Masthead graphic based on a painting by Gudrun Thriemer.

Saturday, January 24, 2009

Economic chain reaction isn't over: Everyone has an "only solution"

Mound of Sound asks the right question, or one of the right questions. "Are the governments, especially the American and British administrations, simply squandering trillions of dollars in bailouts and stimulus spending?" ("America's problem isn't illiquidity--it's insolvency" The Disaffected Lib Jan 24 09)

And is Canada's government about to do the same?

Ed Kemp isn't the only one who thinks so but his article is a valuable contribution to our understanding of the scope and meaning of the economic crisis. See for example Philip Blond's article (Indpendent Mar 23 08)

"The trouble is that nobody in power recognises this crisis for what it is – an asset insolvency crisis brought about by massive debt leverage. Neo-liberals are still reacting as if the emergency was one of liquidity. They are wrong. Governments should bail out not banks and speculators but the customers who now have every reason to fear for the future."

(Note that Kemp calls it the "debt crisis" instead of the "financial crisis" or the "economic crisis.") I will continue to use "economic crisis" for several reasons. First and foremost, I tend to subscribe to the "straw that broke the camel's back" notion of what is happening.

My research showed me a global economic architecture that was imbalanced and a global economy that was fractured and weak long before the stock market crashes in October 2008. Economists on the left (Dean Baker) and the right (Peter Schiff) argued the weakness of the banks and the susceptibility of the housing bubble to small fluctuations in interest rates.

Persistent stalling of the Doha Round WTO talks, dollar hegemony, rampant military spending and the clear argument that climate change is a market failure of unprecedented proportions are the main features of the "straw that broke the camel's back" version of the economic crisis. The neoliberal package of prescriptions and economic tools was clearly inadequate and the ideology was a big, well-documented part of the problem--in Argentina, Russia, Japan, Mexico, to name just the best known places.

In my opinion, the economic crisis is one aspect of the decline of the US as "the world's only or last remaining superpower" and the re-emergence of a multipolar world order. I say re-emergence because multipolar order has been the rule in the past. But the shape of this emerging multipolarity is still not clear. Investors know this is happening; some are even motivated to punish the US for failing them.

Still the debt crisis is part of the economic crisis. Individuals--like home owners whose main asset is their home and who have just been lost their jobs for the last time--will experience a crisis in liquidity. This is certainly part of the economic crisis.

If the ship is sinking, the carpet in your stateroom will probably get wet. But it would be a mistake to think that you have solved the problem by putting on your slippers.

We are still seeing a chain reaction which isn't over: . Until it is over, it will be hard to get an accurate idea of the scope. So we have to keep trying.

Some people will view bailouts and stimulus packages as "pouring gasoline on the fire," i.e., making the situation worse. The market responded to Obama's inauguration in much the same way it responded to Bush's bailouts and efforts to restore confidence. Massive declines.

It seems more likely that there is simply no real fuel for the fire, not here at home. Our exalted financial institutions and business leaders have been creating the illusion of a fire (prosperity=Steaks will be ready in 10 minutes), but we're out of charcoal (No manufacturing, iconic industries owned by foreign shareholders, even our favorite local enemies have become penny stocks). The cook keeps squirting fire starter into the BBQ (lower interest rates, more credit, innovative structured investments) so that there will be something of a flame (however smelly) to cook our steaks. It's a real steak, but the prosperity it symbolizes smells like a Molotov cocktail.

Meanwhile, governments have convinced themselves that it's not right for them to interfere. This is an interesting position when it comes from some of the same folks who believe that it is clearly their right to intervene in the the Taliban dress code.

It isn't just America's problem either. Many Canadians are still in denial about this. They aren't the Canadians whose mill has been bankrupt since mid-2007 or who have already lost their homes. But there appears to be lots more to come. And Canadians are still just learning how much better off we are than Iceland. David Goldman argues that the solution is offshore (see below), but Peter Schiff thinks that holders of the American debt will have to forego their own opportunities.

Insolvency is an inability to pay debts. Bankruptcy is not insolvency. Bankruptcy is a determination of insolvency made by a court of law which results in legal orders that aim to "resolve" the insolvency--debt restructuring, receivership, etc. Bankruptcy is not the same as "going out of business" either. Going out of business entails liquidating or selling off the assets of a business as a precondition to eliminating it, i.e., closing its doors. It is one approach to bankruptcy.

Nortel isn't going out of business, but it was insolvent and is going bankrupt. CanWest is teetering on the brink of insolvency. Bad stock prices are indicators, potential signs of things to come, but are most serious if you happen to be a shareholder.

David Goldman at Asia Times says that fixing the banks is the easy part. He argues that the real problem is that "the market's willingness to buy credit-sensitive American bonds has collapsed."

Looking at the banks, Goldman concludes that they "will resemble a regulated public utility more than the buccaneers of the 1990s and 2000s. But they will survive."

He argues with urgency against nationalization of the banks.

"If the Treasury has to take on an additional $2 trillion of debt as the cost of bank nationalization, the hairline cracks in the credit of the US Treasury could widen into something very dangerous. During the past few days, term Treasury yields backed up violently, from just over 2% on December 31 to 2.65% at the end of last week for the 10-year Treasury. This occurred while risk aversion spiked. That is an ominous sign.

"During previous episodes of risk aversion, investors bought Treasuries as a safe haven. Now the threat is that the Treasury will have to borrow trillions of dollars to buy the banking system. If Treasuries lose their safe-haven status, the entire financial system is in extreme danger. That is not an exaggeration."

Goldman's solution is short on details and that hasn't changed in a couple of months.
"The national illusion that capital gains would substitute for savings has disappeared, and Americans are now attempting to save as much as they can. If they all try to save at the same time by shutting down expenditures, of course, the economy will collapse.

"As Francesco Sisci and I wrote in this space last November: "No recovery is possible unless American households can save, and they cannot save in an economic contraction when incomes spiral downwards. To save, Americans must sell goods and services to someone else, and a glance at the globe makes clear who that must be: nearly half the world's population, and most of the world's capacity for economic growth, is concentrated in China and the Pacific Littoral." (see US's road to recovery runs through Beijing, Asia Times Online, November 15, 2008).

America must seek a global solution to its economic problems. Defusing the bank crisis would buy time to put a real solution in place."
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