Economic Crisis - UK and US Bankruptcy

It would be hard to miss the headlines of plunging stock markets around the world. In a note on my post on 'The Banking Crisis - What is REALLY Going on' I had this to say in a note at the end:

The justification for the bailout is to avoid a repeat of the Great Depression. However, the world is not in the 1930s, so why would an imagined solution to a 1930s problem fit the circumstances of 2008. . There is no evidence that it would have worked then, and even if had worked then, would that suggest that this would solve the different crisis that is occurring today?

I also proposed many reasons, in many posts, why the US bailout was foolish, and proposed that the best that it could do was delay the progress of the crisis. It seems that is has not even managed that. The simple fact is that it was like trying to hand a prozac tablet to a raging elephant. It was never going to work in the long run, and has actually made the situation even worse. In this case, in trying to hand over the prozac necessitated putting oneself in the metaphorical path of the elephant.

Meanwhile we have the financial commentators such as Anatole Kaletsky saying things like this:

'Does all this mean that banks that lent imprudently during the boom should now be supported with taxpayers' funds? The answer is emphatically: Yes! The time to worry about “greedy bankers” and tighten regulations will be in the next boom. Today, the risks of excessive caution are much higher than the hazards of rewarding greed. This may sound immoral; isn't far greater immorality to throw millions of workers, homeowners and businesses on to the scrapheap of recession?'

I have been critical of the views of Kaletsky before. It is not that he is any more wrong than many other commentators, but that he is representative of the self-delusion of so many commentators, that he professes to believe in the market, but still thinks that government can reverse the consequences of actions of many years and, by magic, make the world economy sunny again. It is the dangerous continuation of the delusions that have really caused this crisis. It is worth noting that he focuses on the question of the morality of bailing out the banks, rather than the real criticism that should be made; that government intervention can not save the economy, that only a switch from debt consumption to wealth creation can fix the problems., along with a massive restructuring of the Western economies.

Perhaps the most laughable (in a painful way) response in all of this was the agreement of a package of support in Europe for small businesses through the crisis. I can not find any of the original articles to get the figures for this, but I seem to remember it was £GB 16 billion. It returns me to the elephant analogy, but in this case it is like trying to stop the elephant with a pea shooter.

I also posted recently about the danger that the Irish guarantee of all deposits would likely result in other governments following this action. It seems that this is now occurring, thereby negating any benefits to this action for Ireland, whilst exposing governments around Europe to ever greater liabilities. I have generally avoided the subject of the Euro area, as views on the EU are very partisan, and not amenable to reasoned discussion. However, at this stage, it may be worth taking the chance of wading in. A currency built upon different countries following different economic policies, with different economic structures, was always a rather dangerous experiment. In previous posts I have discussed the potentially different outcomes of the crisis for different economies within the Euro zone, and suggested that the Euro would devalue, but less than the $US or £GB.

I am now coming to a conclusion that this crisis might well see the end of the Euro. The crisis is going to highlight the problems of trying to bind together very different economies, and I suspect that nationalism will triumph in the face of the crisis. Curiously the inability of Europe to act in concert may actually be a good thing, but will be seen as a bad thing. This will probably cause ever rising tensions, and also possibly a popular backlash against the Euro in countries like Germany (which has in any case always been worried about the loss of control over their own currency). I am cautious in suggesting this, as it is largely in the hands of politicians, but believe that 'events' may create their own momentum. Such a mish-mash of different economies made the Euro difficult to predict, and this remains the case, though now it is possible that the contradictions at the heart of the idea will destroy it altogether.

The really shocking thing in the responses to the crisis is how governments are progressively digging themselves into ever deeper financial holes. More and more money and guarantees of the financial system are being offered to try to hold back the crisis. This is going to accelerate the decline in the finances of both the US and UK governments, as well as Euro countries. I predicted a long while ago that the UK would be going to the IMF for a financial bailout. More recently, I asked who would be financing the IMF to provide for the bailout, and this question still nags at me without an answer. In other words, there will be no rescue of the UK and US by the IMF, as both governments fall into effective bankruptcy. The crisis is now progressing such that there is no chance of the rest of the world continuing to finance the deficits of the UK and US. In a very short time, in the next few months, there are going to be two possible alternatives for the UK and US governments to finance their activities. One is that they will have to 'print' money, with resulting hyper-inflation, and the other is that there will be a horrendous carnage in the public sector payroll, with either massive pay cuts (expect chaotic political reaction), or massive lay-offs.

Whilst being able to predict the crisis, I pointed out that the world economy would enter a state of chaos, and that it would then be the actions of individuals that would shape the direction. I was always gloomy about the prospects for an intelligent response, but the reality of the situation and the response makes my previous gloom look positively optimistic. Where are the leaders who are willing to look at the crisis square in the face, and accept that it is not some financial aberration, but a fundamental problem in the structure of the economies of the Western World? In order for the Western countries to restore confidence, the only solution is firm proposals of change in their economic structures.

Rather than letting crisis drive the change they have a brief window of opportunity to drive through reform. Such reform might, just might, be enough to prevent the onset of ruinous disaster. The first step is to rein back public sector spending NOW, before it is too late. That means no more bailouts, no more financing of the banks, and massive cuts in public expenditure. It is only if the creditors of the West see such action now, that there is any chance that they will keep lending, and thereby give a breathing space for the Western economies to adjust to the re- balancing of the word economy. Such action is, of course, a dream.

A very pessimistic post, but I make no apologies for this. I have always tried to see the situation as it is, not as we would like it to be. I have often said, whilst predicting this disaster, that I would like to be proven wrong. There is no satisfaction in having been proven right, and I hope in this case that the progression of the crisis that I am now predicting will be wrong. However, on my record so far, this is a forlorn hope. I can not not believe my own analysis of the situation....

Note: As ever I have jumped about from the US to the UK to Europe. Please accept my apologies for this, but I hope that there is at least some coherence in the post.

Note 2: It is now apparent that the damage to the western economies is now spreading far and wide. As I have previously suggested, gold seems to be winning, and other commodities are losing. However, for the medium to long term, I would emphasise that commodities will rise again, though (as I have said before) in about 4 years time. I am sticking with my price for oil at around $60 per barrel (or maybe lower?), but suggest that this price may come sooner than my original prediction. Maybe within a year. I also stick by my assertion that emerging economy and commodity producing economies will see their currencies strenghten against the £GB, Euro, and $US, as the current panic settles. From the current state of chaos, the underlying realities behind the world economy will emerge, and that will mean that the Western currencies must fall relative to the rest of the world. Furthermore, as I have explained elswhere, the slack in commodities being produced by the shrinkage of the OECD economies will be taken up by the emerging economies. At that point, expect commodities to return to an upwards ascent.

Note 3: A Telegraph article (just published) suggests that the bailout might not be enough....it is amazing how wise everyone can be with hindsight. The real questions that the article should be discussing are how much is 'enough' and where will it come from?

Note 4 Added 8 October: Am I the only one who has noticed? I am sure I can not be, but will post in the assumption that I am. The people who pressed for the financial bailout in the US pointed to the crash in the stockmarkets as one of the reasons for suggesting that the bailout MUST be passed (written in uppercase to reflect the panic effect) to restore 'confidence'. Once the bailout passed, and the stockmarket fell anyway, did any of those who were pushing for the bailout on this basis change their mind? After all, if it was needed to restore confidence, and failed in that task, should they not now be saying that the bailout should be cancelled? It is rather a large sum of money, and if it does not do what is is supposed to.....?