Thursday, September 18, 2008

King Canute and the Banking Crisis

I very rarely post this often, but it is an unusual point in time. I have long predicted this crisis (for new visitors to the site see the links to the left and browse the posts in the archive), knew what would happen but, somehow, now that it is here, there is a sense of unreality about it. I predicted this crisis but now we are in the situation, it seems less real than it did in my imagination and thoughts. In my imagination I did not have a sense of the panic that would ensue, but imagined the world looking on with the same dispassionate perspective that I take in considering these matters. A strange point of view with hindsight.

The reason for this quick post is that I have just browsed onto the Times website and found the following news:
'The Bank of England today joined forces with five of the world's most powerful central banks to inject up to $180 billion (£100 billion) into the world's financial system in a concerted bid to ease the funding pressure on international markets.'
From the title of this post, it is probably fairly obvious what I think of this action. More to the point, how much money are governments going to keep pumping into the markets before they realise that there is no stopping the crisis. They may delay it, but nothing can alter the fact that the fundamental problems that have caused the crisis will still be there.

The reasons that the banks are not lending to each other is that they all know that they are all holding toxic debt. This is not just CDOs etc. but also fast deteriorating commercial debt, unsecured consumer debt, and old fashioned mortgage debt (held on devaluing assets with people with ever more insecure job prospects). Furthermore, the sources of liquidity from the East are drying up as confidence in the 'rich world' banking system is evaporating.

The trouble is that, government balance sheets were already looking ugly and were getting uglier by the day as revenues will have been falling like a sone. Government are now piling more toxic debt onto the balance sheets, hastening the day when governments start to default. Had they accepted the reality of the situation, then there was a real possibility that they could have cut back on expenditure, reformed structurally, and perhaps have scraped through (just). Instead they are pouring money into black holes, and daily raising the likelihood of default.

Of all of the actions that governments could take, I can not think of a worse solution. There is going to be a very, very painful period of adjustment. Governments need to hold whatever resources they can for when their economies go through restructuring. It will not be possible to reform the cost bases of the world economy overnight, and that means that there is a need for as much of a breathing space as possible. Every $ that is poured into the black hole of the banking system shortens that breathing space. Furthermore, as I have said in my previous posts, it will eventually be repaid from the healthy sectors of the economy.

I am starting to find myself repeating myself, but it also needs to be said that the current crisis is not the real crisis but the symptom of the imbalances in the world economy. The only way to address these imbalances is to actually address the structure of the Western economies such that they are once again able to compete.

As I suggested at the start of the post, what we are witnessing is blind panic - and an irrational belief that something can be done. The trouble is that what is being done will be both ineffective and costly, and can (at best) delay the adjustments. It is a tragic waste of resource just at the time when those resources will be needed most.


The Telegraph also has article on the rescue package here, and the FT offers the best summary here...

Note 2:

We are currently undergoing an experiment in seeing whether governments can hold back economic reality. It is, when you think of this, very much like Canute holding back the tide. However, in the case of Canute, he knew that he could not really do it, and that was the point. Do the central bankers think they can really hold back the economic tide?

Note 3: In my last post I answered a question on what was a safe investment, and suggested that gold was a reasonable bet (I had mentioned a similar sentiment in an earlier post). I have just noticed that gold had already been posting record gains (not surprising under the circumstances). I have never looked closely at the gold market, so have no sense of how these gains can be measured, but perhaps it is too late to buy into gold. As such I would strongly recommend a long look at the history of gold prices before jumping into the market. However, as I mentioned before, gold prices are driven by sentiment, and any positive sentiment on the latest bailout is not likely to last that long.

1 comment:

  1. Mark

    It occurred to me a while ago that as the actual mechanisms of finance were about to break down, it might somehow be an idea to 'reset' the economy, effectively cancelling existing debts. I have noticed a couple of comments in newspapers over the last couple of days suggesting something similar.

    Some people would be very happy with this, and some would not!

    Presumably inflation achieves the same thing in a more subtle way, progressively reducing both existing savings and debts. Do you think that inflation might actually be used as a deliberate policy in the coming months and years?


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