Times)
In effect, the current credit crunch, while likely to be horribly painful and hugely destructive, is not the biggest crisis we face!
The growing scarcity of oil and commodities, and the increasingly strained fight for these between the big economies of the planet, is driving a parallel, and even more momentous reallocation of resources and value.
Both the money printing policies of the Fed to fight the deflation in the financial world, and the inflationary effect of commodity scarcity threaten to squeeze the middle classes.
The only good news, so to speak, is that there is a common solution to both problems, and it is one we can choose. That solution is to focus economic policy towards energy efficiency and moving away from oil. This will have the simultaneous advantage of weaning the economy off an increasingly rare resource, to provide a timely keynesian economic boost to the economy, and to re-industrialise the same economy. A massive energy efficiency programme for homes will help slow down the real estate collaspse while providing jobs to a sector (construction) in full retreat right now ; massive investment in reneawable energies, the grid, and public transportation will help put in place the infrastructure needed for the coming decades and create non-offshoreable jobs.