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Thursday, 9 October 2008

New v. Old World order values

UK banks, led the FTSE100 higher but ended mixed (FTSE350 banks down 1.3%, which is really just camera shake, even HSBC down 2%, but Barclays down 13% is serious! It may be because of its intention to tap Government funds though moderated by offering existing investors the chance to take preference shares or other instruments beforehand. HBOS led the FTSE100 risers again by a long way, up 31% to reach the Lloyd TSB offer price, while RBS added 5.8% and Lloyds TSB up 1%.
The drop in the FTSE's afternoon session coincided with the expiration of a U.S. SEC's ban on short selling in more than 950 financial stocks.It seems to me the ban should have been extended. LIBOR rates fell with the base rate cut. There is a possibility that the Fed will do more to force banks to start lending to one another across the Atlantic. This was not the best result for the UK so-called bail-out plan. One bit of good news is that oil is now 40% below its July peak!
The newspaper posters and banners are screaming "Darling's £260bn Bail-out!", "£500bn World's Biggest Gamble Ever!", "New World Order!" and the revolutionary Economist magazine's September cover, "OH FUCK!". The FT today has calculated the figure to be £400bn with headlines, "Banks thrown £400bn lifeline!", "The great British bail-out" and "There can be no return to business as usual!" At a face the press yesterday, our Scottish First Minister, Alex Salmon, began by saying not many people know that the Chinese "May you live in interesting times!" is actually a curse! We got that one.
The New World Order is a gathering recognition that the boot is on Asia's foot. Martin Wolf titles his full page essay on the subject "Asia's revenge" seeing that the credit crunch infects one half of the world economy but not the other half. Actually, both halves are interdependent and complicit in this problem. For years economists like Wynne Godley, Francis Cripps and Alex Izurieta have accurately predicted the current crisis seeing its origins in the extreme imbalance that grew in world trade (+ FDI flows) whereby credit boom high deficit economies had to package and sell financial assets to the trade surplus countries in order to maintain their GDP growth. This was not without massive benefits for credit boom economies (high employment and low inflation) and for emerging economies (double-digit growth despite high inflation). So what is this New World Order apart from cynical and deriseful loss of confidence in banks and in neo-liberal "small government is beautiful" ideology?
Already, we see a massive 180-degree turnabout in the world trade trends. China and Japan have no external growth impulse from exports (exports have stopped growing) while the USA is now increasingly reliant on export-growth while imports slump. So far so good, except all economies are now slowing down and Japan, USA, UK, Ireland, Italy, others are either officially in recession or probably in recession or close to it (at least two quarters of negative growth in profits and earned income and/or measured as falling general spending.) But is this 'new'? The world's stock markets have all been falling this week on recession fears more than fears for the banking sectors' problems. That we've come through recessions before is not a salve to those fearing this time will be deeper and longer than any time since the 1930s and maybe even worse than that!
Property and financial assets worth somewhere between $10 and $20 trillions (maybe one third ratio to annual global income) have evaporated. It appears to be like a spreading global epidemic, like necrotizing fasciitis caused by a financial streptococcus pyogenes (flesh-eating bacteria). Are there more such fasciitis to come?

The above graphic shows states of the USA named after those countries in the rest of the world with the same GDP values.
The present global financial crisis began modestly with property boils bursting in parts of the USA like parts of California, Florida, Nevada and Ohio, which infected banks' mortgage-books worth a third of banking assets. Credit defaults like bacteria spores took a year to double and triple to about 6-8% in aggregate. Capital flight followed into government paper, cash deposits, equities, Europe, commodities (oil, food, gold etc.) and Emerging Markets until the last three in turn also began deflating as Europe's finance sector crashed and global recession fears did for the rest. Somewhat hidden under residential property price falls in the US, parts of Europe and elsewhere has been the predictably faster fall in commercial property. Next, as consumer spending falters and private savings rise, will be falls in corporate profits and defaults in corporate debt that will match and then exceed defaults on household debts. Banks can roll-over some of these for fear of triggering a domino effect. Small business closures will rise by half to over 10% of all firms, employing about 2% of workforces, but new firm creation will fall dramatically and unemployment will rise by about 5% of the total workforce. Large employers may fire another 2-5% of the workforce depending on how prolonged any recession appears to be? Unemployment figures will lag the underlying reality by 6 months or so, just as actual GDP figures may take a year to catch up with 'the actuality'.
But the sequence is a ripple effect. Recession impulses spreading out from the USA and the USA investor dominance (25% or more, usually much more) of all global markets with ebbs and flows of the tides of US dollars means that after US (Anglo-Saxon countries') credit and economic cycles there are later peaks and troughs for Europe, then Asia and rest of the world, by which time USA et al. have recovered - and we can see early signs of recovery in the rising dollar, falling oil and large increases planned for 2009 budget deficits.
The remaining fear is that the banking sector will not be fit to resume normal service for some years. This risk was long recognised and discussed by bank regulators and a central aspect of Basel II Pillar II whereby banks should become far more cyclically aware but not (it was warned again and again) to the extent of acting severely pro-cyclically otherwise all the responsibility would rest with governments to refloat beached economies! Governments know this and were most anxious to intervene early and often to jump-start banks' transmission mechanisms before hurricane Recession would land-fall. They failed, why? There were several institutional impossible obstacles, very broadly stated: 1. banks failing to act collectively to save themselves (continuing to jockey individually for commercial advantage); 2. political hesitancy and disbelief that missed psychological moments to restore confidence in the markets; 3. trusting belief in self-righting buoyancy of capitalist markets to automatically rediscover fundamental values and bounce back. Nothing controversial or unexpected about anyu of that, surely?
It is equally easy to describe the circumstances of boom to bust as banks and businesses sweating their assets to the maximum (a business virtue) and everyone else sweating their incomes to the maximum (and beyond) to invest in expensive assets (in a seller's market) that should become more expensive and did so for years much faster than employment earnings rose. When the boils are lanced or bubbles burst, those most highly leveraged are the first to become technically insolvent. Cash was the joker only so long as property was King.
The only sectors that cannot become technically insolvent, indeed the only truly fundamental values (in market confidence terms) are Governments (especially OECD governments) and the top 5% of households and half of major corporations that remain solvent even when all or most major asset classes have fallen in market price. Of these, only Governments are motivated and big enough to act counter-cyclically to restore general economic growth. There was a vague hope developing for years that if prudential rulebooks are successfully imposed on all banks they could and would become partners with governments in refinancing economies out of the inevitable holes they will find themselves in periodically? This private-partnership was most apparent when banks extended mortgage lending to low-income households thereby saving government the cost of building new public housing. Indeed, in the UK alone for over 20 years, at the rate that new social housing was built or replaced by direct government spending, most social housing would have to survive as long as Stone Henge! But, as the insightful reader will have noticed this brings us full-circle: was it not mortgages for the 'sub-prime' poor (a policy measure that appeared practical, neo-liberal, and new socialist) that started the present sorry mess?

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