Don't Stop Looking for the Exits

How many times have we heard the Policy makers emphasise that there is no crisis and that they are top of a situation? Their bland speeches, ad nauseam content is actually taking a toll on my health (though not the financial part, because I dont believe them anyway). In late 2007 and early 2008, we were told that the banks were safe and then were told that the bailouts were essential to save the financial system. Any discerning investor should have avoided investing in the financial sector (unless one was a speculator). Everybody loves a rally, especially the financial sector and the policy makers for the simple reason that for one (financial sector) they can profit immensely from the proclivities of investors who think this time is different; while for the other (Policy makers) capital is easy to come by during market rallies. They dont have to do anything. Rising asset prices give a false sense of capital buffer (as they did during 2003-2007 rally).  

This time is different. But, for the wrong reasons.

It is imperative to note that the basis of calculating the price of an asset is at best inaccurate or at its worst speculative. It depends on two parties making a lot of inferences about the future, which is essentially unknown. This could have remained at the realm of abstraction but for the fact that with fiat money and financialisation the financial markets cannot be ignored. In 2008 and 2009, the policy makers transferred private risk from the banks onto themselves by massive bailouts and by assuming more debt by attempting to reinvigorate the global economy. The money would probably have been well spent had they immediately forced the much delayed structural change that was needed. Instead, their thinking was based on only one assumption: hoping that private demand would come back. Unfortunately, that has not and now we are in the throes of yet another crisis: only this time it is much larger than the previous only. The postponement of a surgery only leads to greater problems down the line. 

I am reproducing two important charts. One chart shows that Europe is so interconnected that we have now reached the end of the road because till date various countries were only running a ponzi scheme.  The chart below shows the amount of debt that each country owes the other cannot and no way can they repay such large amounts. Add to this other obligations of the countries including those related to pensions, health, etc and the only way that a country can meet its obligations to all other stake holders is by defaulting on their loans. I believe that it is a matter of time before there is one form or another of debt default (or call it restructuring if you may).

The bond market is not going to like that and it would instead prefer that the governments' cut down on spending, which would hurtle the global economy into a deflationary spiral. But creditors will be big winners in such a scenario. I am quite sure that it is going to be disappointed in the long-term because the polity of west is not like China. Take the case of Greece: It has promised austerity measures that are nearly 13% of its national income spread over the next four years. If the government actually attempts to deliver on its promise then rest assured that the ruling party will not be elected for at least another 20 years. 

A candid confession to this possible outcome created a flutter in UK recently when Mervin King is supposed to have claimed that if the parties deliver on their promised reduction in expenditure then they will not be elected for a generation. 

The Second Chart (above) shows why the problem has just got out of hand. The banks in most of the countries are on the verge of insolvency. Hence the urgent need for the Greek bailout (and many more down the line).It shows that the banks of Europe have exponentially large amounts of money (nearly 150 billion Euros) to Greece and Portugal. Add to that the monies lent to Spain, Italy and UK. Compound that to the lending spree in Eastern Europe, Latin America and USA.

There is another short-term solution to the problem: create an even bigger bubble by pumping in more money. The interesting aspect that has been missed is that the very fundamental nature of Capitalism has changed due to the most recent crisis in the following ways:

1. State Capitalism now rules most parts of the developed world (OECD, India, China, etc)

2. Public Sector is the only game in town

3. The time duration between two recessions have been cut short: in the 1970s the next recession was 10 years, by the 1990s it was 5 years away and now it is probably 18 months to 2 years (or who knows may be even more)