A seminiar I attended in 2007 confirmed my thinking on some global tends and opened my eyes to the magnatute of trends taking place in CHINA.
I've included a video segment of the seminar (top right excluding CHINA). It is an ominous prelude to the current financial crisis. While I was amused with the “old-school” overhead projector presentation tools, I found the facts reviewed amazing.
The crisis in world financial markets began when prices started declining in the US real estate market in late 2006. Banks and finance companies worldwide have reported almost $690 billion in writedowns and loan losses since the start of 2007, according to Bloomberg News reports.
This Real Estate Boom to Bust trend was happening around the world as easy access to low cost money fueled a frensy of real estate building and buying around the globe.
In America the Federal Reserve keep rates low to stimulate America out of the recession created from declining tech and telecom spending and by 9/11.
Wall Street Investment Bankers looking for new sources of profit (after the Tech and Telecom and dot-com IPO bust) profited by expanding the collateral debt obligations (CDO's) market for home mortgages.
Consumers benefited from the lowest cost mortgage rates in 40 years. And the housing boom was touted by the government as proof the American economy was strong.
So, during the boom everyone benefited. Wall-Street profited from CDO's and Consumers profited by obtaining historically low rates. Builders and Mortgage Lenders profited and in-turn employeed millions of workers who profited. And now during the bust everyone will focus on playing the blame-game.
Here is a chronology of major U.S.A. financial events:
March/April 2007: New Century Financial corporation stops making new loans as the practice of giving high risk mortgage loans to people with bad credit histories becomes a problem. The International Monetary Fund (IMF) warns of risks to global financial markets from weakened US home mortgage market.
June 2007: Alarm bells ring on Wall Street as two hedge funds of New York investment bank Bear Stearns lurch to the brink of collapse because of their extensive investments in mortgage-backed securities.
July/August 2007: German banks with bad investments in the US real estate market are caught up in the crisis, including IKB Deutsche Industriebank, Sachsen LB (Saxony State Bank) and BayernLB (Bavaria State Bank).
US President George W Bush rejects government intervention to ease the crisis in the home mortgage market and says he wants the market to work. He later pledges help for struggling homeowners to help ease the mortgage crisis.
Foreclosures of US homes in July were up 93 percent from a year earlier, to 180,000 owners.
September 2007: British bank Northern Rock is besieged by worried savers; British government and Bank of England guarantee the deposits; the bank is nationalized. The US Federal Reserve (Fed) starts series of interest rate drops to ease impact of housing slump and mortgage crisis.
October 2007: Profits at US financial giant Citigroup drop sharply. IMF lowers 2008 growth forecast for the euro area to 2.1 percent from 2.5 percent, in part because of spillover from the US subprime mortgage crisis and credit market crunch.
December 2007: Bush unveils plan to help up to 1.2 million homeowners pay their loans.
January 2008: Swiss banking giant UBS reports more than $18 billion in writedowns due to exposure to US real estate market. In the US, Bank of America
acquires Countrywide Financial, the country's biggest mortgage lender. Fed slashes interest rate by three quarters of a percentage point to 3.5 percent following sell-off on global markets. Another cut at month's end lowers it to 3 percent.
February 2008: Fannie Mae, the largest source of money for US home loans, reports a $3.55-billion loss for the fourth quarter of 2007, three times what had been expected.
March 2008: On the verge of collapse and under pressure by the Fed, Bear Stearns is forced to accept a buyout by US investment bank JP Morgan Chase. The deal is backed by Fed loans of $30 billion.
In Germany, Deutsche Bank reports a loss of 141 million euros for the first quarter of 2008, its first quarterly loss in five years. Fed spearheads coordinated push by world central banks to bolster global economic confidence by announcing moves to pump $200-billion liquidity into markets.
Carlyle Capital falls victim to US credit crisis as it defaults on $16.6 billion of indebtedness. US frees up another $200 billion to back troubled Fannie Mae and Freddie Mac.
April 2008: IMF projects $945-billionlosses from financial crisis. G7 ministers agree to new wave of financial regulation to combat protracted financial crisis.
June 2008: Home repossessions more than double as US housing crisis deepens. Bear Stearns execs join 400 charged with mortgage fraud.
July 2008: California mortgage lender IndyMac collapses. Troubles for Fannie Mae and Freddie Mac continue to grow. US Treasury, Fed move to guarantee debts of Fannie, Freddie. Bush defends move, telling Americans to take a "deep breath" and have "confidence in the mortgage markets."
US Congress gives final passage to multi-billion-dollar program to address mortgage and foreclosure crisis. Spain's largest property developer, Martinsa-Fadesa, declares insolvency.
September 7: US government seizes control of Fannie, Freddie in $200-billion bailout.
September 15: Lehman Brothers investment bank declares $600-billion bankruptcy. Merrill Lynch acquired by Bank of America.
September 17: US bails out AIG insurance giant for $85 billion.
September 19: White House requests $700-billion bailout plan from Congress for all financial firms with bad mortgage securities to free up tightening credit flow.
September 22: Last two standing investment banks, Morgan Stanley and Goldman Sachs, convert to bank holding companies.
September 26: Feds seize Washington Mutual in largest-ever US bank failure.
September 29: US House of Representatives rejects mammoth $700-billion bailout plan.
September 29: Governmental bail-outs announced for key banks in Britain, the Benelux and Germany as well as a state takeover of a bank in Iceland. British government intervenes to save major mortgage lender Bradford & Bingley. Netherlands, Belgium and Luxembourg to take over substantial parts of Belgian-Dutch banking and insurance company Fortis.
German Finance Ministry announces that government and top banks were moving to inject billions of euros into troubled mortgage lender Hypo Real Estate. Iceland government and Glitnir bank announce state takeover of 75-percent stake in Glitnir.
September 30: Wachovia Bank teeters on collapse, starts negotiating with Citigroup for takeover deal.
October 1: US Senate adopts massive bail-out plan, adding sweeteners to get House acceptance.
October 3: Wells Fargo bank and the fourth-largest US bank Wachovia Corp announce merger.
October 3: The largest government intervention in capital markets in US history clears the US House of Representatives, becoming law with signature by President Bush. The dollar amount -$700 billion.
The financial crisis is not over. Neither tax rebates nor low interest rates nor higher or lower exchange rates can do the job of reviving an economy that is burdened by debt loads that are too high. On the contrary: the policy measures that the US authorities have been applying will prolong the agony. Be prepared for the challenges of extended financial turmoil and economic stagnation.
Early this year, the US central bank decided to manage the debt crisis in the light-hearted belief that a few aggressive rate cuts would "unfreeze" the banking system. Yet as of the end of the third quarter of 2008, the arteries of the financial system are still cluttered, and the financial system has moved even closer to total collapse.
Those banks and brokerages that haven't yet failed have been kept alive by emergency monetary transfusions from the US central bank. The Fed has cast away all restraints of economic rationality and is acting in a purely political way. The Board of Governors of the US Federal Reserve System is pursuing the goal of getting the financial system through the mess — at least until the end of the year, no matter how high the costs will be thereafter.
The American central bank has adopted the financial equivalent of the military strategy of scorched earth. The economic philosophy of the current chairman of the US Federal Reserve System can be summarized in the slogan, "No depression under my rule!" He resembles a military leader who stubbornly declares, "No defeat under my rule!" the more the chance of victory is slipping away, and defeat can be denied no longer.
The current economic disaster is the result of the combination of negligence, hubris, and wrong economic theory. For decades, an economic and monetary policy has been practiced based on the illusion of, "It doesn't matter." At first it was, "Deficits don't matter." From that, the policy of "it doesn't matter" got extended to money creation, the credit expansion, the stock-market bubble, and the housing boom. Now, we're being told that buying financial junk by the central bank to beef up banks and brokerages also doesn't matter.
As a byproduct of this mindless economic and monetary policy, financial market operators, too, have lost their heads. Trusting the official cheerleaders, investors hold on in the trenches until they will have lost their last shirt. Economic weakness is spreading around the globe. There is no new spurt of economic growth in sight. Yet many investors stay put because they have been conditioned to believe that government will bail them out.
The current financial crisis is not of a cyclical nature. The financial turmoil is the symptom of the structural imbalances in the real economy. Over decades, expansive monetary policy has gone hand in hand with implicit and explicit bailout guarantees, and this has distorted the process of capital allocation. Under such perverted conditions, those investors will win most who cast away the restraints of prudence. It is a game that can go on for a long time — up to the point when the irrationality has become systemic.
The behavior of the investment community reflects the incentive structure that has been put in place by the authorities. Investors have learnt to dance to the tunes of the pied pipers at high places. After all, the individual market player could see from those who were ahead of him in the abandonment of prudence how money is being made. In the wake of this, financial companies have become overextended and are now in need of deleveraging.
Yet the core problem lies in the imbalances of the real economy. In the Austrian theory of the business cycle, the distinction is made between the "primary" and "secondary" depression. The secondary depression is what catches the eye: the turmoil in the financial markets. Yet the underlying cause is the distortion of the economy's capital structure: the primary depression.
The simple fact is that the US economy is burdened with a highly lopsided capital structure as the consequence of a wide discrepancy between consumption and production, which, in turn, is the result of monetary policy. Persistent trade imbalances are the symptoms of this discrepancy. This means for the US economy that lower interest rates and government incentives aimed at boosting consumption work as pure poison. Instead of more consumption, more savings, less consumption and fewer imports are needed.
The current financial crisis reflects that many debtors have reached their debt limit and that creditors are lowering that limit. From now on, business and consumers, governments and investors must work under the restraints of lowered debt ceilings.
Economic policy as it is currently practiced is in a fix: lower interest rates may temporarily help to alleviate the financial crisis, but they exacerbate the fundamentals that are the cause of the financial crisis. Equally, a lower dollar would make imports costlier for the United States, while a strong dollar comes with lower import prices. But while a low dollar would help to expand exports, a strong dollar impedes export growth.
Therefore, the United States will have high trade deficits as long as the economy does not fall deeper into recession.
Without an adaptation that would increase savings, decrease consumption, and reduce imports, the US economy can only go on in the old fashion with ever more debt accumulation. But the limit of debt expansion has been reached. The financial crisis has reduced the willingness of domestic and foreign creditors to extend loans.
Foreign creditors are getting ready to reduce their holding of US debt in a more drastic way. The governmental takeover of the mortgage agencies Fannie Mae and Freddie Mac bailed out the monetary authorities of China, Japan, Russia, and other foreign countries that hold agency debt. As a result of the socialization of the so-called government-sponsored enterprises, the Treasury opened a window of opportunity for these countries to unload their US assets at subsidized prices, all at the cost of the US taxpayer.
A profound restructuring of global capital has become unavoidable. Such a process is quite different from a recession in the traditional sense. In contrast to a sharp and typically short-lived recession, when, after the rupture, business as usual can go on, the restructuring of a distorted capital structure will require time to play out. Rebalancing the distorted capital structure of an economy requires enduring nitty-gritty entrepreneurial piecemeal work. This can only be done under the guidance of the discovery process of competition, as it is inherent in the workings of the price system of the unhampered market.
Anticyclical fiscal and monetary policies are of no help when it comes to the daily toil in business to work towards reestablishing a balanced capital structure. The so-called income multiplier won't work, and lower interest rates won't stimulate spending. On the contrary: these policy measures only make the task of the entrepreneur harder.
The difficulties ahead arise from the problem that business as usual cannot go on under conditions of a credit crunch, which has its roots in the distortions of the economy's capital structure. Thus, even if the financial market turmoil were to settle, there won't be the simple resumption of the old ways of doing business. The belief that, after the financial crisis is over, the real economy can reemerge unscathed is probably the greatest error that many investors share with the policymakers.
As a result of the bailouts and the socialization of the mortgage agencies, the financial system is now fully infected with moral hazard. The disastrous effects of these government interventions will show up soon. The major task of bringing the capital structure in order is still ahead and more pain is in the waiting.
As long as governments and central banks continue to focus on the monetary symptoms of the "secondary depression" and continue to ignore the structural aspects of the "primary depression," they act like quacks. Ignorant of the lessons of the Austrian School, the authorities will most likely continue with their disastrous policies.
Antony Mueller is the founder of the Continental Economics Institute . He is an adjunct scholar of the Ludwig von Mises Institute and academic director of the Instituto Ludwig von Mises Brasil. He maintains the blog Money, Markets, and the Business Cycle. Comment on the blog.