Tell a friend:
 

06th March 2010
The Failure of the Banking System
Cont’d from last weekend
By Max Johannes

There are structural weaknesses such as the weakness of sovereign debt worries from Ukraine, Greece and possibly others soon to be added to the total. When this weakness is being masked by the impulses of the system, we know that the structural weakness will end sooner rather than later, perhaps June to July. After comparing the U.S. bull markets since the 1930’s, we discovered that the first bull market correction typically arrives 300-450 days after the bull market begins, which if the past turns out to be any guide to the future would be before July.
Another Great Depression may have been averted but the crisis is far from over. Credit is tight and contagion is spreading to all highly leveraged points in the global economy: mortgage-ridden household (Iceland, the US, the UK, Spain, Ireland, central and eastern Europe); banks (Iceland, the US, the EU, Russia and the former Soviet Union); quasi-sovereign debt (Ukraine’s Naftogaz, Dubai World); and now Greece and other weak links in the eurozone. Greece has long been an accident waiting to happen due to heavy public debt and lack of competitiveness. But it problems are not unique. On their resolution rides the fate of its neighbours, the eurozone and perhaps the European Union itself.
“Fiscal incontinence and uncompetitiveness are interlinked across southern Europe. Euro accession and bullmarket ‘convergence trades’ pushed the bond yields of Portugal, Italy, Greece and Spain towards German bonds. The ensuing credit boom supported consumption but papered over wage inflation that outstripped productivity growth and priced Greece out of traditional export markets. As bond yields rise, Greece and its peers face difficult choices. The best course would be to follow Ireland, Hungary and Latvia with a credible fiscal plan heavy on spending cuts that government can control, rather than depend on historically weak compliance. This could achieve an internal devaluation with deep real wage cuts and structural reforms to boost competitiveness, as Germany has since unification.
“What country experienced the biggest jump in debt, relative to gross domestic product over the past decade? A year ago, as the world reeled from the subprime mortgage crisis, most investors might have said America. And these days, countries such as Iceland, Dubai or Greece tend to spring to mind, in connection with deadly debt burdens.
“However, if the McKinsey consultants are to be believed, the real leverage giant – at least among the big western economies – is actually the UK. After crunching the data, McKinsey estimates that the gross level of Britain private and public debt is now 449% of GDP – up from 350% at the start of the decade. And even excluding the liabilities of foreign banks based in the UK, the ratio still runs at 380% -- higher than any country except Japan (closely followed by Spain) where debt has also spiralled dramatically, according to the McKinsey report issued today.
 
 
Contrary to popular perception, for example, McKinsey points out that, by historical standards, most of the financial world was not crazily leveraged in the past decade. Instead, the crazy debt increase was focused on a small group of broker, and global banks. Moreover, alongside the [limited] rise in broker borrowing in the past decade, there was also a far more startling increase in ‘real economy’ debt, particularly in the household and real estate sector leverage has fallen considerably. But since public debt has spiralled, gross leverage levels for most large nations have not fallen. And that, in turn, has a crucial implications: namely that , insofar as deleveraging is inevitable, much of it is still to come. From a historcial perspective, this challenge is not entirely unprcedented. The UK and US have, after all, slashed vast debt burdens before during the last two centuries, and McKinsey has identified four dozen smaller deleveraging episodes around the world since 1950.
“But while governments have sometimes softened this task before by creating rapid growth, often due to exports (via devaluation), or a peace dividend (after a war), those routes do not offer easy escape this time. Growth, in other words, could be tough to achieve. So McKinsey suggests: outright default, inflation or belt-tightening. McKinsey’s best guess – or hope – is that belt-tightening will predominate, and it consequently forecasts a grim climate of austerity for the next decade.
As I forecast a few months ago, the first world-wide banking crisis of the twenty-first century that caused the Great Recession, came to a statistical end in the fourth quarter of 2009, but the recession it caused continues unabated. The end is only a statistical end, but the citizens and states would not notice the difference before and after the date of the statistical cessation. If the recession has slightly relaxed its grip on us, it has been replaced thus far by a time of debate over the clarity of economic indicators; the failure of the regulatory systems; the staying power of apparent improvements; the penalities that sovereign states would levy on their respective banking centres as well as the volumes of new books that define the causes, the impact of the crisis and the potential cures of this economic disaster.
Bankers caused this economic disaster that nearly brought down three of the world’s greatest economies. So who pays for this disaster? Does cause and affect apply? Until the Davos meeting, it appeared that the bankers did not understand why the citizens of the respective states blamed them for their worst fears. By the end of meeting and public pronouncements by the USA, UK, and EU, bankers were asking among themselves, “how do we limit the damage” and “what must we do to protect ourselves?” Will be continued next weekend.

Discuss Story
 
Top Stories  
 
 
   
Developed