When will the Credit Crunch end?
20th September 2008 - This was the week the world changed.
This was the week that the world financial system finally collapsed under its own weight of debt built up through the Era of Growth.
It started with the US authorities trying to rescue Lehman Brothers. It ended with the US taxpayer preparing to pick up the tab for the mistakes of Wall Street's elite. Britain's biggest lender was rescued and the Chinese government lined up to take a 49% stake in Morgan Stanley, one of the last US investment banks left after a week of carnage.
Over and above the extraordinary individual events, there was the capitulation of the prevailing economic model. History will show that the great experiment with financial deregulation lasted from the first post-war oil shock in 1973 to the third oil shock in 2008.
Between those years the constraints on capital that were imposed after the Great Depression were whittled away, leaving a world of easy credit, complex financial instruments, stratospheric salaries and supine regulators.
The changed mood is evident from the media backlash against hedge funds, short-sellers and other banksters. Only rarely is there a palpable public mood swing in Britain; the Winter of Discontent in 1978-9 was one; this is another.
The financial system is broken. Many of the more thoughtful people working in the markets know that deregulation has led to anarchy not freedom, and that boundaries need to be set.
It remains to be seen, however, whether the plan by the US authorities to buy-up the toxic mortgage-backed derivatives will have the desired results - the restoration of market confidence and the resumption of more normal patterns of lending.
Some experts were talking this week (20th September 2008!) as if the financial crisis was nearly over. They could not be more wrong. The downturn has only just begun — and for most citizens the consequences have not been felt at all.
But they will be felt very soon and very brutally.
We can expect a sharp increase in personal bankruptcies. Yet the numbers will not peak until next year at the earliest.
Hundreds of thousands of people will lose their jobs, with many forced to sell their houses. Property prices will slump.
There will be extreme human suffering, panic and despair. Many careers will be destroyed.
This crisis is vicious, dynamic and only just beginning.
First, the fate of City bankers from firms such as Lehman Brothers. They will receive no severance payment and almost no chance ever again of benefiting from the high salaries and massive bonuses they got used to.
That means they cannot service the huge mortgages they have taken out on hugely expensive houses. If they bought near the top of the market, they now face the prospect of personal bankruptcy.
With so many vendors on the market obliged to sell, it can be assumed that any London house will fetch 20 per cent less in the near future than this time last week.
But that body-blow is just the start. Banks will foreclose on thousands of small businesses. Massive corporate failures are inevitable.
These disasters will then rebound on the financial sector, as company bankruptcies and plunging house prices force fresh balance sheet write-downs and yet more sackings.
Unemployment is set to surge ahead and will increase well above the two million predicted by economists, which will produce a vicious spiral. Every worker out of a job means less tax receipts and higher welfare payments.
Alistair Darling's forecast borrowing this year was £43 billion. Even at the time, this figure was shockingly large. It meant that only Egypt, Pakistan and Hungary among significant world economies had more profligate government spending than Britain.
As of this weekend, 20th September 2008, Government borrowing is out of control. It will soar nearer £100 billion next year.
In the medium term, the only resolution to this debt crisis is a rise in inflation to double digit figures, as governments are forced to print money to fend off depression.
Another question facing the world today is whether the U.S. — already crippled by the estimated $2 trillion cost of financing the Iraq occupation — can afford to continue its global role after the estimated further $2 trillion cost of the wholesale nationalisation of mortgages, financial insurance and bad debts of the whole financial sector.
As a result, U.S. global creditworthiness is in jeopardy, and it is likely that the dollar will lose its status as the world’s reserve currency. There are signs that this process has already begun.
The world that will emerge from the Great Crash of 2008 will be dark and unpredictable.
This weekend, all sensible families will go through their finances, anticipate the inevitable problems that lie ahead, and cut back at once on unnecessary spending such as eating out, second cars and foreign holidays.
And all that is the result of unbridled human greed coupled with laxed regulations, which allowed ever more fraudulant financial behaviour by the same financial institutions, which we are now obliged to rescue.
That would be a grim enough prospect in its own right, but there is more.
World oil consumption may decline somewhat as a result of the now inevitable world recession and oil prices will collapse. This may have the effect of postponing the start of the Great Oil Slide (when world production of oil starts to decline year on year), which was likely to start at the end of 2009, but now may not begin until early in 2010.
In other words it will hit us just as we reach the bottom of the recesion and start hoping for a turnaround.
No such luck. Get used it. The End of Growth has truly arrived.
The actual figures are:
Data on the $500 trillion worth of derivatives comes from the most recent survey by the Bank of International Settlements, the world's clearinghouse for central banks in Basel, Switzerland. BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil and where we give China IOUs for all we buy from them.
To grasp how significant this bubble is, let's put it in the context of some other monetary data:
US annual GDP is about $15 tr
UK annual GDP is about $2.8 tr
Current proposed U.S. federal budget is $3 tr
US government's maximum legal debt is $9 tr
World's GDPs for all nations is approx $50 tr
Total value of the world's property is estimated at about $75 tr
Total value of world's stock and bond markets is more than $100 tr
BIS valuation of world's derivatives back in 2002 was about $100 tr
BIS 2007 valuation of the world's derivatives is a whopping $516 trillion
Why is it so dangerous, apart from the raw size? Because banks are required to keep reserves. Derivatives don't. They're not "real money." They're paper promises closer to "Monopoly" money than any real currency ...