The Deepening Crisis

Chris Waller - November 2011
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As I wrote that title I felt as if I might have been a journalist writing in the late nineteen-thirties as political storm clouds gathered over Europe and all but the most deluded realised that sooner or late the storm would indeed break in all its fury. For those interested in economics, these are interesting times, and I use those words in the sense implied by the Chinese who, when they say "May you live in interesting times" are in fact calling down a curse upon the other party.

What began three years ago with the collapse of Lehman Brothers is now spreading around the entire world as the global financial system unravels. Lehman's were not the first financial institution in the US to founder upon the rocks: back in the nineteen-nineties almost a quarter of the 'thrifts', the American equivalent of our old building societies, were on the verge of collapse, and had to be bailed out to the tune of over $85 billion in the late eighties and early nineties. Within that same decade Long Term Capital Management (LTCM), a speculative hedge fund founded in 1994 by one John Meriwether, and whose board of directors included Robert C Merton and Myron Scholes, winners of the 1997 Nobel Prize for Economics, had to be bailed out in 1998 by the Federal Reserve having accumulated losses of $4.6 billion; two years later the fund was liquidated. There is a certain irony in the collapse of an institution run, in part, by two Nobel Laureate economists: Robert C Merton was an economist and sometime professor of economics; in conjunction with Fischer Black, Myron Scholes was the co-author of the Black-Scholes equation for the pricing of derivatives. In light of the catastrophic collapse of LTCM one might reasonably suggest they should have checked their arithmetic.

Lehman Brothers were very exposed to the American housing market, being heavily involved in the purchase of mortgage-backed securities and having borrowed extensively to finance their investment in this market. In mid-2006, the American housing bubble burst and property prices began to fall. The crisis deepened during 2007/08 and in September 2008 Lehman filed for bankruptcy, the largest in American history at over $600 billion.

As Lehman Brothers was listing to starboard, here in Britain, the harbinger of the financial crisis was the request for liquidity support from the Bank of England by Northern Rock; the international credit markets had seized up due to nervousness about companies involved in mortgage lending and Northern Rock was facing serious difficulties. In February 2008, Northern Rock, facing collapse and with savers queuing outside its branches, lacking any viable private sector buyer, was taken into state ownership. During that year the crisis continued to spread resulting, in October, in the government's having to rescue Royal Bank of Scotland, Halifax Bank of Scotland and Lloyds TSB to the tune of 37 billion. Later that month Gordon Brown announced a 500 billion package to underpin the British banking system. As the crisis spread to Europe, Gordon Brown met with his German, French and Italian counterparts to formulate a similar rescue package for the European banks amounting to €300 billion.

While the rescue packages might have averted an immediate disaster, the underlying problems remained and their effects leached out, poisoning not only other private institutions but now national finances. Greece, having accumulated enormous debts, was faced, in late 2009 with the awful reality that it could not service that debt; in May 2010 a rescue package in the e amount of €110 billion, financed by other European governments, was agreed, conditional upon certain economic strictures to be imposed upon Greek public finances. As the terms of the agreement became clear, the Greek people took to the streets and there have been demonstrations and riots on an almost weekly basis. In late July of this year, 2011, a second rescue package of just over €100 billion was agreed, conditional upon further fiscal measures. It is apparent that the Greek government is having the utmost difficulty in enforcing those cuts and public opposition is growing such that the next tranche of the bailout has yet to be agreed. In the meantime the Greek economy is shrinking at an annualised rate of 6 percent, further impeding its ability to repay any loans. It is now accepted that Greece will default on its borrowing to the tune of between 50 and 70 percent.

The Greek crisis, perhaps soon to be a Greek tragedy, has begun to affect the eurozone as a whole, not just economically but politically, as recriminations start to fly about the parliaments of Europe. Angela Merkel is faced with domestic political opposition as German taxpayers have to fund the Greek bailout. While international markets move not in hours but in minutes, it takes days for the European finance ministers to convene a meeting and come to an agreement. As soon as an agreement to a situation is announced, the world has moved on and the proposed solution is no longer relevant. As the European Leviathan lumbers on, the crisis moves increasingly towards a tragic denouement.

In the US, President Obama has been exhorting the European governments to get their act together and agree a rescue package for Greece specifically and the euro generally. However, he should be wary of being quite so judgmental: the US economy is foundering, currently growing at less than 1 percent per annum, and in September of this year Congress is debating a $400 billion package to boost growth and employment. The effects of the previous stimulus of over $800 billion, agreed in early 2009, seem now to have petered out. American debt is currently being bought by the Chinese government and this has led to a call in the US Congress for tariffs against Chinese goods, the US government arguing that the yuan is seriously undervalued. China has warned of a trade war but it should be wary of sabre rattling. China has not yet developed sufficient domestic demand to provide a sufficient market for its producers; China needs export markets and if those markets shrink, China will have problems of its own, both economic and political.

Despite David Cameron's recent exhortation to optimism at the Conservative Party Conference, probably motivated by the publication of figures revealing that the British economy was only growing at 0.1 percent per annum, the Bank of England announced today (6th October) that it would be injecting a further 75 billion into the economy. This process is known by the euphemism 'quantitative easing' whicch is a technical expression for 'throwing money at it'.

In recent days (October 4th 2011), the Italian government's credit rating has been downgraded by Moody's due to fears that it too is moving towards default. In taking this action, Moody was following Standard & Poor's decision taken the previous month. Italy is the third largest economy in Europe and such is international concern that even Chinas has been moved to admonish Europe about its apparent inability to react concertedly to the crisis. In the meantime China is buying European government debt and European industrial assets.

In all of this France has been strangely quiet, but it too faces problems as its banks are heavily exposed to debt in the countries of the European periphery, that is, Greece, Italy, Portugal and Spain. This situation is compounded by the fact that Sarkozy faces a presidential election in spring of 2012. One senses that Sarkozy is trying to avoid unpopularity at home by keeping a low profile, allowing Angela Merkel to do all the talking and also take all the political flak. However, in the final analysis, Germany needs France's support for any proposed European agreement to underpin the euro.

All in all we have the making of a perfect economic storm as the world's major trading blocks become increasingly mired in debt and the concomitant political problems.

I argued 18 years ago that the euro would fail. As a Europhile this is not something I relish: I would have wished the euro to be a success to further the greater European project but in my view Europe expanded too quickly and was too keen to enrol member states into the common currency when they were ill-prepared for its disciplines: Greece is a prime example of this error.

I contended that a common currency would fail in all practical senses as have the Utopian dreams of 'universal languages'. There have been over 200 attempts to create universal languages, from the Reverend Schleyer's 'Volapuk, through Ogden's 'Basic English' to Esperanto, that last's name expressing the doomed hope of its purpose. I have heard Esperanto spoken only once in my entire life and that was on a Radio 4 programme - about Esperanto! For a universal language to succeed it would demand a congruency of culture between participating nations adopting it and there is too much cultural weight in existing languages for that to happen. There is, however, a further and more general problem and that is the problem of scale. The global financial system is now so vast and so beyond the control of any single government that we have a recipe for chaos.

The late Leopold Kohr, former economist and political scientist, is the author of 'The Breakdown of Nations', published in 1957, a warning of the consequences when institutions become too large. Sadly Kohr did not become as famous as other writers on politics and economics such as Marx, Keynes, Hayek and Friedman, possibly because his message did not appeal to the megalomaniacal dispositions of those in power or those who seek power.

We find ourselves in a situation where the global financial system is so large as to be completely beyond the control of national governments, or even groups of national governments. Its power is too diffuse and the sums of money it ostensibly controls are larger than national economies. To a large extent politicians have conspired with the financial institutions, granting them privilege in exchange for financial support: politicians sold their souls to the bankers. Now, the folly of this Faustian pact is revealed for all to see.

I sense that we are on the verge of what Thomas Kuhn called a 'paradigm shift': governments overthrown in Egypt, Tunisia and Libya; political turmoil in Syria; rioting in Greece and public demonstrations in the US, strangely unreported in the British media, as Americans storm Wall Street. There are riots and demonstrations also in China, but we hear little of them due to censorship. It is apparent that there is growing disaffection throughout the world with those who claim to govern.

To close, I quote from Ren Cutforth's 1976 book, 'Later Than We Thought - A Portrait of the Thirties'.

"What was true was that the generation which had been born around 1900 was left without any credible landmarks. The gap between them and the rest was suddenly gigantic: it was manifest that their fathers had made a ghastly mess of everything. Civilisation had not perished by an act of God, such as an earthquake or an invasion from Mars. Civilisation has simply failed, and its heirs and assigns, those elder statesmen whose long immersion in the classics and the histories of Rome and Greece had been held uniquely to fit them for the corridors of power, were seen as mere clowns, if not murderers. Wisdom had been their stock in trade, and it had not been forthcoming."

That was Cutforth writing about the nineteen-thirties: our leaders seem to have learned nothing in the interim.

Chris Waller - Permission granted to freely distribute this article for non-commercial purposes if attributed to Chris Waller, unedited and copied in full, including this notice.

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