How we just avoided the big D
Paul Sheehan March 31, 2008
It's time we got serious and used the D-word, given that most people seem blithely unaware just how close we came to a catastrophic financial event this month, an event brought about by reckless greed on a reckless scale. Given how close we came to a depression, not a mere recession, it is going to take years to recover from this financial near-catastrophe. Don't expect your superannuation fund or home value to surge any time soon.
As long ago as last June the Bank for International Settlements, which acts as a central bank for the world's central banks, warned of the potential of a financial collapse on a scale not seen since the Great Depression in the 1930s. In its last annual report, delivered on June 24, the bank blamed years of loose monetary policy by governments for fuelling a credit bubble so large and unconstrained it had left the world vulnerable to a system-wide catastrophe.
It repeatedly used the D word: "Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and South-East Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a 'new era' had arrived."
There is no new era. Just a huge amount of speculative, parasitic debt.
This month the system meltdown that the bank had warned about was almost triggered by the collapse of one of the world's leading merchant banks, Bear Stearns. When US federal regulators examined the bank's collapse, they were aghast at what they found. Bear Stearns was enmeshed in financial derivative positions totalling almost $15 trillion, a figure notionally equivalent to a quarter of the world's entire economic output. Underpinning this edifice of speculative excess was about $90 billion of actual financial reserves. These reserves were, in turn, underpinned by about $20 billion in cash reserves. The $20 billion evaporated in 48 hours when the bank was hit by a run. The bank was insolvent.
History will record that the hero of the hour was Ben Bernanke, chairman of the US Federal Reserve, who mobilised his fellow bank governors over the weekend of March 15-16, and invoked emergency powers not used since the Depression. In effect, the US government went guarantor for $US30 billion ($32.7 billion) of what would otherwise be worthless mortgage-backed securities held by Bear Stearns. This averted the complete collapse of the bank and a catastrophic blow to confidence in the system of financial derivatives, a system whose contracts now total more than $500 trillion.
Bear Stearns would have merely been the first domino. Another big merchant bank, Lehman Brothers, would have fallen next. Even bigger banks were shaking under the stress.
One person who has been warning about the possibility of a system-wide financial meltdown, well before the Bank for International Settlements did so, is Ambrose Evans-Pritchard, international business editor of London's Daily Telegraph. He has been a Cassandra for more than a year, and his commentaries have been generating heavy traffic on the internet. I interviewed him recently and asked him where Australia stood in all this. He was bearish.
"Smaller, open economies like Australia are vulnerable during times of instability like this," he said. "Like Britain and the US, you've had a housing boom, and a credit boom and a consumption boom. So Australia is looking pretty vulnerable. I would be short on the Aussie dollar …"
"The commodities boom will be affected by the financial crash. It always is. Australia also has an unhealthy 7 per cent current account deficit, which makes it extremely overstretched for a commodity-based economy."
As for the Aussie dollar, he said Japanese bonds had inflated its value by washing through the system as Japanese pension funds looked for higher yields. The Australian Reserve Bank was overmatched by financial flows on this scale, he said, so the dollar would be vulnerable to forces well beyond the control of government intervention.
He believes the Anglo-Saxon economies - the US, Britain, Australia, Canada and Ireland - having created a speculative bubble even bigger than the one that caused the dotcom sharemarket crash of 2000, will take years to unwind this period of excess. He foresees a long penance.
"We could easily be at the beginning of a Japanese-style outcome, a long, hard slog back to sound fundamentals for the Anglo-Saxon property bubble in the US, the UK, Australia and Ireland …
"The world is in deep trouble. It is time for states to act like states. We should be thankful that the man now heading the Federal Reserve, Ben Bernanke, spent his early career immersed in the details of the Depression. He has written books about it, and he moved with lightning speed."
He believes Bernanke made the right move, just as his predecessor at the Federal Reserve, Alan Greenspan, made all the wrong moves. "Alan Greenspan caused this bubble. He excessively deregulated the market, he let the market fundamentalists run, and allowed the mortgage sector to run rampant. He lifted government controls where they were needed and interfered where it was not needed. He forced the price of credit down artificially even when the economy was growing at 4 per cent."
Last week Evans-Pritchard, ever pungent, wrote in an opinion piece: "Put a clothes peg on your nose. The moral stench of bailouts for the uber-rich will be sickening.
"None of us wants to pay a farthing to rescue the bankers and assorted debt pimps who got us into this financial mess, and in doing so exposed our societies to such harm … Yet we must forbear. It was such sentiments that turned the 1930 recession into [the Depression]."
Bear Stearns would have merely been the first domino. Another big merchant bank, Lehman Brothers, would have fallen next. Even bigger banks were shaking under the stress.
One person who has been warning about the possibility of a system-wide financial meltdown, well before the Bank for International Settlements did so, is Ambrose Evans-Pritchard, international business editor of London's Daily Telegraph. He has been a Cassandra for more than a year, and his commentaries have been generating heavy traffic on the internet. I interviewed him recently and asked him where Australia stood in all this. He was bearish.
"Smaller, open economies like Australia are vulnerable during times of instability like this," he said. "Like Britain and the US, you've had a housing boom, and a credit boom and a consumption boom. So Australia is looking pretty vulnerable. I would be short on the Aussie dollar …"
"The commodities boom will be affected by the financial crash. It always is. Australia also has an unhealthy 7 per cent current account deficit, which makes it extremely overstretched for a commodity-based economy."
As for the Aussie dollar, he said Japanese bonds had inflated its value by washing through the system as Japanese pension funds looked for higher yields. The Australian Reserve Bank was overmatched by financial flows on this scale, he said, so the dollar would be vulnerable to forces well beyond the control of government intervention.
He believes the Anglo-Saxon economies - the US, Britain, Australia, Canada and Ireland - having created a speculative bubble even bigger than the one that caused the dotcom sharemarket crash of 2000, will take years to unwind this period of excess. He foresees a long penance.
"We could easily be at the beginning of a Japanese-style outcome, a long, hard slog back to sound fundamentals for the Anglo-Saxon property bubble in the US, the UK, Australia and Ireland …
"The world is in deep trouble. It is time for states to act like states. We should be thankful that the man now heading the Federal Reserve, Ben Bernanke, spent his early career immersed in the details of the Depression. He has written books about it, and he moved with lightning speed."
He believes Bernanke made the right move, just as his predecessor at the Federal Reserve, Alan Greenspan, made all the wrong moves. "Alan Greenspan caused this bubble. He excessively deregulated the market, he let the market fundamentalists run, and allowed the mortgage sector to run rampant. He lifted government controls where they were needed and interfered where it was not needed. He forced the price of credit down artificially even when the economy was growing at 4 per cent."
Last week Evans-Pritchard, ever pungent, wrote in an opinion piece: "Put a clothes peg on your nose. The moral stench of bailouts for the uber-rich will be sickening.
"None of us wants to pay a farthing to rescue the bankers and assorted debt pimps who got us into this financial mess, and in doing so exposed our societies to such harm … Yet we must forbear. It was such sentiments that turned the 1930 recession into [the Depression]."