In the last several months we have experienced increased nervousness around the Mediterranean Eurozone countries and their sovereign debt, with Greece in the spotlight and now Spain and Italy creating further political divergence among euro members. All this comes to a climax now with the US itself under attack by one of the rating agencies. These are of course the same agencies that were heavily criticised before for being too loose in their credit assessments during the build-up to the previous credit crisis.
We have absolutely no pleasure in reiterating that we warned about all of this in our book “The Future of Finance: a New Model for Banking and Investment”, which was written back in 2009. At that time, among many other issues, we pointed out the risk of increased volatility and sovereign debt crises of the magnitude observed during the Great Credit Crisis of 2007-2009. Furthermore we warned that this sovereign debt crisis would go hand in hand with a currency crisis, where hard underlying assets would function as safe heavens.
We are now in the middle of what can be described as the third and final phase of this Great Debt Cycle. The first one can be identified as the period where the seeds of the crisis of 2007-2009 were sown. This was characterised by a complex mixture of financial deregulation, globalization, increased financial innovation, a shadow banking system, political and monetary intervention, currency manipulations and moral hazard issues. By the end of this cycle, back in September 2008, governments all over the world had to step in to save the financial system from a total implosion, by transferring the debt liabilities from the private to the public sector. Remember banks, as well as corporates such as GM, were bailed out at the time.
The end result was that public deficits and debts as a percentage of GDP rose exponentially. The euphoria experienced on the stock markets back then from March 2009 onwards, was misplaced as the outstanding debt did not disappear. This can be identified as the second stage in the Great Debt Cycle, where central banks started expanding their balance sheets rapidly. Some of these monetary institutions were more reluctant than others, for example the Federal Reserve versus the ECB. However, now that the sovereign crisis is coming to a climax, the latter also has been forced to give up its final political independence and has stated buying up debt that cannot be absorbed anymore by governments.
This is the start of the third and final cycle where continuous balance sheet expansion will result to a point where it will no longer be accepted by the financial markets. These financial markets are blamed by indecisive politicians as the cause of the turmoil. Unfortunately they only act as a thermometer that displays that the patient has a high fever and is very ill. At this stage politicians lean back comfortably in their chairs as central banks once again will come to the rescue and reinforce the moral hazard principle. However this “kicking-the-can-down-the-road” game will come to an end in due course, as there is a limit to how much a central bank can stretch its balance sheet. Note that the ECB’s and Fed’s balance sheets are already leveraged approximately 1:25 (EUR 81 bio of capital versus EUR 2.3 trillion outstanding assets) and 1:50 ($51 bio capital versus $ 2.6 trillion outstanding assets) respectively. We point out once again that this does not make the debt issue go away. Sooner or later one has to start paying all this debt back. However in the meantime the central banks are running the risk of becoming insolvent themselves. Bear in mind that for example a decrease of only 4% of the value of the ECB’s assets is enough to erase its capital completely.
More then ever politicians need to face reality and bring their household finances in order. This will become even more urgent as the ageing of society is now just around the corner and will put further pressure on welfare payments and public finances. Just passing on the problem to the lender-of-last resort is not an option anymore, as this will end up in global demonetization and collective pauperization. Neither is throwing away the thermometer. The longer we put off the solution, the more painful the end implosion will be.
Gino Landuyt, Brussels, August 2011
Sunday 2 October 2011
Subscribe to:
Posts (Atom)
