Financial markets are driving the world towards another Great Depression with incalcul by Flickr
Financial markets are driving the world towards another Great Depression with incalculable political consequences - The authorities, particularly in Europe, have lost control of the situation. They need to regain control and they need to do so now." George Soros, international financier, ( Does the Euro Have a Future?, New York Review of Books, September 15, 2011.)
"The [ financial ] crisis was not a failure of the free market system and the answer is not to try to reinvent that system...Government intervention is not a cure-all." President George W. Bush, Thursday November 13, 2008.
"There is no cause to worry. The high tide of prosperity will continue." Andrew W. Mellon, President Herbert Hoover's Secretary of the Treasury. September 1929.
"I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the government at defiance. The issuing power of money should be taken away from the banks and restored to the people to whom it properly belongs." Thomas Jefferson (1743-1826), 3rd U.S. President.
Presently, one has the net impression that today's governments, both in Europe and in the United States, have their fingers plugging the holes in the financial dike, but fear that the entire dam could collapse in the not too distant future with dire economic consequences.
Let's see if we can make sense of it all.
Let's say to begin with that most financial crises are the direct result of unsustainable debt levels relative to income that need to be wrung out of the
economic system. It has happened in the past ( notably in 1873, in 1907 and in
1931, for example ), and numerous times in developing countries, and it will
undoubtedly happen again in the future. The process is more often than not
always the same: some large banks, corporations, consumers or governments, take
on too much risky debt that becomes unsustainable when economic conditions
change, thus launching the entire economy into a devastating process of debt deflation.
Sometimes, it may take decades to overcome such a debt deflation and it usually creates an environment of economic stagnation [http://en.wikipedia.org/wiki/Economic_stagnation] when aggregate demand [http://en.wikipedia.org/wiki/Aggregate_demand] collapses.
What makes the current financial crisis so troublesome is not
only that debt levels are historically high for some countries, but also because
the usual instruments and procedures to reduce the debt burden, while doing the
least damage to the real economy, have been rendered inoperative, due to a large
extent, to the poisonous so-called financial "innovations" that have taken place
since 1999 in the general climate of wholesale financial deregulation.
consequence, financial debt in many countries creates a sort of financial black
hole that siphons off money income and prevents it from being re-circulated back
into the economy. This creates a serious deficiency of demand when consumers spend less, when
corporations postpone investments, and when governments adopt austerity programs
that translates into low output growth, economic stagnation and high
[http://en.wikipedia.org/wiki/Depression_ [ (economics) ]
I have done this in the past, again, in 2006, and again, in 2007, and again and again in 2010, but obviously some politicians, both in Europe and in North America, don't seem to get it. Instead, they seem to think that fiscal austerity and lower taxes is all that it takes to stimulate the economy and lower unemployment. They cannot be more wrong in the current context. Such policies in an open economy are going to make things worse, much worse if they are applied over time.
Here is why:
Many governments had the imprudence of piling up debt upon debt over the last thirty years, but especially over the last ten years. There are four main causes for such a public binge of debt in many countries.
- First, in Europe, the creation of the Euro zone in 1999 induced some imprudent member countries to go deep into debt by taking advantage of the credibility of the euro and by issuing bonds in euros at favorable interest rates. There was, indeed, a widely held belief on the part of lenders and borrowers alike that the new monetary union provided an implicit guarantee of stability to the safety of the loans.
- Secondly, lenders were induced to lend large sums at low interest rates because
borrowers could avail themselves of a newly created financial instrument, the Credit
Default Swaps (CDS) that allowed them to take a low cost insurance against
an eventual default on their bonds. (By the way, the financial crises on both
sides of the Atlantic are closely linked due to the fact that some large U.S.
banks are heavily exposed to the European sovereign debt crisis as sellers of
credit default swaps.)
- Thirdly, the persistent large trade imbalances in the world
meant that some countries, such as mainland China (which joined the World Trade
Organization [http://en.wikipedia.org/wiki/World_Trade_Organization] in
December 2001), piled up tremendous external trade surpluses and their excess
funds became available to foreign borrowers. Indeed, large international banks
found it most profitable to channel these newly created funds to willing
sovereign borrowers around the world.