The End of Ponzi Prosperity ~ Satyajit Das

04.05.2009
Lessons of the Global Financial Crisis: 1. The End of Ponzi Prosperity

By: Satyajit Das



We Are All Keynesians Now!

In January 1971, Richard Nixon recanted years of opposition to budget deficits declaring: "Now, I am a Keynesian." Nixon had borrowed the line from Milton Friedman who had used it in 1965. Then, we embraced Monetarism and flirted with "supply side" economics, christened "voodoo economics" by President George Bush Senior. Now, in the wake of the Global Financial Crisis ("GFC"), it seems that we are all Keynesians again.

The GFC is really a "Minsky moment". In Stabilizing an Unstable Economy (1986), Hyman Minsky outlined a hypotheses that excessive risk taking, driven in part by stability lead to market breakdowns - stability is itself destablising.

The current crisis is financial, economic, social and increasingly ideological. Nikolas Sarkozy, President of France, has pronounced the death of laissez-faire capitalism: "c’est fini". World leaders have penned fevered attacks on neo-liberalism. Even religious leaders have spoken out.

Dead economists have been resurrected in support of political positions. As Keynes himself observed: "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back."

No "pure" economic model has been implemented in living memory, except perhaps in North Korea. The theories themselves rarely work. John Kenneth Galbraith is reported as saying: "Milton’s [Friedman’s] misfortune is that his policies have been tried."

Criticisms of the ancien regime are substantive and deserved. There have been undoubtedly egregious market failures, management excesses and errors in the lead up to the GFC. But the key lessons of the crisis may be subtler than first evident.

Growth has been driven by cheap and abundant debt and uncosted carbon emissions and other forms of pollution. The reality is that this period of growth may be coming to an end.

All brands of politics and economics have been informed by assumptions about the sustainability of high levels of economic growth and the belief that governments and central bankers can exert a substantial degree of control over the economy. Harry Johnson, the famed Chicago economist, writing about England in the 1970s with his wife Elizabeth in (1978) The Shadow of Keynes provides a vivid description of this pre-occupation: "…faster economic growth is the pancea for all..economic and for all that matter political problems and that faster growth can be easily achieved by a combination of inflationary demand-managementpolocies and poltically appealing fiscal gimmickry."

Goldilocks Economy

P.J.O’Rourke writing in Eat The Rich (1998) observed that: "Economics is an entire scientific discipline of not knowing what you’re talking about."

Recent global prosperity derived from a fortunate confluence of low inflation and low interest rates. In the 1980s, brutally high interest rates and recessions squeezed inflation out of the economy facilitating lower interest rates. Low energy prices, following the first Gulf War, helped keep inflation low and fuelled growth.

The fall of the Berlin Wall in 1989 and the reintegration of the command economies of Eastern Europe, China and India into global trade provided low cost labour helping maintain the supply of cheap goods and services. Emerging economies provided substantial new markets for products and capital driven by the very high levels of savings in these countries.

Deregulation of key industries, such as banking and telecommunications, fostered growth by increasing access to finance and improved essential infrastructure. Adoption of new technologies, such as information technology and the Internet, improved productivity and assisted growth, though the extent is disputed.

Many countries switched from employer or government pension schemes to private retirement saving arrangements underwritten by generous tax incentives. Rapid growth in this pool of investment capital was also a factor in growth.

Governments, irrespective of political persuasion, benefited from the favourable economic environment. The ability of governments and central banks to control and "fine tune" the economy with a judicial mixture of monetary and fiscal policy became an article of accepted faith. Voters were lulled into false confidence by a mixture of rising wealth, improved living standards and stability.

Elegant theories about the "Great Moderation" or "Goldilocks Economy", with the benefit of hindsight, seem to be little more than narrative fallacies where a convincing but meaningless story is shaped to fit unconnected facts and coincidence is confused with causality.

Ponzi Prosperity

Growth, in reality, was founded on a series of elegant Ponzi schemes.

Consumption rather than investment drove growth, particularly in the developed world. Debt fuelled consumption became the norm. In the new economy, there were three kinds of people – "the haves", "the have-nots", and "the have-not-paid-for-what-they-haves".

The consumption was financed by borrowings supplied by a deregulated financial system. Many workers’ earnings fell in inflation adjusted terms as a result of global competition and associated outsourcing and off shoring practices. The ability to borrow against the appreciation in owner occupied houses and other financial assets underpinned consumption.

Investors, central banks with large reserves, pension funds and asset managers channeling privatised retirement savings, eagerly purchased the debt. Borrowing fueled higher asset prices allowing even greater levels of borrowing against the value of the asset. This virtuous cycle – a "positive feedback loop" – fueled the "doctor feel good" economy of recent years.

"Financial engineering" replaced "real engineering" in many countries. Entire cities (London and New York) and economies (Iceland) become dominated by the rapidly growing financial services industry. In the US, financial services’ share of total corporate profits increased from 10% in the early 1980s to 40% in 2007. The stockmarket value of financial services firms increased from 6% in the early 1980s to 23% in 2007.

The reliance on financial innovation proved disastrous. In A Short History of Financial Euphoria (1994), John Kenneth Galbraith noted that: "Financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design . . . The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version."

Financially engineered growth extended into international trade flows. Since the 1990s, there has been a substantial build-up of foreign reserves in central banks of emerging markets and developing countries that became the foundation for a trade finance scheme.

Many global currencies were pegged to the dollar at an artificially low rate, like the Chinese Renminbi, to maintain export competitiveness. This created an outflow of dollars (via the trade deficit driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers purchased US debt with dollars to mitigate upward pressure on their domestic currency. The recycled dollars flowed back to the US to finance the spending on imports.

The process relied on the historically unimpeachable credit quality of the USA and large, liquid markets in dollars and dollar investments capable of accommodating the very large investment requirements. This merry-go-round kept US interest rates and cost of capital low encouraging further borrowing to finance consumption and imports to keep the cycle going.

Foreign central banks holding reserves were lending the funds used to purchase goods from the country. The exporting nations never got paid at least until the loan to the buyer (the vendor finance) was paid off. Essentially, growth in global trade was also debt fuelled.

Moderate debt levels are sustainable provided the value of the asset supporting the borrowing is stable and significantly higher than the amount of the loan. The borrower or the collateral for the loan must generate sufficient income to service and repay the borrowing. In the frenzied market environment of low interest rates and ever rising asset prices, the level of collateral cover and ability to service the loans deteriorated sharply. In 2005, rising interest rates and a cooling in the US housing market set the stage for the GFC.

Sigmund Freud once remarked that: "Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces." The GFC was the reality on which the fake pleasure of the Great Moderation and Goldilocks economy was smashed.

Taking the Cure

There is currently confusion between the disease and the cure. The "disease" is the excessive debt and leverage in the financial system, especially in the US, Great Britain, Spain and Australia. The "cure" is the reduction of the level of debt that is now underway (the great "de-leveraging").

The initial phase of the cure is the reduction in debt within the financial system. Some of the debt created during the Ponzi prosperity years will not be repaid. Non-repayment of this debt, in turn, has caused the failure of financial institutions. The process destroys both existing debt and also limits the capacity for further credit creation by financial institutions.

Total losses from the GFC to financial institutions, according the latest estimates, will be in excess of US$ 2 trillion. Banks need additional capital to cover assets that were parked in the "shadow banking system" (the complex of off-balance sheet special purpose vehicles) but are now returning to the mother ship’s balance sheet. The global banking system, in aggregate, is close to technically insolvent.

Commercial sources for recapitalisation are limited as losses mount and the outlook for the financial services industry has deteriorated. Government ownership or de facto nationalisation is the only option to maintain a viable banking system in many countries.

Even after recapitalisation the capital shortfall in the global banking system is likely to be around US$ 1-3 trillion. This equates to a forced contraction in global credit of around 20-30% from existing levels.

The second phase of the cure is the effect on the real economy. The problems of the financial sector have increased the cost and reduced availability of debt to borrowers for legitimate business purposes. The scarcity of capital means that banks must reduce their balance sheets by reducing their stock of loans. Normal financing and loans are now being effectively rationed in global markets.

This forces corporations to reduce leverage by cutting costs, selling assets, reducing investment and raising equity. This also forces consumers to reduce debt by selling assets (where available) and reducing consumption.

"Negative feedback loops" mean reduction in investment and consumption lowers economic activity, placing stresses on corporations and individuals setting off bankruptcies that trigger losses for the financial system that further reduces lending capacity. De-leveraging continues through these iterations until overall levels of debt reach a sustainable level determined by lower asset prices and cash flows available to service the debt.

Within the financial sector, de-leveraging is well advanced. In the real economy it is in the early stages. The process echoes Joseph Schumpter’s famous maxim of "creative destruction".

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

This article draws on the ideas first published in Satyajit Das "Built to Fail" in The Monthly (April 2009) 8-13

http://www.eurointelligence.com/article.581+M553774d2c37.0.html

On buying dips in this environment

The idea that this bear market will end and life will return to "normal" is, in the opinion of this writer, completely mistaken. The public domain, as far as opinion goes, in this writers view is still contaminated by the paid optimism of vested interests. The sponsors of our media are the winners of the great boom and their opinions regarding a return to a "dollar hegemony based debt fueled once in a lifetime blowoff" normality must be discounted.

No doubt a golden age based on digitisation and measurment efficiency, smart grids, biology based extraction technologies and a revitalised if somewhat localised agriculture lies ahead but I expect that to some extent the whole globalisation paradigm will have to be rebuilt from the ground up on more economically sustainable grounds. The winners in that recovery, when it comes, are probably small companies unknown to the public.

A true new bull market, if it is not driven by the mere inflation of nominal values must arise out of a backdrop of near total and universal despair and capitulation, not the denial we see all around.

People who rushed to by bargains last time we had a bear market like this one, and those who came after, and those who came after them, were all destroyed..

The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to ensure that as few as possible escaped the common misfortune. The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost.

The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. (Not only were a recoreded 12,894,650 shares sold on 24 October; precisely the same number were bought.)

The bargains then suffered a ruiness fall. Even the man who waited out all of October and all of November, who saw the volumne of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or a fourth of the purchase price in the next twenty-four months.

The Coolidge bull market was a remarkable phenonmemon. The ruthlessness of its liquidation was, in its own way, equally remarkable."

Capitalism's Greatest Vulnerability:~ Nolan

The great Hyman Minsky postulated that Capitalism was “flawed.” Over the years I’ve taken exception with this particular view, countering that Capitalism is more appropriately described as “vulnerable.” As part of this line of analysis, I have used the analogy of the human eye. We would not think of its delicate nature and susceptibility to injury as some “flaw” in our eye’s design. Instead, this inherent vulnerability is fundamental to the nature of this important organ’s functionality. We worry much less about our elbows, but they’re not going to do an adequate job detecting light and transmitting visual signals to our brains.

I have argued over the years that an extraordinary backdrop has beckoned for keen focus in order to protect our Capitalistic system from its inherent vulnerabilities - just as one would don sun glasses on a sunny beach or ski slope or insist upon tight-fitting safety goggles before entering a metal-working shop. One must first recognize inherent vulnerabilities and then take more aggressive preventative measures as necessary in response to riskier environments.

We, as a society, failed to take preventive action. Now, Capitalism as we have known it is under fierce attack from many directions and on various levels. At the same time, there is regrettably scant indication that we now possess any clearer understanding of the nature of Capitalism or its inherent vulnerabilities. We’re still entwined in Mistakes Beget Mistakes.

But there’s lots of blame being bandied about. Many pinpoint “Wall Street greed.” The securities firms, reckless traders, hedge funds, rank speculation and egregious leverage are viewed today as the major culprits. Executive pay and Wall Street bonuses are pilloried for fomenting dangerous excess. Others trumpet the failure of regulation and corporate governance. Some attribute the mess to the Asian propensity to save. There’s a more sensible case that flawed banking and Wall Street risk models played an integral role in the fateful Bubble. Many that participated in the bountiful upside of the speculative Bubble these days posit that the rating agencies were at fault for garnishing “AAA” ratings on Trillions of risky securities and debt instruments. And a very strong argument can be made that hundreds of Trillions of derivatives played a fundamental role in the near financial implosion. But how could it be that so many things went so wrong all at the same time?

I have over the years expressed disdain with the “free market ideologues” for their steadfast refusal to even contemplate the possibility that “Capitalism” could possess vulnerabilities of need of recognition and corrective action. Yet, economic history is replete with boom and bust cycles, along with a bevy of post-Bubble writings providing us fertile ground for cogent analysis of system vulnerabilities. Contemporaneous analysis during the Great Depression focused clearly on the acutely susceptible U.S. Credit system that emerged from “Roaring Twenties” lending and speculative excesses. During the forties, fifties and even into the early sixties there was some adroit analysis of the Credit system’s role in the boom and subsequent depression. This entire fruitful line of analysis was, however, stopped dead in its tracks with the emergence of a revisionist view of the twenties as the “Golden Age of Capitalism” needlessly terminated by post-crash policy blunders.

The Great Depression and today’s turmoil expose Capitalism’s vulnerabilities. And as easy (and accurate) as it would be for me to write that the problem lies first and foremost in the “Credit system,” I have come to believe that it is vital to dig deeper to get to the root of the problem: Capitalism’s Greatest Vulnerability lies with Risk Intermediation.

The essence of Capitalism is one of a predominantly private system of allocating resources based on market price signals. A private Credit mechanism is fundamental to financing the economic system in a manner that effectively allocates both financial and real resources. And we can stop right here and recognize potential pitfalls. First, Credit flows may be inadequate to finance sound investments or to sustain economic activity. Second, there may be too much Credit. I have for some time argued that Credit excess (“Credit inflation”) is the Bane of Capitalism. Credit excesses distort the various costs of finance throughout the system, while inflating asset prices and fostering distorted spending and investing patterns (among other effects). And, importantly, Credit inflation inherently fosters self-reinforcing Credit inflation through asset price, economic, and speculative Bubble dynamics. In short, “Credit excess begets Credit excess,” with its subtle but corrosive effect upon pricing mechanisms.

But how on earth does the always-existing nature of “Credit Begetting Credit” somehow morph into the history’s greatest Credit Bubble? One way: Unfettered Risk Intermediation.

I often referred to “Wall Street Alchemy” - the process of various methods of intermediation (Wall Street securitization structures, myriad Credit insurance and financial guarantees, liquidity arrangements, dynamic hedging, explicit and implicit government backing, etc.) transforming risky loans into coveted instruments perceived by the marketplace as safe and liquid (“money-like”). I have also theorized that a boom predominantly financed by, say, junk bonds would never run too far before the market loses its appetite for the inflating quantity of (conspicuously) risky debt. In contrast, our recent Credit Bubble was financed by endless Trillions of “AAA” debt instruments (GSE debt, MBS, ABS, CDOs, CP, “repos”, auction-rate securities, top-rated guaranteed muni debt, Treasuries, bank deposits and such) ran to unmatched excess.

Importantly, there was a direct relationship between our contemporary system’s capacity to intermediate Credit risk and the expanding scope of the Bubble. Over years, risk was in varying degrees distorted, camouflaged, or deceptively concealed to the point that it was no longer even possible to monitor, analyze or regulate it. Worse yet, the risk intermediation process was self-reinforcing instead of self-adjusting and correcting. Wall Street “alchemy” was the true source of this period’s “easy money.”

Our Credit system’s capacity to intermediate Trillions of mortgage and consumer debt into “money-like” instruments was instrumental in fueling real estate and asset Bubbles throughout. It was the capacity of Credit system intermediation to create Trillions of instruments (chiefly Treasuries, agency debt, MBS, and “Repos”) perceived as safe and liquid by our foreign trading partners that accommodated our massive current account deficits (and attendant domestic and international imbalances). It was contemporary risk intermediation at the heart of a historic mispricing of finance for, in particular, mortgages and U.S. international borrowings. And it was the potent interplay of contemporary risk intermediation and contemporary monetary management/central banking (i.e. “pegged” interest rates, liquidity assurances, and asymmetrical policy responses) that cultivated unprecedented financial sector and speculator leveraging.

Most historical analyses of busts (going back about 300 years to John Law!) focus on banking ineptness, negligence, excesses and nuances. Banks, creating “money-like” (i.e. deposit) liabilities in the process of intermediating loans, have historically been at the center of boom/bust cycles. Contemporary finance – with its focus on marketable debt instruments - took intermediation risk to a completely new danger level. For one, traditional bank capital and reserve requirements no longer provided any restraint on the quantity of Credit that could be extended and intermediated (in the “market” or “off balance sheet”). Furthermore, the marketable nature of these instruments (created in the intermediation process) cultivated speculative demand for leveraging higher-yielding securities (i.e. hedge funds buying collateralized debt obligations that had acquired private-label subprime MBS). Cheap finance literally flooded the riskiest sectors of the economy

All of this led to extreme systemic distortions in the pricing of risk - along with the attendant massive over-expansion of Credit and the economy-wide (and global) misallocation of real and financial resources. Buyers of intensively intermediated instruments (say “AAA” senior CDO tranches or auction-rate securities) in many cases could not have cared less with regard to the type of underlying loans being financed. Elsewhere, the buyer (leveraged speculator or trade partner) of agency securities could not have been less concerned with GSE balance sheet issues or California home prices. This entire process of contemporary (marketable instrument-based) intermediation developed an overwhelming propensity for financing asset-based loans instead of real economic wealth-producing investment (unlimited supplies of mortgages were viewed as a more appealing asset class than limited amounts of corporate loans). It is not only in hindsight that this process of risk intermediation should be viewed as central to system asset price distortions and economic maladjustment.

I am tempted to write “I am as tired writing about the previous Credit Bubble as readers are reading about it.” But I’m not tired. And this topic is not as much about rehashing the past as it is about providing a perspective as to why I believe the current course of policymaking will inevitably end in failure. Why? Because of the very complex and unresolved issue of Risk Intermediation.

Wall Street “finance” self-destructed in the process of intermediating Trillions of risky loans. It was the quantity of Credit and the nature of resulting spending patterns (resource allocation) that both doomed this endeavor and ensured a deeply maladjusted economic structure. This terribly flawed financial structure has morphed into a system where our government has stepped forward to supplant Wall Street as predominant risk intermediator. Basically, the Fed and Treasury are in the process of intermediating risk on a system-wide basis – to the tune of tens of Trillions – with little possibility of extricating themselves from this endeavor going forward.

This development may be welcomed by Wall Street and the markets - and it certainly goes a long way toward getting the Credit wheels rolling again. It would be expected to help spur some level of global economic “recovery.” I would argue, however, at the end of the day we will see that it has only exacerbated the problems of risk mispricing, Monetary Disorder, financial and real resource misallocation, and economic maladjustment.

Our Capitalistic system has been severely injured. I don’t expect meaningful structural recovery until there is some semblance of restoration to our Credit system’s mechanism for the pricing and allocation finance. This, I believe, will require our system to wean itself both off of its dependence on enormous Credit expansion and away from Washington’s newfound role of chief system risk intermediator and allocator (the “Government Finance Bubble).

http://www.prudentbear.com/index.php/commentary/creditbubblebulletin

The real deal, more or less, is common sense

http://prudentinvestor.blogspot.com/2009/03/capitalism-socialism-and-democracy-and.html


SUNDAY, MARCH 15, 2009
Capitalism, Socialism and Democracy - and Common Sense
Monitoring financial and political news has become a very depressing task recently.
While the USA enjoyed a short fairy tale period between president Obama Barack's election and his inauguration, the staccato of catastrophic news has accelerated into a crescendo of crisis since January. Financial TV gushes with appearances of the global top brass, united in the goal to fend off the consequences of 22 years of highly expansive monetary policy, free market gospel and excessive leverage on public and private levels, but clueless how to achieve this.
Europe fares still worse. What looks like a nosedive in American economic activity evokes images of a freefall in the old world at close range.
Overindebted consumers, now also fearing the increasing possibility of losing their jobs and tightening the grip on wallets thinned by rising public service fees, overshadow the progress in the East.
China's exports hit a roadblock in January with no signs of an improvement and India has to sober up from a credit financed shopping spree, now that the demand for online personal valets is on a steep decline and endangers many a call centre.
Daily closures in the Western hospitality industry clearly mirror a new mindset of frugality among consumers.
Eastern Europe is the ticking time bomb in the backyard of the Eurozone. The region currently wakes up to the devastating effects of forex borrwoing to finance consumer goods. Now the local currencies languish close to their record lows.
Major forecasters offer no relief. The World Bank, the OECD and many other institutions expect the global economy to shrink for the first time in ages. Deutsche Bank recently warned that the German economy could shrink an unprecedented 5% this year. This may still be optimistic given the recent halving of German machinery orders.
"They" Don't Have a Clue
While first being overwhelmed by the fastest contraction in economic activity in recorded history, hanging on the lips of central bankers and politicians in order to get an idea about the future, I have rescinded from this time-wasting procedure for a simple reason. "They" don't have any clue how to handle the rapid disintegration of the world's financial fiat currency system.
Memorializing financial history the current crisis finds multiple precedents. All economic crises in the western hemisphere have rooted in excessive monetary expansion that is only possible under a fiat currency system.
One cannot blame politicians for their preference of a monetary system that allows to catch voters with perks and benefits that will have to be paid for by future generations. But how could I cast a vote for them when they ultimately hang on to economic theories that have never proven to work in the last 4 centuries??
It is a fact that the purchasing power of all unbacked fiat currencies has always been wiped out by inflation. Floating currencies don't float. They only sink at different speeds.
This leads to the ultimate crux in the enduring discussion how to mitigate and solve the crisis. This is not a problem of the acting persons but a problem of the domineering theories where the supremacy of fiat money does never get questioned in the first place.
The global big-wig elite comprised of central bankers, bankers and CEOs, finance ministers and other government members, clings on to a bizarre mix of empty free market phraseology that stands in deep contrast to recent nationalizations on both sides of the Atlantic, and Keynesian attempts to jumpstart the economy with new debts on top of those that have become unbearable already, leading to the current disastrous environment.
Plunging stock markets may be a good indicator that investors correctly mistrust public promises that those in charge have a plan other than to echo the fallacies of John Maynard Keynes, who preached anti-cyclical government intervention to revv up the economic engine. But they conveniently forget the other part of Keynes' model. Keynes also talked about government savings in the fat years in order to finance the deficit spending periods.
At the same time the government's share in the economy rests well above the 40% threshold, hardly a proof that capitalism has developed according to the slogans of promoters from all political camps.
Conservative and progressive political camps apply the old standard fare. Hypocritical calls from the right that demand to let markets work their way through this crisis of epochal proportions are nothing but empty words, given the string of nationalizations initiated by comrades Henry Paulson, Britain's Alistair Darling and Germany's Peer Steinbrueck, all with a strong conservative background.
Capitalism, Socialism Converge in Their Late Stages
Current events disclose a remarkable convergence of capitalism and socialism in their final stages. A privileged few cronies enjoy the perks of power and money while the other 95% have to come to terms with policies that are beneath contempt to the true interests of the average citizen/consumer.
It is not in my interest to prop up ailing banks with my future tax payments who steered themselves into unsustainable profit expectations by rejecting common sense for years.
Peer pressure adds to the systemic problem that no banker can forego profits made by all others. Going back to 2005 there were only a handful of bloggers, economists and market pundits who stood out by warning well ahead of August 2007 when irrational exuberance vanished overnight and the credit crunch set in.
Calming official voices have failed to inform the public correctly ever since.
ECB president Jean-Claude Trichet erred especially at the beginning of the crisis, spreading the wrong word that central banks are capable of ending the crisis. By now he concedes that the end may be far off.
Fed chairman Ben Bernanke did not perform better. Both his speeches and the FOMC's monetary policy of the past 18 months are undeniable proof that the Fed has been behind the curve since the onset of the crisis, fulfilling former Fed chairman Paul Volcker's predictions that US fiscal and monetary policy would be "too little, too late."
The short breath of relief in the aftermath of Obama Barack's electoral victory has meanwhile given way to a far more somber scenario. The president's daily live appearances may show his commitment to the American people, but they lack any guiding substance. Neither he nor treasury secretary Tim Geithner have offered more than vague promises to fix the system, unfortunately omitting anything that could be construed as an effective start to tackle the worst insolvency crisis in history. Do they have a plan, it has to be asked repeatedly until they come forward with an unambiguous policy that shows a willingness to save and distribute government money to those in need.
The situation in the final era of busting fiat currencies reminds me a bit of the system wars between a sleek Apple MacBook Pro and the failure-prone Windows software architecture. Although 90% of PCs are running Windows this does not make them better computers. Remember Microsoft CEO Steven Ballmer who wrote in an email last year that he would get a Mac were he not working for Microsoft!?
The same happens on capital markets. Although the history of fiat currencies is a stream of hyper inflation tales the gold standard does not even get discussed in top circles. This will be hard to overcome as the hopeless indebtedness of the first world can only be written off via hyper inflation or war.
Also do not forget that the world has alrady turned upside down. Now it is the former paupers financing the profligacy of the western money sultans who wrongly thought that creating more paper equals more wealth.
What Happened To Common Sense?
The failure to apply common sense in a world where external business consultants direct company fortunes with their one size fits all templates appears systematic. Over-specialization has elevated many consultants to their own level of incompetence.
Take the car industry for instance. German producers still bet heavily on HP monsters capable of 150 mph top speeds. That's maybe useful for 3 AM commutes between Frankfurt and Hamburg, but in the daily traffic jam choking all metropolitan areas worldwide I would rather prefer some sort of living room on 4 wheels.
The Wrong Dogma of Ever Expanding Credit
Monetary policy has the same shortcomings. Blind to any other model than the perma-failing fiat currency ideology central banks shy away from any thought other than the current - but probably outdated - dogma of ever expanding credit.
Continuous failings of the fiat money system in the past 3 centuries have been aggressively ignored by economists and those actually involved in the economic process. Apart from Hungarian Antal E. Fekete there are no scholars researching the virtues of a gold standard that held inflation close to zero for more than a century in the USA before the Federal Reserve was formed.
Central banks have certainly done an excellent job in demon(eti)zing mankind's oldest currencies: gold and silver.
I am always appalled that the majority of fund managers still doubt the virtues of the only asset that is not somebody else's obligation.
As the whole world is about to suffer dearly from a crisis that has its roots in the irresponsible easy money policy of central banks I begin to wonder why there are no calls for responsibility. Like 9/11, where not a single military was charged with the greatest blunder in American defense policy, all those responsible for the current economic mess have been sent home with a golden parachute after proving their incompetence in the field. This is morale hazard and socialism for the rich at its best.
Who Will Be Held to Account?
While stealing an apple in a grocery store can earn a hungry impoverished evictee a life sentence if it was the third apple he grabbed to fill his revolting stomach, Ponzi schemers like Bernie Madoff are treated with silk gloves. Bankrupting thousands of investors to the tune of $50 billion, Bernie was let to enjoy his luxury condo another 3 months. What an awkward reminder of the sad truth that you are a murderer when killing one while one advances to a statesman when having killed thousands. The same seems to apply for fund managers who bet their clients money on exotic derivatives. It can be safely assumed that Madoff is only the tip of the iceberg.
The breakdown of morale at the wealthiest levels came with the markets nosedive to its current lows: When the going gets tough, everybody runs for the cover of cash.
While the banking crisis in the Great Depression took ist victims, today's Wall Streeters can only be seen jumping out of windows with fat golden parachutes. So much about the self-esteem of the posterboys who had never tired to preach the virtues of performance optimization and risk-taking.
Those few changes made at the top executive level are only window dressing a yet unsolved problem: Out goes the guy who didn't see it coming, and in comes another guy who had not see the oncoming disintegration of American (or European) banking. Is this really the needed change? I highly doubt it.
Politicians Asleep at the Wheel
Our honorable representatives in national and supra-national parliaments are asleep at the wheel meanwhile. Their ears filled with SOS calls from the banking lobbies they are not shy to announce 14-digit bailout packages as if they had only to reach into the state's coffers.
This is not the case anymore. After 4 decades of Keynesian politics all Western countries find themselves at the top of international creditor lists, meaning they have only excelled in creating more public debts instead of obeying the basic rule of commerce: You cannot live on debts forever.
American and European politicians are in for a rude awakening any day soon. China has already publicly voiced its concerns about the solidity of US debt paper in light of an economy caving inward.
The enormous self-destructive dynamics of the current economic hurricane may bring rapid change. People were trampled to death when Wal-Mart offered cheap holiday packages. What will happen if there is a food shortage?
I do not fear that there will be not enough food. But the fact that foods goes through 20 transport stations, on average, until it lands on our table, leave enough risk factors for possible supply disruptions that a recession inevitably creates.
Politicians, now still willing to throw gazillions of fresh fiat money, will very soon have to come to terms with a broadly changed capital market. Close to a billion mostly indebted Western consumers are not exactly the kind of clientele the emerging nations in the eastern hemisphere would like to have. Confronted themselves by faltering economies due to plunging exports they are more likely to use their national savings for domestic stimuli instead of feeding a Western elite that was entirely wrong in its predictions about economic developments although deteriorating indicators had written it on the wall since at least 2005.
Western States Find Themselves in the Role of Beggars
10% unemployment in the USA and not much less in the EU, at least according to official figures, will not make raising capital any easier.
While Mr. Obama certainly radiates a strong commitment to change America's fate, it can nevertheless be denied that he is the biggest beggar in the world who has to come up with some $5 billion in new funds every day, 365 days a year, in order to keep the US in its ill-fated tracks where the military's role seems only to grow.
The situation is not much different in Europe. Starting with my home country Austria that turns out to become the biggest victim of the financial recolonization of the former Austro-Hungarian empire and will probably need IMF help at some later stage, faltering property bubbles in other European parts will only serve as a precursor to a wave of corporate and personal bankruptcies.
Investors have already shed quite some fat last year. According to venture capital group Blackstone, in 2008 $50 trillion or half of the world's savings, were eradicated by crashing stock markets. Or do you know anybody who still made a good bundle last year?
This will limit lending for governments too, when even the ultra-rich have downgraded to merely ultra-rich within a year.
A Struggle of 2 Ideologies That Have Both Failed
This leads me back to my headline. As we have now witnessed the complete and total failure of both Communism and Capitalims within 2 decades the question has to be allowed why politicians still stare at the same worn out pages of their PR cook books, offering only more of the same nonsense that has brought the global economy down to its knees in the first place.
The dispute whether state management or private management is the better option is so long meaningless as we are not able to improve the safeguards that effectively block opportunities to loot the system. As we see these days it often was not a problem that authorities did not know about possible felonies among fund managers and bankers, but that the whole regulation procedures were not enacted against the respective cronies profiting illegally from it. IMHO effective regulation can only be enacted with a focus on true transparency. Why not the Swedish model, where all public documents are indeed public and accessible online?
When taking a closer look at the EU, I notice alarming trends towards more secrecy of this supra-national body that intervenes in the daily lives of some 500 million Europeans. I cannot shed the impression that current political activity serves more the ruling powers who keep telling us they are proteting democracy for us while a slew of police state like legislative shows the opposite. Do they want to save democracy from their citizens who may think very differently than the elected representatives.
As long as there is cronyism and tightly knit elites both political models mainly serve their promoters but not the voters. It is time to think about a 3rd way that combines the motivating factors of capitalism with a social security net that is an expression of the development of our civilization. After all, we should be able to talk instead of wielding ever more sophisticated sticks and stones in countless wars around the world.
Labels: central banks, credit, crisis, ecb, europe, Fed, fiat money, usa

Perfect Storm for a Balance of Payments Crisis?

As argued in “Road to Ruin: Final stretch” the US is vulnerable to a balance of payments crisis. The cause of that crisis is the convergence of four main crisis events, and we are ready to say that these may occur within the next three quarters:
Epiphany that tax receipts will be dramatically lower than current estimates and expectations, creating a fiscal deficit shock (Timing: Late April or early May?)
Epiphany that demands on the Federal budget are higher than currently expected due to extension of lender of last resort operations to finance current credit market challenges and the inclusion of new rescue operations, such as to support credit card and insurance companies, and a series of funding crises, such as public pensions, and state and local government budget shortfalls. (Timing: Ongoing)
Supply crash meets money supply boom, resulting in rising inflation. All across the supply chain, from raw to finished goods, supply is falling. Starting with raw materials, it is easy to forget that mining is a capital-intensive process, and without credit production has slowed dramatically. Without trade credit shipping and trade have slowed dramatically. In terms of finished goods, the retail trade industry is contracting quickly. Much as occurred starting in 1975, government efforts to reflate the economy by increasing the money supply ran head long into a collapse in goods supply. Looking at trends in goods supply and money supply, a rise in inflation starting with consumer prices may have already begun. (Timing: Q4 2009 or Q1 2010?)
Epiphany that China will as its economy contracts not be able to afford to continue to purchase US Treasury bonds despite the virtually guaranteed result, a collapse in US export demand and value of dollar denominated reserve assets. The situation will be similar to that which the US and UK found themselves in 1930, unable to continue to make payments that maintained capital inflows that the German economy depended on to finance its fiscal and current account imbalances: the German economy collapsed in a Sudden Stop event in 1931. The timing of this event is very difficult because it is political; at what point does the cost of buying Treasuries outweigh the cost of not buying them? (See Economic M.A.D.) Long before the now common warnings from China are acted on, we should see some early signs [See: Headed for a Sudden Stop). One of those signs will be investors hiding out in dollar inflation hedges like commodities and precious metals, and we take the coincidence of falling Treasury yields and rising gold prices as a sign that some investors are preparing for a Sudden Stop event. (Timing: Q3 or Q4 2009?)
The near convergence of these events means they may occur either in sequence or more or less at the same time. For example, if clear evidence of inflation arises soon, that will cause Treasury prices to fall, and in fact may be causing them to do so already. The most likely trigger is a Tax Receipt Epiphany that leads to a Fiscal Deficit Shock and sudden loss of confidence in US sovereign credit quality.

The result in the fabled “Poom” of iTulip’s 1999 Ka-Poom Theory, a theory of the final stage of the disinflation and reflation process of the asset price inflation cycles that began in the early 1980s, began to end in early 2008 with the onset of debt deflation.

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London Banker Repost ~ What We Value Is What We Save In a Crisis

“When a woman thinks that her house is on fire, her instinct is at once to rush to the thing which she values most. It is a perfectly overpowering impulse, and I have more than once taken advantage of it. . . . A married woman grabs at her baby; an unmarried one reaches for her jewel-box.”

-- Sherlock Holmes from A Scandal in Bohemia, by Arthur Conan Doyle

When a central bank thinks its house is on fire, it too will rush to save the thing valued most. In the United States, the central bank has rushed to save the bonuses and dividends of its Wall Street clientele by hiding away the bad assets that can no longer be foisted on gullible investors. In Europe too the response of central banks has been to save the wholesale banking and securities industry rather than the consumers and businesses underlying the real economy’s longer term productive strength.

For a comparative of what is valued elsewhere, it is worthwhile to look at what is being saved. I received in my inbox yesterday documents outlining the efforts being taken by the Hong Kong and Chinese authorities to address the liquidity crisis in their respective jurisdictions. They are available online here (Hong Kong) and here (PRC). The contrasts with the West are striking, and humbling.

Hong Kong is swiftly introducing a scheme to guarantee credit to SMEs (small and medium enterprises) and exporters. China is introducing controls to limit bank credit to over-extended speculative sectors, accelerate rebuilding in the regions affected by the earthquake earlier this year, and promote improvements in local infrastructure, education and economic adjustment.

Holmes would have been disgusted by a married woman who grabbed her jewel-box in preference to her baby. In the same way, I am disgusted by the central banks preserving the privileges of the financial elite in preference to the jobs, incomes and businesses powering the real economy. The US and UK authorities may criticise the banks for their inaction in freeing up lending to commercial businesses constrained by the credit crunch. The Hong Kong and Chinese authorities are implementing guarantee schemes and innovating initiatives to rapidly address the problem.

As Holmes would have considered a child’s life worth more than jewels, I consider the workers and businesses in the real economy as meriting greater protection than the financial elite. It is not merely that I think the financial elite little better than criminals for their irresponsible excesses of recent years, but that I fear long term harm and political instability will come from neglecting the needs of the real economy.

Shortsightedness is a peculiar affliction of the Western economies. We cannot seem to project the consequences of our actions beyond the next quarterly report, fiscal year or - at most - election cycle. Eastern policy makers have a capacity for longer vision – and longer memory – which makes them appreciate sooner the potential consequences of bad policy. Perhaps this is a consequence of the longer term dedication required to gain political ascendancy in their less cyclical heirarchy.

That China's leadership is concerned with the implications for the real economy – and political stability – was confirmed this morning in an unusually blunt public statement by the chairman of the National Development and Reform Commission. From the Financial Times:

The downturn in the Chinese economy accelerated over the past month and could lead to high unemployment and social unrest, the country’s top economic planner warned on Thursday.

Zhang Ping, chairman of the National Development and Reform Commission, said the government needed to take “forceful” measures to limit the slowdown in the economy, which included Wednesday’s large cut in interest rates and a sharp increase in fiscal spending. The rate cut was the fourth since September.

“The global financial crisis has not bottomed out yet. The impact is spreading globally and deepening in China. Some domestic economic indicators point to an accelerated slowdown in November,” Mr Zhang said on Thursday at a rare news conference.

Mr Zhang’s warning about the potential for social unrest as a result of factory closures underlined the mounting concern in Beijing about the fallout from the global financial crisis.

“Excessive production cuts and closures of businesses will cause massive unemployment, which will lead to instability,” Mr Zhang said.


As Jim Rohm observed, “Failure is not a single, cataclysmic event. You don't fail overnight. Instead, failure is a few errors in judgement, repeated every day.”

The crisis in debt markets has been rolling since the sub-prime collapse of August 2007. The increasing illiquidity of commercial paper, trade credit, municipal finance and other debt markets was foreseeable and inevitable. And yet the central banks and treasury authorities of the Western nations have done nothing to shield these essential sectors from the ill effects of the financial sector implosion while giving virtually unlimited funds to the banks authoring the collapse.

Any discussion of China always invites criticism of its anti-democratic governance. It is worth remembering that the philisophical defense of democracy lies in the proposition that it is more likely over time to serve the interests of the electorate than a system which disenfranchises the people from the determination of their leadership. If the democratically elected governments - through their appointed executives and central bankers - are free over an extended timespan to ignore the interests of the people, then how is a Western democracy superior to a Chinese bureaucracy? From looking at the policies and practices of the past year, the merits of Western democracy are not immediately apparent in ensuring that policy responses to the financial crisis are aligned with the interests of the people. Even over the past decade, it is not clear that the policies of the democratic Western governments have aimed to strengthen and broaden the economy to benefit of the electorate rather than a narrow, self-serving elite.

According to Brad Setser, the World Bank is projecting increases to China’s trade surplus in 2009 as falling commodity prices lower production costs. Those unelected bureaucrats are doing something right.

If China and Hong Kong recover sooner, prosper more, and gain global political and economic authority in consequence, it will be because they made fewer mistakes and made them less persistently than their Western counterparts. If the promoters of democracy want to strengthen their case, they might best do so by ensuring that their leadership adheres to policies which promote the longer term health and well being of the economy as a whole rather than the short term enrichment of an undemocratic elite.
Posted by London Banker at 04:32

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GEAB N°29 is available! Phase IV of the Global Systemic crisis: Breakdown of the Global Monetary System by summer 2009

The G20-meeting held in Washington on November 14/15, 2008, is in its essence a historical indicator that the Western - above all Anglo-Saxon - monopoly on global economic and financial governance, is coming to an end. Nevertheless, according to LEAP/E2020, this meeting also clearly demonstrated that this kind of summits is doomed to inefficiency because they concentrate on curing the symptoms (banks’ and hedge funds’ financial difficulties, derivative markets’ explosion, financial and currency markets’ dramatic volatility, ...) rather than the fundamental root of the current crisis, i.e. the collapse of the Bretton Woods system based on the US Dollar as sole pillar of the global monetary system. Without a complete overhaul of the system inherited from 1944 by summer 2009, the failing of the current system and that of the United States at the center, will lead the whole planet to an unprecedented economic, social, political and strategic instability, and more specifically to a breakdown of the global monetary system by summer 2009. In light of the technocratic jargon and calendar of the declaration released after this first G20-meeting (totally disconnected from the speed and scope of the unfolding crisis (1)), it is more than likely that the disaster will have to happen for the fundamental problems to be seriously addressed and for the beginning of a reply to be initiated.

Four key-factors are now pushing the Bretton Woods II (2) system to collapse in the course of the year 2009:

• Fast weakening of the central players: USA, UK
• Three visions of the future of global governance will be dividing world’s largest players (United-States, Eurozone, China, Japan, Russia, Brazil) by spring 2009
• Unbridled speeding-up of the last decade’s (de-)stabilizing processes
• Increasing number of more and more violent backlashes.

LEAP/E2020 already extensively described factors 1 and 4 in previous editions of the GEAB. Therefore we will concentrate on factors 2 and 3 in the present edition (GEAB N°29).

The agitation that has seized global leaders since the end of September 2008 indicates that panic has struck at the highest level. Worldwide political leaders have now understood that the house is on fire. But they have not yet perceived something obvious: that the very structure of the building is involved. Improving fire-regulations or reorganizing emergency services will not be sufficient. To use a strong symbolic image, the World Trade Center’s twin towers did not collapse because firemen were late or because water was missing in the automatic fire-system, they collapsed because their structure was not meant to support the shock of two airliners hitting them in just a few minutes.

Today’s global monetary system is in a similar situation: the twin-towers are the Bretton Woods system, and the airliners are called « subprime crisis », « banking failures », « economic recession », « Very Great US Depression », « US deficits », … a whole squadron.


First year of major correction (Dow, as percentage, since 1900) - Source ChartoftheDay
Today’s leaders, who all belong to the collapsing world (including Barak Obama (3)), cannot possibly imagine how to solve the problem, just like central bankers in 2006/2007 could not possibly imagine the scope the unfolding crisis could reach (4). It is their world which is disappearing under their eyes, their beliefs and their illusions (sometimes similar) (5). According to our team, a 20 percent renewal of worldwide leaders is required to begin to see sustainable solutions (6) appear. This is indeed, according to LEAP/E2020, the « critical mass » needed to permit any fundamental change of perspective in a complex not very hierarchical human group. Today we are still far from reaching this critical mass: in order to contribute to finding solutions to the crisis, those new leaders must accede power in full awareness of the crisis’ specific nature.

According to LEAP/E2020, if global leaders fail to realize that in the next three months and to take actions in the next six months, as explained in GEAB N°28, the US debt will « implode » by summer 2009 under the shape of the country’s defaulting or the Dollar’s dramatic devaluation. This implosion will follow closely a number of similar episodes affecting less central countries (see GEAB N°28), including the United Kingdom whose already huge debt is ballooning at the same pace as Washington’s (7). In the same way as the US Federal Reserve saw, month after month, its « Primary Dealers » (8) being swept away by the crisis before it was itself confronted to a real problem of capitalization and therefore survival, the United States in the coming year will witness the implosion of all countries too-closely integrated to their economy and finance, and of their allies financially too-dependent on them (9).


Monetary authorities with the largest foreign reserves in 2008 - Sources FMI/BRI/Wikipedia , 10/2008
The role the Europeans can play in the matter is essential (10). The Eurozone in particular must send out a strong message towards Washington: « The United States will fall into an economic and financial pitfall in 2009 if they cling to their past « privileges ». Once the world has given up on the Dollar, it will be too late to negotiate ». With more than 550-billion USD, the Eurozone owns the third largest reserve (ex-aequo with Russia who is not very accurate on that aspect) after China and Japan, and before the Gulf oil-monarchies (see table above). It therefore has the diplomatic weight, the financial weight, the economic weight, the commercial weight and the monetary weight required to compel Washington to face realities (11). The EU altogether will follow because non-Euro EU countries are all on the verge of a severe crisis of their currency or economy or both (12). Without the Euroland, their outlook is very gloomy in the short and medium term. As a matter of fact, the Euro is the only currency a growing number of initially reluctant (Iceland, Denmark…) or skeptical (Poland, Czech Republic, Hungary…) countries now wish to join (13).

Sign of the times, the Financial Times has started to list the US federal state’s tangible assets: military bases, national parks, public buildings, museums, etc… everything has been evaluated for a total amount of approximately 1,500-billion USD, i.e. more or less the probable amount of the budget deficit in 2009 (see the detail of these assets in the chart below). No wonder why Taiwan, despite its dependence on the security provided by Washington, decided to stop buying one of the three great components of the US public deficit, the Fannie Mae and Freddy Mac securities (despite the fact that they were « rescued » by the government (14)); or why Japan is now a net-seller of US T-Bonds.

All those who, despite our advice in the past two years, invested in Fannie and Freddy securities or in stock markets or in large US private equity banks or in the banking sector in general, have no reason to worry: it will not happen because « they » will prevent it! A problem remains however: “they” are now panic stricken and “they” understand nothing to this situation “they” were never prepared to face. Like we explained in the GEAB N°28, 2008 was only the detonator of the global systemic crisis. Now comes Phase IV, phase of the aftermath!

Leap2020

Another reason for the credit crunch

As for this most recent phase of the withdrawal of credit, which has caused financial crises for a series of emerging economies in eastern Europe, Asia and South America (see "Now there are runs on countries") and also global falls in share prices, it was in a way wholly foreseeable.

It was caused, to a large extent, by an exceptional and unprecedented shrinkage in the prime brokerage industry, which in turn led to a serious reduction in the volume of credit extended to hedge funds, which in turn forced hedge funds to sell assets, especially those perceived as higher risk.

This contraction in loans provide through prime brokers was the inevitable consequence of the collapse of Lehman, but also - far more importantly - of the recent conversion into banks of Morgan Stanley and Goldman Sachs.

Morgan Stanley and Goldman are - by far - the biggest prime brokers, with Morgan Stanley the number one.

But as banks, they're prevented by regulators from lending as much relative to their capital resources as they had been as securities firms.

So the US authorities should have known - and presumably did know - that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.

Which, as if you needed telling, only goes to show that regulatory intervention carried out with the best of intentions can have consequences that - in the short term at least - can be very painful.

The financial crisis: China's role - and responsibilities?

The superpower of the East (ouch - they really don't like the sound of that phrase in Washington!) is so big and so rich that it's just about everywhere nowadays. As the cash-strapped U.S. government's second-largest creditor after Japan, it would seem that China would or should have some cards to play in the completely unpredictable game and drama of the still-unfolding, banking-and-credit-crunch crisis that started in the U.S. and has spread and spread and spread around the world. Now, apparently, it may be ready to play some of them.

» Inter Press Service, in a report published in the Asia Times (Hong Kong), reports: "The Wall Street fire-sale has prompted economic pundits in China and elsewhere to call on Beijing to snap up stakes in United States financial institutions and further China's influence on global financial power." Chen Jie, an economics professor at Shanghai Fudan University, commented: "China cannot easily afford to pass up such an opportunity....We have been anxiously trying to find investment opportunities for our financial capital, but before the crisis, there existed a myriad of visible and invisible barriers for Chinese investment overseas, particularly in the United States."

However, so far, "China's response to expectations at home and abroad has been unassuming. Although fortified with great liquidity and large reserves, Chinese banks and government investors have preferred to sit on their hands rather than go on a shopping spree of tumbling Wall Street firms....Chinese bank officials have dismissed as groundless reports that China plans to buy up to $200 billion worth of U.S. Treasuries to help Washington combat the deepening financial crisis....Some of Beijing's conservatism stems from the fact that the global credit crisis has walloped the value of the Chinese government's initial batch of investments in U.S. financial institutions such as Morgan Stanley and Blackstone Group."

Nevertheless, none other than Carlos Slim Helú, the Mexican billionaire and the world's second or third richest person (depending on how the values of his own holdings have been seesawing lately), has suggested that "China should lead rescue efforts for the U.S. financial crisis." This week Slim noted: "China is now the most important country to help responsibly in this crisis....In the past, developed countries had reserves and financed developing countries, while today developed countries, especially the United States, are being financed with resources from developing countries."

» Reuters notes that although, reportedly, the head of the China Banking Regulatory Commission recently said that "China might consider injecting liquidity into the United States to help it save the market," a spokesman for that Chinese-government agency has indicated that its chief "never made such comments anywhere." Meanwhile, "[s]peculation is swirling that China, with U.S. bonds making up the lion's share of its $1.81 trillion in foreign-exchange reserves, the world's biggest stockpile, could have a role to play in any globally coordinated response to the global banking crisis" that began in the United States and has taken some of its hardest toll on Wall Street. Earlier this week, it was rumored that that the China "was planning to invest another $200 billion in U.S. Treasury bonds," however, China's central bank "said it had no information to that effect."

In China, a financial-news newspaper associated with People's Daily, a national newssheet, "on Tuesday quoted Liu Yuhui, an economist at the Chinese Academy of Social Sciences, as saying the Chinese government was on the horns of a dilemma." Liu was quoted as saying: "If China does not participate in the U.S. bailout plan, and that causes the financial crises to sweep over the real U.S. economy, then the damage to China will certainly be very great....China's bind is that, if the Chinese government actively participates in the U.S. bailout plan, that will mean the government assumes some of the bailout risk. If the bailout plan is aborted, China may be dragged in even deeper."

For now, China's foreign ministry has emphasized, "China's main contribution in the face of the current uncertainty is to ensure that it keeps growing quite fast." In other words, what's good for China has got to be good for the rest of the world - right? A spokesman for the foreign ministry said: "China feels strongly that faced with this kind of crisis, it will be difficult to solve it by relying on just one country's strength....We need the global community to join hands to deal with it together. This is China's clear position and commitment to the global community."

» Bloomberg notes that "Japan and China are the two largest foreign creditors of the U.S.: Japan holds $593 billion of U.S. Treasury bills, followed by China with $519 billion." The American financial-news service quotes the chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, who remarked: "China owns us, lock, stock and barrel, so it's more important than ever that the U.S. monetary authorities coordinate their monetary policies with China."

In a news dispatch yesterday, Bloomberg added that Wednesday of this week might "go down as the day the economic balance of power shifted in Asia. In a move weighted with symbolism, China reduced its interest rate within minutes of cuts by the U.S. Federal Reserve and five other central banks, while Japan, the world's second-biggest economy, stayed on the sidelines." James Lilley, a former U.S. ambassador to China, said: "Japan is still a very big economic power, but China is the big enchilada on the field....They really, in their own way, are joining the world financial community in dealing with a very severe crisis."

Bloomberg noted: "China's move reflects how deeply the world's fourth-biggest economy has become integrated in the global financial system. While its gross domestic product expanded at 10.1 percent in the second quarter from a year earlier, its exports have been hit by a collapse in demand from the U.S. and Europe."

» Looking ahead and getting a head start in picking up some of the pieces from the fallout from the current crisis, an editorial in Japan's Asahi Shimbun notes: "Much like a tail wagging the dog, investment banks [in the U.S.] had engaged in practices that reaped huge profits using debt totaling several dozen times the capital held by the company. However, that system has now collapsed. The U.S. strategy of allowing its manufacturing base to dry up and turning to a financial plan specializing in finance and information technology has also reached a dead end."

As a result, Asahi Shimbun adds, as the current period of reckoning seems to be indicating, from now on Americans "will no longer be able to enjoy consumption patterns well in excess of their incomes that were made possible by an expanding credit line. 'Reaganomics,' or the neo-liberal economic policies that emerged since the 1980s, was based on two main pillars - tax cuts and deregulation. Those policies will likely face a critical review. It will become increasingly difficult for the United States to sustain its current account deficit - disparagingly referred to as a 'deficit without tears' - by simply printing more dollars. Problems with the dollar as the world's key currency will emerge in the future course of the current financial crisis."