We could not agree more that this crisis is far from over. The Fed has temporarily stopped the bleeding and is trying to stabilize the patient. But the problem of the huge amount of bad debt to be liquidated still needs to be taken on, and its not just related to subprime mortgages.
What few people recall is that one of the first steps taken to put a bottom in the US Great Depression was the devaluation of the US dollar by approximately fifty percent in terms of the gold standard. The devaluation of the dollar has been underway for several years now, for anyone with an open enough mind to look at the evidence. Did the Treasury devalue the dollar by 50% in 1933 by making bank loans? By taking on additional debt? No. They did it by declaring it to be so, by fiat which means 'let it be done.'
There is little doubt in our minds that dollar devaluation will once again occur by at least fifty percent in terms of real goods. How this translates to the relationship among world currencies is another matter entirely, since they are all fiat at this time. Debtors do not embrace deflation: that is the course of choice for net creditors and exporters, such as Japan in the 1980s. Understanding this is key to grasping the nature of our monetary policy options.
What would be interesting is if the Cold War resumed, not on military terms, but in competitive economic terms. It requires a significant amount of international cooperation to achieve the financial alchemy United States is attempting. Our security we believe is that the US is too big for anyone to allow it to fail, in sort of an assured monetary mutual destruction. We are not so sure this is a valid proposition in which to place our future and our trust.
Credit crisis far from over
By Geoffrey Newman
May 02, 2008
A DERIVATIVES expert who two years ago warned of a potential meltdown in global credit markets has cautioned that the crisis is far from over, and has endorsed recent calls to relax controls on inflation and allow higher prices to help markets trade their way out of their problems.
Longtime critic of derivatives markets, Satyajit Das, says those who believe the US sub-prime loans crisis, and the drought in credit markets it triggered, are nearly over are wrong.
"I think the cycle has some way to run yet," he told a Financial Services Institute of Australasia function in Sydney yesterday. "It's a matter of years, not a matter of months."
In particular, investors in the US stock market, which has climbed off its lows amid a growing mood that the worst of the crunch was over, were being too optimistic, he said.
The author of Traders, Guns & Money warned that many of the problem financial instruments were still hidden and the total amount of debt attached to them largely unknown.
Losses incurred by US banks were certain to rise as $US1 trillion ($1.06 trillion) in sub-prime housing loans was due to reset to higher interest rates in the next two years.
The use of credit card debt -- now totalling $US915 billion -- was cushioning US home owners. But, in an ominous sign, card issuers were rapidly increasing their provisions for bad debts, by as much as 500 per cent in the case of one bank.
The use of sub-prime debt structures was also a feature of other markets, such as private equity, where $US300 billion in loans were due to be refinanced in the next two years.
Mr Das said another $US1-$US5 trillion of assets would have to come back on to US bank balance sheets as a result of defaults on housing and other debts, and it was unclear how the banks could fund them -- issuance of preference shares by US banks was already at a record high. He said losses at financial institutions from the credit crunch were likely to almost double to $US400 billion.
There were also second-round effects to come as the damage done to the real economy from financial sector losses fed back into further bank losses.
Mr Das said there needed to be a massive reduction in debt levels globally or a "nuclear deleveraging" before the crisis could be said to be over. That could be achieved through an economic crash "on the scale of 1929" but allowing inflation to rise would help to avoid that scenario. Higher inflation was a legitimate policy option since it reduced the real value of debt and gave companies and individuals breathing space to reduce their leverage by helping to put a floor under asset prices.
His comments come as some economists urge Australia's Reserve Bank to relax its inflation targeting policy to help avoid a severe economic downturn.
He acknowledged that as inflation rose higher it was more difficult to control it, but noted the global economy was moving into a period of higher inflation anyway. "It could be the lesser of two evils," he said.
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