Whilst the UK obsesses with phone hacking, Murdoch and idiots with shaving foam I have a strong suspicion that right now is just what July 1914 felt like. The world and its scandals seemed to be going on as normal, but around the corner untold trauma awaited then, and may do now.
Almost unnoticed it seems in the UK the US is moving towards defaulting on its debt. That's the result of acts of the utmost and craven irresponsibility on the part of the Republican Party, but it seems like it's going to happen nonetheless unless something little short of a miracle happens. Hundreds of billions will be wiped off the value of the world's banks as the value of US bonds falls. And tens of millions of Americans will have their lives thrown into turmoil, at least temporarily.
In Europe leaders, in an act of craven irresponsibility, are refusing to compromise on a deal on European debt. Merkel is simply refusing to recognise that her country's currency is causing a crisis within Europe that requires her country to make compromise if resolution is to be found. The result is that there will at the very least be massive market turmoil as contagion spreads on sovereign debt in much of Europe, risk of default rises and the burden of financing beocmes unaffordable for many countries.
In both cases politicians, acting in the interests of small sections of the community whose interests they serve are refusing to act in the common interest. The consequences will be profond. It is likely that serious sovereign debt defaults might happen in August. The impact will be enormous: we simply do not know how far the consequences will spread or in what amount, but given the enormous capacity of markets to turn molehills into mountains contagion is highly likely once this process starts.
The risk of bank insolvencies - inclduing in the UK - is very, very high. We are facing a situation where once again we have the prospect of cash not being available in cash point machines sometime soon.
I keep wishing that this feeling on my part was just melodrama, but I last felt this way in the weeks running up to the crash in 2008, and I was right then, and unless something dramatically changes over the next couple of days, I fear I am right now.
There are, however, some differences. First of all, this crash will be much more significant, of wider scale, and long-lasting. We're not seeing the collapse of one investment bank this time triggering a crisis, we're seeing the collapse of confidence in the two major currencies in the world, and the inability of the government of the largest country in the world to pay its debts and of maybe five European countries to do likewise. Last time was, in comparison, a minor crisis.
That is the first downside, and that it is enormous. There is a second outside. This time we seem to have politicians, whether they be Merkel, Cameron, Obama or others who do not have the political capital to now deal with this situation. That is extraordinarily worrying.
On the upside, there is just a chance that someone will rise to the challenge and address the fundamental issues that are going to arise. There are two of them. The first is that we will have insolvent countries. This can be remedied by them defaulting: that will be inevitable. That however leaves banks with a second, dual crisis. The first is of solvency, and the second is of liquidity. Solvency is a long-term issue: many of these banks will not be able in the long-term settle to their liabilities as they fall due. Liquidity is a short-term issue: simple shortage of cash, and that's not the same thing solvency. However, in this case because a crisis of confidence in the Euro may arise they may coincide.
That means that we need to have a massive disaster management plan in place to get us through the potential crisis that August represents. I admit that I don't have time to write that whole plan this morning, but here's an outline of what is needed.
First we have to accept that this time there is no prospect of banks of surviving as independent entities: in most cases their capital is going to be wiped out. If that happens nationalisation is the only course of option we have available to us. And it is also the only way we can go forward to reform banking for ever. That is a silver lining, although maybe a while in coming.
Second, there is absolutely no way round the fact that governments are going to have to, in effect, print vast amounts of money. Quantitative easing is going to be on the agenda again, and very rapidly. Short-term cash injections will be necessary, partly through recapitalising the banks with new taxpayer funds which will have to be raised through the issue of bonds, and those bonds will have to be purchased by central governments is no one else will have the capacity to do so. That is printing money, by any other name. The process of issuing that cash through banks will on this occasion have to be ignored: there is no point in pretending that governments can't borrow from their central banks when commercial banks will at that time have to be under state control.
Third, once that round of what will in effect be crisis driven quantitative easing is complete I strongly recommend that governments must move towards green quantitative easing. This is the way forward once the immediate crisis is over because major capital injections into the broader economy will also be required to assist recovery from this crisis which will result in a significant risk of a massive increase in unemployment throughout Europe, the USA, and elsewhere. Saving the banks will not be enough this time, rebuilding our economies is what is required, and what was not happened to date, to our cost.
Fourth, what happens after this? Well, banking will have to be restored: I make no pretence that banking should remain a state-owned activity for ever, but wise countries will ensure that banking is returned to the private sector on a very different basis to that on which it is operated to date. Mutualisation is essential for some parts of banking. The splitting of investment banking from plain vanilla banking is vital: nothing else will do. Significant control over speculation is essential: banks continue to threaten our well-being because of that speculation, and the contagion which may precipitate this crisis is the consequence of it. And yes, we will need financial transaction taxes to make sure that there is sand in the mechanism of speculation, as we will also have to take action against the world's tax havens to ensure that banking is not moved offshore and beyond this regulatory environment: we can no longer afford the risk.
Such a programme will require enormous courage on the part of governments. I have no idea if that courage is available. I really rather hope it won't be necessary, but in my heart I have this deep fear that we are on the edge of a precipice. This can still be averted. European leaders may take bold action this week to avert crisis, and give breathing space for a negotiated way forward on debt. Obama might find a way around the Tea Party. I can hope. But realistically, the possibility of catastrophic failure of the financial system has to now be recognised to exist and to fail to plan for that right now would be negligence on the part of any government, anywhere.
Perhaps my greatest fear is that planning is not happening either; that too many will be complacent about this being a crisis that will be ' over by Christmas'. That is what they thought in July 1914. Heaven forbid that people will look back and say that is what was thought in July 2011. But unless some very serious action is being taken now that could be the case. And whilst I have no fear of war arising from this, at least as yet, my fear that what might happen in the next month will have untold consequences in terms of turmoil, disruption, anguish, and simple despair for hundreds of millions, if not billions of people, is very real whilst I still cling to the hope that it is misplaced.
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We’re not seeing the collapse of one investment bank this time triggering a crisis, we’re seeing the collapse of confidence in the two major currencies in the world, and the inability of the government of the largest country in the world to pay its debts and of maybe five European countries to do likewise.
The trouble is that one part of that statement isn’t entirely true. The US could manage its debts: raising the debt ceiling would not (from what I have read elsewhere) be a major issue. But the Republican right elects to play stupid.
So it’s not quite like July 1914. Then, everybody found they had alliances and commitments that meant once trouble started in one place the whole of Europe would be dragged into the resulting conflict. Whereas today we have one party apparently determined that it will pile in anyway even though it has no obligation to, and if it didn’t other problems would be bad but would eventually fizzle.
You dare to dream, Mr. Murphy. Personally, I’m intriuged by the idea of introducing Greece’s soveriegn debt as a form of currency across the eurozone but your plan certainly has merit. I question though, is it possible that due to the financial deregulation 30 years ago we have been, in effect, growing thanks to an underlying bubble in our economy? Prior to Reagan the US economy had effetively flatlined, some might say it had reached an equilibrium level and that the growth post-deregulation was caused entirely by one big economic bubble. I also refer you to the fact that the UK’s GDP per capita grew by 28.7% in real terms between Q1 1997 and Q4 2007, which, to me seems highly unsustainable and well above the level of growth possible in an already developed country. What this suggests to me is that we are on the verge of facing a massive market correction on global scale to bring us back in line with our (much lower then previously believed) LRTRG.
I’ll spare the rant on why this will greatly benefit the rich and end up screwing the poor horrifically, as I’m sure you already know it by heart but I’ll finish with this question: If we are facing a massive market correction due to the fact our economic growth for the past 3 decades was effectively a bubble than surely your demand stimulating plan won’t work?
Oh, also my ‘dare to dream’ comment was a reference to the fact that if I’m incorrect and your demnd stimulating plan is what’s needed it will never come to pass as keynsian economics seems to be out of fashion these days among the elite who run the world economy.
Frightening stuff Richard, but I have a horrible feeling that you’re correct in fearing a financial catastrophe. Whilst the phone hacking scandal is a long overdue reckoning for Murdoch and the rotten journalism he espouses, it is distracting a lot of attention from the situation in the States and the EU. What’s happening in the US is incredible, and demonstrates yet again how far many on the right have descendrd into irrational lunacy.
I wonder if any of the right wingers who’ve been pushing the neoliberal ideology that’s got us to this point will finally admit their ideas are a disaster?
And as you say, one of the consequences of another financial crisis is that the banks will have to be nationalised, and proper banking reform carried out, which of course it should have been in 2008. If the state has to take over major financial institutions to keep the most basic functions of a modern economy like ATM’s going, then so be it.
We need local currencies. Or rather, we needed them a while ago so they’d already be in place for this. Where they’ve arisen as they’ve become to be successful they’ve been stamped upon by the authorities. If there’s a resurrected society after this one, it needs to be ours, one that has arisen naturally and works, not an inevitable consequence of ham-fisted central planning. We should remember that in all likelihood there’d be alternative currencies already were it not for the authorities, be they banks of politicians, abusing the law to sustain their monopoly on currency creation. If we are damned here, we’re damned by their wishing to sustain the financial elites at the cost to the rest of us of our quality of life.
BB
I do agree that the Republican Party are playing politics and that it is ‘potentially’ irresponsible – although I suspect that it will get resolved before it comes to a default. That is, after all, the stuff of politics and a game that is played by all politicians, whatever their party.
I’d humbly suggest though that the craven irresponsibility is not on the part of any one party either in the US or here, but on all parties. Successive governments of all colours have seen fit to rack up the credit card bills, borrowing excessively and running suicidal fiscal policies.
If only our politicians (of all colours) had thought that it might be a good idea to live within ‘our’ means then it’s likely that we wouldn’t be in this predicament.
Sadly now we’re in a situation where where we’re trying to help the terminally indebted governments, corporates and individuals a lifeline by extending their credit even further when they can’t even pay what they owe now.
What we need is not more QE and borrowing but a bit (well a lot actually) of belt tightening. Looking at what we’ve got coming in and cutting our cloth accordingly.
Anything else is utter, utter madness.
Respectfully, that shows that you have not read what I’ve written. I am not suggesting borrowing for the sake of funding current spending, and do not. I am suggesting borrowing for investment to create jobs, to create future well-being and sustainable prosperity. That is something fundamentally different.
Yes we have had governments that have wasted vast amounts of money, for example on stupid wars, weapons systems we do not need, and the support for markets that were no such thing. But of course, the real crisis was in banking, and that was not, whatever is said, the fault of government: that was the fault of bankers. You can’t pass the buck. Nonetheless, in the States, if a culprit is to be found it is George W Bush, beyond a doubt at all. Debt ballooned under his regime, Clinton cut it.
What would you recommend we do individually, Richard?
Get in a stock of pasta, cooking oil, tinned food and something to heat it on
I did that last time and didn’t regret it
There may be chaos if banks can’t deliver cash
For which reason holding some cash makes sense…
‘Holding cash’ Already done, Richard. Mostly on the basis of what you’ve written here recently.
Google for UK Preppers. I’m the Economania site, by the way.
BB
I have read that, come hell or high water, the US wll prevent a real default happening. however, it is believed in other quarters that a “technical default”, that is, a belief that a US default COULD happen, could be enough to trigger a crisis even if a true default didn’t happen.
The US foam fleced right wing nut jobs are in danger of causing financial armeggedon in the US if they do not stop their absurd game of “chicken” with the US economy!
Get in a stock of pasta, cooking oil, tinned food and something to heat it on
Before investing in an independent heat source matches are probably the first consideration.
However once the starving mobs observe that you are surviving (and not becoming extremely thin) they will break into your house to demand (perhaps with the aid of torture) to know where your cache of resources is hidden.
Similarly cash will become irrelevant as all the shops/supermarkets will be stripped bare by the greedy and starving.
The choice boils down to be being either a member of or a casualty of the starving gangs.
I agree with much of your analysis, but not all.
Politicians everywhere have tried to treat this as a crisis of liquidity because this enabled them to pretend it was a little local difficulty, kick the can down the road a little and not confront powerful constituencies. In fact it’s always been a solvency problem and that reality is about to reassert itself.
The problem is the sheer scale of the insolvency. I can’t quickly lay my hands on recent figures but from memory the UK (ie UK banks) are exposed to the tune of around $300 – $400 bn in Europe of which around $180 bn or so is in Ireland. France and Germany have aggregate exposures that are even higher. Then there are the Credit Default Swops (CDSs) which are in effect insurance that pays out if loans default; the global total is put at circa $600 TRILLION – many times larger than the world economy. In theory, most of these are offset one against another so the net exposure is far smaller.
Although Greece is smallish, its default will be like trowing a lighted match into a very large box of fireworks. Banks that pretend solvency by pretending that Greece et al are good for their loans will be blown away. This will trigger CDSs but if some the counterparties have just failed the netting out fails and the gross positions will be exposed. Hence, other institutions will be pulled down in a spreading domino collapse.
So, nationalising the banks will NOT be an option. The potential liabilities will far exceed the govt’s ability to backstop them (which will be further reduced by the implosion of the financial sector and consequent loss of tax revenues).
As with the Great Fire of London, a very close parallel, the best that can be achieved is to cut emergency firebreaks never mind the normal proprieties of property rights and the like. In 1666 that meant blowing up houses; today that means legislating that CDSs are illegal and unenforceable. (Helpfully, there is a figleaf here. They are insurance contracts thinly disguised by a name change. It’s pretty certain that few are regulated by the FSA as insurance).
It also means acting to preserve the money-transmission part of the banks and customer deposits (the High Street and its back office) while leaving the banks’ bondholders to take their chances. Since some of these are our pension funds – even fully funded pensions – will have to be slashed. (Yes, all those bankers’ bonusess really did come from somewhere – perhaps a future govt will write to pensioners explaining that regulatory capture and bad economic theory saw them standing idly by while penssion funds were being systemmatically looted.) The alternative is even worse; no pensions at all – wiped out by a complete financial collapse.
The next probem govt will face is that the country is how we, as a nation, will pay for basics like food and energy.
We do, indeed, live in interesting times.
I just found some data on cross border exposures although they leave out Italy which is looking very iffy. They also leave out domestic exposures – goodness knows what the banks exposure is in the event of a severe drop in real estate which has to be on the cards in a domino collapse scenario.
http://www.zerohedge.com/article/how-greece-could-create-another-round-systemic-risk-pt-1-0
“So, nationalising the banks will NOT be an option. The potential liabilities will far exceed the govt’s ability to backstop them (which will be further reduced by the implosion of the financial sector and consequent loss of tax revenues).”
But don’t these only become liabilities if we have to pay them? They are bad debts, hence they could be deemed unrepayable, hence the possibility that they could be written off.
Let the private banks who made these bad bets twist in the wind and let any exposure to the BoE be wriiten off as unrecoverable debt.
Greece is systematically being robbed of all its national assets because the government has been convinced that defaulting on debts that aren’t really theirs is the worst option. If the Greeks, Portuguese, Spanish and Italians either defaulted or told the IMF/World Bank/IMF to take a hike, yes, there would be another big crash in the banking sector, but any debt central banks are exposed to could be written off as bad debts. The banking sector could then be natonalised and EU countries could go back to their own currencies and start afresh. Argentina did this. They told the IMF to take a long walk off a short pier, started their own currency and started to show a recovery within six months.
There will be some short term pain, but let the banks take the hit, let our central banks write off any debt the country is exposed to and start afresh by nationalising the banks for a temporary or indefinite period,
The economic blackmail of sovereign nations by the banks has to be brought to an end.
Stevo,
I think perhaps you are misunderstanding me. What I am saying is that if, as seems highly likely, one or more UK banks fails then it should be/must be allowed to fail – to twist in the wind as you put it. The risk is that if the govt gives any guarantees and a bank then fails the creditors will come to the taxpayer to collect on the guarantee and we will all spend the rest of our lives working largely to pay them off which will act like a sea anchor for the economy. It’s what happened in Japan after their property bubble collapsed 20 years ago and their economy has been labouring under the weight of debt ever since.
If a bank fails the govt has two related problems. Firstly, it must stop the fire spreading in what would undoubtedly be a very nervy panicky athmosphere. It will have only hours to make the key decisions. Secondly, it must decide who takes the loss for it is certain that a huge amount of money will be lost, almost certainly far more than the bank’s capital which is the first line of defence. After that it’s either bondholders or depositors and its a matter of choosing the least worst which for me is bondholders. They are supposed to be professionals and the economy will bounce back quite quickly. If depositors (people and companies) are wiped out or badly damaged the collateral damage will be immense and the economy will take a lot longer to recover.
For Osborne it’ll be the depositers because the bondholders are his mates. Neither he nor they could give a damn about anyone else.
BB
Yes, you mention gaurantees, but how many times are taxpayers expected to bail them out? I do take your point about legitimate bank depositors. I did naively used to believe that these were the only ones taken care of by the Financial Services Compensation Scheme. I was obviously wrong. Some American Economist pointed out that many of the US financial insitutions were insured (NOT by the FDIC) and therefore, if they went bust and were allowed to do so, the economy would have quickly bounced back.
A moral hazard has unwittingly been created in which banks can be as irresponsible as they like and, if the balloon goes up, the taxpayer cleans up the mess…this has to be cancelled. As has been proved with Qiantitative Easing, the government do NOT need to lend taxpayers money in order to prop up the banks, it can be created on a computer keyboard. Pay legitimate depositors their compensation and leave bondholders and those who took bad bets go hang. They can be deemed unrecoverable debts and written off! I believe many of these debts can be classified as this and can be legitimately written off.
I still advocate nationalising the banks, either by using the national debt to do it, or, much better, by using debt free money to do it.
Doing it with debt free money (which, as QE has demonstrated, is perfectly possible) would save taxpayers a fortune, capital could then be freed up by using the backing of state funds as capital for low cost loans to businesses and people. This could be done on a not-for -profit basis, redistributing most of the money from loans and interest back into society.
The way that Wall Street banks and speculators are turning Greece, Ireland, Portugal, Spain and, very soon, Italy, into their personal financial plaything and usurping he democratic will of the people at every turn shows that governments have to say enough is enough and stop pandering to them.
Stevo!!, there doesn’t seem to be any guarantee of depostits at all if you look into it, as this guy’s done http://forum.positivemoney.org.uk/viewtopic.php?f=4&t=15 also of course it’s not in government’s interest to adopt a plan using debt-free money because then what would they boss us about with? The point of keeping the national debt the way it is is that it’s a stick to beat us with, not an economic necessity. With very few honorable exceptions I know of (Baker, Caldwell, Austin) the government wants to keep it this way. Governments generally aren’t nice people! They’re not going to do what’s best for the community through choice. They’re just in it for themselves.
BB
I would not be so quick to reach for QE. There is always a cost even though it’s not obvious.
In this case it means that a resolution has been delayed. We should be well on the way to recovery by now.
The other big problem is that it represents ‘free’ money for bankers. And what do they do with free money? Why speculate on commodities and buy up any tangible assets they can get their grubby hands on. There’s is no risk (as prior rescues prove) and no cost. That is why the cost of oil, food etc is so high when the economy is so weak.
Green QE is designed to overcome those issues
“The other big problem is that it represents ‘free’ money for bankers. And what do they do with free money? Why speculate on commodities and buy up any tangible assets they can get their grubby hands on. There’s is no risk (as prior rescues prove) and no cost. That is why the cost of oil, food etc is so high when the economy is so weak.”
Well, that’s only because instead of putting the money directly into the real economy, the money was paid to the banks.
The government still has a majority shareholding in at least two banks that were part-nationalised. The money could be distributed through those or even the Post Office to get loans into the real economy.
Of course, the government could also acheive a bottom up stimulus of the economy by providing much needed work on council housing, infrastructure and modernising our creaking transport system by the simple route of a fiscal stimulus. This would be hugely helped if the rich were finally made to pay their true whack of tax. With QE though, there’s no interest (and hence no banks) to pay off.
Get QE money into the real economy, rather than just to the banks, help get demand going that will no doubt encourage corporations to invest in the economy instead of just hanging on to most of their money like they are at the moment.
In 2008 a detailed analysis was carried out in relation to the claims made by Goldman Sachs on AIG in respect of CDS contracts. The claims would have bankrupted AIG and the US taxpayer had to step in. You might ask why AIG had not re-insured some of this risk. Collusion was suspected. Specialist lawyers examined the detail of the CDS contracts and it was found that neither “Insurable Interest” nor “Consideration” could be properly established amongst other technical aspects.
If large CDS claims are made again, all these issues may well re-appear and the size of the (make-believe) sums involved would swamp the insurance industry.
[…] To continue yesterday’s metaphor…it looks like the Archduke may survive after all. Merkel and Sarkozy supposedly have the umpteenth deal to save the Euro without making fundamental change and Obama is going to agree to slash spending and not increase taxes after all (the ultimate failure of the Courageous State). […]
The parallels with July 1914 do seem amazingly apt.
The constitutional deadlock in the world’s most powerful nation – the US today, the Home Rule crisis in the UK, with the conservatives willing to risk anything, including national dislocation, to get their way.
The enormous media/political scandal in the world’s most powerful nation’s closest ally completely distracting it; Murdochgate in the UK today, the Madame Cailloux trial in France in July 1914 (where the French PM’s wife did what Sarah Brown would surely love to have done, and marched into a newspaper editor’s office and shot him dead).
Meanwhile, the Germans are embarked on a selfish and ultimately self-defeating course of action, in an attempt to resolve a crisis in southeastern Europe to their liking.
What’s most striking in similarity is how our pygmy leaders are being overtaken by events, and seem locked into disaster by a combination of prejudices, ignorance, ideology and sheer blind selfishness.
It should be born in mind that this is all funny money we’re talking about. It’s all just made-up stuff. When they say bank A owes bank B squillions, they mean bank A doodled at its keyboard for a time whereupon squillions appeared in the account of bank B. No-one really lent anyone anything of any merit. However, these are the rules of the game as played by much of the Western world. We pretend that our currencies have merit even when it’s clear to all that they do not. Clearly, it’s not in the interest of the majority to follow these rules, so why are we still playing it that way? The answer is playing the game this way makes it possible to create and maintain a financial elite who lord it over the rest of us by virtue of their ability to control the money supply. To preserve this they will happily damn the rest of us as they have done several times in the past. It’s time now, in this the information age, to step away from this absurdity and follow a new set of rules. Brazil has recently done just this, and over in Brazil they’re doing very nicely, thank you http://taxjustice.blogspot.com/2011/07/some-heartening-news-from-brazil.html
Why aren’t we in the good times here in the UK, or in Euroland in general? Apparently we could be but the elite I refer to would rather we all starve in our beds than that they lose any shred of their authority, this after repeated example of their complete inability to manage that authority. This is all an absolute nonsense. Where are our political so-called representatives? Mostly clamouring to climb aboard the same elite bandwagon even as the wheels fall off it. They haven’t even got the wit to be self-serving. We must fall back on our own individual resources for the future. There’s simply no responsible authority we can appeal to.
BB
I should mention I meant Austin Mitchell 🙂
BB