A credit-crunch stuffing, injections of cheap money can solve nothing....
By Martin Hutchinson
Two successive articles in the Financial Times last week gave warning of a new problem approaching: they spoke of expected 25% declines in financing volume for both commodities finance and aircraft purchases. In addition, the tottering euro-zone provides another route by which a credit crunch may be unleashed on the world. In today's distorted world financial system, a combination of over-loose monetary policy, intractable budget deficits and tightening regulation has made a crunch more or less inevitable. It's worth looking at who the winners and losers might be.
At first glance, it would seem impossible to suffer a credit crunch (absent a severe market crash) at a time when central banks worldwide have for three years pursued policies of reckless monetary expansion. The International Monetary Fund's COFER database of global central bank reserves shows an increase of 33.2% in only two years to the second quarter of 2011. US banks have US$1.5 trillion of excess reserves deposited with the Federal Reserve. However, the current attempts to solve a potential liquidity crisis by stuffing the overfed banks with yet more central bank cheap money are appropriate policy only if you're trying to make pate de foie gras.
On the lending side, there are a number of signs that the money is not getting through to the wealth-creators. Commodities inventories need financing, and even commodity speculators have a reasonable claim on it, albeit at higher interest rates than those currently prevailing.
Even though the glut of airline capacity could be alleviated by a shortage of aircraft financing, with great benefit to airline profitability, such a shortage does not bode well for expansion of international trade, essential to economic recovery. Furthermore, if commodity finance is short, the chances are that trade finance is tight also, and we saw in 2008 (not to speak of in 1929-32) what happens if trade financing becomes scarce.
As for small business financing, the most important item of all in the job-creation economic engine, Fed data shows that US banks' commercial loans have recovered somewhat in the last year, but are still running 20% below their 2008 peak.
It is thus clear that the link is broken between the ample supply of money and the meager supply of lending to productive enterprise. Fed chairman Ben Bernanke and his international colleagues can drop money on banks from helicopters as much as they like. If the banks do not lend it, and central bankers make no effort to ensure the money reaches productive businesses, that money will be wasted. There are a number of reasons for this non-functionality:
Yield curve. Bernanke and other central bankers have kept short-term interest rates far below the level of long-term rates for a number of years and have made it clear that they will intervene if long-term rates rise. Accordingly, banks can borrow short-term, lend in the long term markets, and through this ''gapping'' use massive leverage to boost their returns, being secured against capital losses by the central banks' commitments to low interest rates. Basel Committee regulations, which allow banks to escape allocating capital to their holdings of OECD government debt. These are a massive and unwarranted subsidy to governments. The regulations allow banks to play the gapping/leverage game ad infinitum, provided they invest in government or government-guaranteed bonds. Both in Europe and the US banks have engaged enormously in this unproductive if profitable activity, allowing bankers to get bonuses whether or not they lend to business. This is the principal mechanism by which gigantic budget deficits of recent years have been financed, and have ''crowded out'' private sector lending. Tightening limits on bank capital. Banks have ample liquidity, but they have only a finite store of capital. Accordingly, if as has happened recently the regulators insist on banks holding more capital, their loan volume becomes limited by their capital base, and they can no longer go on expanding lending (other than to governments, whose paper is freed from this regulation). If as in 2009-10 the stock markets are irrationally exuberant about bank shares, banks can in theory raise more capital and expand lending by that means. More recently, markets have taken a properly more skeptical view of bank earnings, so they can only raise more capital at below their net asset value, diluting their existing shareholders.
Massive liquidity combined with tightly stretched bank balance sheets has led to the beginnings of a credit squeeze. Before 2008, the liquidity tsunami had led to a massive expansion in the shadow banking sector, whose capital rations are either completely unregulated or are much less tightly regulated than those of banks.
MF Global, John Corzine's brokerage that recently filed for bankruptcy, was one such shadow bank, with leverage of 60 to 1 in its last days - approximately four times that permitted to a bank. Hedge funds, money market funds and structured investment vehicles are examples of such institutions, which contributed enormously to the growth of financial system leverage and instability before 2008.
Since 2008 however the shadow banking system has contracted. Structured investment vehicles are, for obvious reasons, a lot less popular than they were before 2008. Hedge funds were until this year even more popular, but they were not permitted by their suddenly cautious bankers to leverage themselves to the extent they had previously done.
Money market funds have lost considerable popularity since their returns have been pathetic for the last three years, while inflation has risen, thereby eroding the real value of their investors' capital. There's still a lot of money in the shadow banking system, but it probably won't be able to make up for any further lending cutbacks in the banks.
Thus in both the banking system and the shadow banking system available finance has declined even as bank reserves have been artificially pumped up. Low interest rates have become counterproductive. The string on which the Fed is pushing is completely slack, and another $1 trillion of Fed monetary stimulus will not lead to an extra $1 of productive loans.
The solution is for interest rates to rise, increasing the supply of savings, reducing the ability of the banks to make money through gapping/leverage games and beginning to restore the linkage between massive systemic liquidity and sluggish productive lending. However while the current central bank theories govern, higher interest rates are off the table, however beneficial they might be.
Thus in 2012, with interest rates so low and banks so restricted, the chance of a market shock that would cause a true credit crunch is quite high. One such shock would be a loss of confidence in the bonds of major eurozone countries, causing an investor flight from those instruments that would quickly spread to other assets, as investors sought safety (and, other than in gold, failed to find it).
In a free market, that would cause interest rates on all kinds of lending to rise, eventually increasing the supply of lendable funds and mitigating the credit crunch problem. In our current system, Bernanke and his eurozone buddies would engage in massive further ''quantitative easing'' thus further boosting the financial system's bias towards governments and worsening the imbalances that had caused the credit crunch in the first place (unless, as has not yet happened, they lined up their monetary helicopters above the global private sector).
A credit crunch in 2012 would re-arrange significantly the participants in the world economy. Countries with large budget deficits, notably Britain, Japan and the United States, would suddenly find funding drying up. While for some such countries this would merely make funding more expensive, for others a market ''redlining'' would take place, at which they were unable to obtain funding at any price.
The rise in long-term interest rates for countries that were not ''redlined'' altogether would push their banking systems even more into the 'gapping' game. The British, Japanese and US private sectors would suffer the worst of the squeeze, being forced to pay higher interest rates and finding funding almost unobtainable. Yet they would gain none of the normal benefit from higher interest rates: an increase in domestic saving. With deposit rates remaining ultra-low, there would be reason for saving to increase - indeed it would very likely decrease if central banks attempted to fight the credit crunch through ''quantitative easing,'' thus raising inflation rates.
Emerging markets would be divided into those with ample domestic savings or currency reserves - for example China, Taiwan, Singapore and Chile - and those already borrowing too much, with bloated public sectors and extravagant consumers - the majority of Latin America, Brazil and above all India, whose profligate government seems incapable of mending its ways. Liquid emerging markets would benefit considerably from a credit crunch, as their liquidity would ease any ill effects and they would gain export market share. Illiquid emerging markets would suffer badly, finding themselves returned to the state of Latin America in the 1980s and Asia after 1997.
In the private sector, businesses such as aircraft financing and commercial real estate that were chunky and not especially people-intensive would find funding through the shadow banking system, albeit at higher rates than they are used to. Conversely, small businesses and ''frontier'' markets such as Vietnam and most of Africa would find funding drying up altogether.
The continuing existence of vast pools of liquidity would support commodity prices, unless the world suffered a major economic downturn, and it would even boost the prices of gold and silver, safe havens in times of crisis that do not depend on a smoothly functioning banking system for their support. To a certain extent, trade financing, difficult to obtain by conventional means, might increasingly be carried out in gold, with sellers happy to carry buyers' credit risks on their balance sheets provided they could be repaid in an inflation proof asset with no linkage to troubled financial systems.
Those currently in charge of the world's monetary system appear to believe that injections of cheap money can solve any credit crunch, with the two being inexorably linked. They're wrong, for the reasons outlined above, and in 2012 we are likely to pay the price of their error. .....
By Martin Hutchinson
Two successive articles in the Financial Times last week gave warning of a new problem approaching: they spoke of expected 25% declines in financing volume for both commodities finance and aircraft purchases. In addition, the tottering euro-zone provides another route by which a credit crunch may be unleashed on the world. In today's distorted world financial system, a combination of over-loose monetary policy, intractable budget deficits and tightening regulation has made a crunch more or less inevitable. It's worth looking at who the winners and losers might be.
At first glance, it would seem impossible to suffer a credit crunch (absent a severe market crash) at a time when central banks worldwide have for three years pursued policies of reckless monetary expansion. The International Monetary Fund's COFER database of global central bank reserves shows an increase of 33.2% in only two years to the second quarter of 2011. US banks have US$1.5 trillion of excess reserves deposited with the Federal Reserve. However, the current attempts to solve a potential liquidity crisis by stuffing the overfed banks with yet more central bank cheap money are appropriate policy only if you're trying to make pate de foie gras.
On the lending side, there are a number of signs that the money is not getting through to the wealth-creators. Commodities inventories need financing, and even commodity speculators have a reasonable claim on it, albeit at higher interest rates than those currently prevailing.
Even though the glut of airline capacity could be alleviated by a shortage of aircraft financing, with great benefit to airline profitability, such a shortage does not bode well for expansion of international trade, essential to economic recovery. Furthermore, if commodity finance is short, the chances are that trade finance is tight also, and we saw in 2008 (not to speak of in 1929-32) what happens if trade financing becomes scarce.
As for small business financing, the most important item of all in the job-creation economic engine, Fed data shows that US banks' commercial loans have recovered somewhat in the last year, but are still running 20% below their 2008 peak.
It is thus clear that the link is broken between the ample supply of money and the meager supply of lending to productive enterprise. Fed chairman Ben Bernanke and his international colleagues can drop money on banks from helicopters as much as they like. If the banks do not lend it, and central bankers make no effort to ensure the money reaches productive businesses, that money will be wasted. There are a number of reasons for this non-functionality:
Massive liquidity combined with tightly stretched bank balance sheets has led to the beginnings of a credit squeeze. Before 2008, the liquidity tsunami had led to a massive expansion in the shadow banking sector, whose capital rations are either completely unregulated or are much less tightly regulated than those of banks.
MF Global, John Corzine's brokerage that recently filed for bankruptcy, was one such shadow bank, with leverage of 60 to 1 in its last days - approximately four times that permitted to a bank. Hedge funds, money market funds and structured investment vehicles are examples of such institutions, which contributed enormously to the growth of financial system leverage and instability before 2008.
Since 2008 however the shadow banking system has contracted. Structured investment vehicles are, for obvious reasons, a lot less popular than they were before 2008. Hedge funds were until this year even more popular, but they were not permitted by their suddenly cautious bankers to leverage themselves to the extent they had previously done.
Money market funds have lost considerable popularity since their returns have been pathetic for the last three years, while inflation has risen, thereby eroding the real value of their investors' capital. There's still a lot of money in the shadow banking system, but it probably won't be able to make up for any further lending cutbacks in the banks.
Thus in both the banking system and the shadow banking system available finance has declined even as bank reserves have been artificially pumped up. Low interest rates have become counterproductive. The string on which the Fed is pushing is completely slack, and another $1 trillion of Fed monetary stimulus will not lead to an extra $1 of productive loans.
The solution is for interest rates to rise, increasing the supply of savings, reducing the ability of the banks to make money through gapping/leverage games and beginning to restore the linkage between massive systemic liquidity and sluggish productive lending. However while the current central bank theories govern, higher interest rates are off the table, however beneficial they might be.
Thus in 2012, with interest rates so low and banks so restricted, the chance of a market shock that would cause a true credit crunch is quite high. One such shock would be a loss of confidence in the bonds of major eurozone countries, causing an investor flight from those instruments that would quickly spread to other assets, as investors sought safety (and, other than in gold, failed to find it).
In a free market, that would cause interest rates on all kinds of lending to rise, eventually increasing the supply of lendable funds and mitigating the credit crunch problem. In our current system, Bernanke and his eurozone buddies would engage in massive further ''quantitative easing'' thus further boosting the financial system's bias towards governments and worsening the imbalances that had caused the credit crunch in the first place (unless, as has not yet happened, they lined up their monetary helicopters above the global private sector).
A credit crunch in 2012 would re-arrange significantly the participants in the world economy. Countries with large budget deficits, notably Britain, Japan and the United States, would suddenly find funding drying up. While for some such countries this would merely make funding more expensive, for others a market ''redlining'' would take place, at which they were unable to obtain funding at any price.
The rise in long-term interest rates for countries that were not ''redlined'' altogether would push their banking systems even more into the 'gapping' game. The British, Japanese and US private sectors would suffer the worst of the squeeze, being forced to pay higher interest rates and finding funding almost unobtainable. Yet they would gain none of the normal benefit from higher interest rates: an increase in domestic saving. With deposit rates remaining ultra-low, there would be reason for saving to increase - indeed it would very likely decrease if central banks attempted to fight the credit crunch through ''quantitative easing,'' thus raising inflation rates.
Emerging markets would be divided into those with ample domestic savings or currency reserves - for example China, Taiwan, Singapore and Chile - and those already borrowing too much, with bloated public sectors and extravagant consumers - the majority of Latin America, Brazil and above all India, whose profligate government seems incapable of mending its ways. Liquid emerging markets would benefit considerably from a credit crunch, as their liquidity would ease any ill effects and they would gain export market share. Illiquid emerging markets would suffer badly, finding themselves returned to the state of Latin America in the 1980s and Asia after 1997.
In the private sector, businesses such as aircraft financing and commercial real estate that were chunky and not especially people-intensive would find funding through the shadow banking system, albeit at higher rates than they are used to. Conversely, small businesses and ''frontier'' markets such as Vietnam and most of Africa would find funding drying up altogether.
The continuing existence of vast pools of liquidity would support commodity prices, unless the world suffered a major economic downturn, and it would even boost the prices of gold and silver, safe havens in times of crisis that do not depend on a smoothly functioning banking system for their support. To a certain extent, trade financing, difficult to obtain by conventional means, might increasingly be carried out in gold, with sellers happy to carry buyers' credit risks on their balance sheets provided they could be repaid in an inflation proof asset with no linkage to troubled financial systems.
Those currently in charge of the world's monetary system appear to believe that injections of cheap money can solve any credit crunch, with the two being inexorably linked. They're wrong, for the reasons outlined above, and in 2012 we are likely to pay the price of their error. .....
The decline of the U.S. as a net exporting nation is the inevitable result of the growing, yawning gulf between rich and poor. A nation cannot be productive if it has failed to invest its wealth in creating jobs. It is, at last, 'labor' which creates wealth to begin with. Since Adam Smith wrote 'The Wealth of Nations' , every major economist --right or left --have espoused a 'labor theory of value'. Simply --'value' (wealth) is created by labor and is the result of labor. A nation in which its wealth is concentrated in the hands of a ruling elite of just 1 percent cannot be productive or efficient. Today --the U.S. is literally owned by China which occupies the No 1 position on the CIA's World Fact Book with the world's largest POSITIVE Current Acct Balance. The U.S. is on the very bottom with the World's largest NEGATIVE Current Account Balance, formerly called the Balance of Trade Deficit.
An aside: the right wing recently tried to blame 'Muslims' for the fall of Detroit. Total BS! Muslims had no more to do with the fall of Detroit than have Christians. The fall of Detroit is in fact the restult of stupid and incompetent policies put into effect by Ronald Reagan and his idiot disciple ---George H.W. Bush. It was under Reagan, that the long and depressing decline of America began. The vast gulf between rich and poor in America is, in fact, a fairly recent development, a product of the 'robber baron' era. Even so --FDR reversed those trends and the official stats prove it. The Great Depression had been both the result and the symptom of absurd inequities associated with and caused by the era of Robber Barons. It was preceded by three very conservative, very Republican administrations --Coolidge, Harding and Hoover.An expanding economy, that is, an economy that creates wealth and jobs requires a more egalitarian distribution of wealth. Otherwise --to whom will manufacturers sell? A prosperous middle class is absolutely ESSENTIAL to 1) GDP growth 2) retail sales. An impoverished population will buy increasingly fewer luxury items; an impoverished population will struggle to maintain the very basics --food and shelter.
A nation in which just 1 percent owns more than the remaining 99 percent is an economy on the very brink of collapse. It has happened many times in the past. The best example is Rome. Like the U.S. today, Rome was a teeming city of the very, very poor. And, like the U.S. today, the currency of Rome --the sesterces --was essentially worthless, a mere 'token' that would admit you to the Gladiator 'games' in the Coliseum. By impoverishing the U.S. middle class, the GOP capitulated to China which found --in GOP America --a market for cheap crap. The PRICE of that 'crap' is not found on the label or the check out counter. It is found in the GOP destruction of the American labor movement, American productivity, the American 'standard of living', and, of course, our very futures....
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