At this time of writing – early Thursday evening – the global financial system is still teetering on the brink of the abyss. There is a fair probability that by the time you read this, we will be over the edge and into a ‘systemic collapse’ – indeed, in many senses, that is already underway. What this new buzzword means is that many banks – perhaps most, numerically – will go bust whilst the biggest will be seized and thus saved by their governments. That means that many – very many – businesses will go bust. In short, a replay of the early 1930’s.
Hopefully, it won’t come to that. The world’s central banks are pumping money into the markets as if there is no tomorrow – because the alternative, from their point of view, is that there will be no tomorrow. Today the central banks had a whip-round and between them raised $180 billion dollars of cash to lend to cash-starved banks, in the hope that this would persuade the banks to at least restart lending to each other, so that the wheels of the inter-bank and money markets can start turning again before illiquidity triggers mass insolvency.
Because the money market is the real problem now. The headlines about the stock exchanges slumping merely reflect the symptom of the contagion sweeping the financial system and killing banks and other financial entities faster than most people can count them. The actual illness is that confidence – the abstract and immeasurable concept that enables the whole apparatus to function – has evaporated.
Don’t think that it’s just confidence in one-branch banks in Nowhereville, Nevada, that’s gone. Or even in Bank of America or Goldman Sachs. By Wednesday, it had reached the point that confidence in the US Treasury and the Federal Reserve had snapped too. So that this morning, serious people in serious blogs were discussing whether central banks can go bust – and if so how, and what happens if they do. We may be about to find out.
As recently as two weeks ago, all this was unimaginable to most people and weird even at a theoretical level to professionals. Then (on Sunday, September 7) came the nationalisation of Fannie Mae and Freddie Mac, which doubled the US national debt. That made the possibility of national bankruptcy into a realistic possibility – very remote, but within the boundaries of the conceivable. One week later came the demise of Lehman and the purchase/ elimination of Merrill. But the hope held out by the decision to let Lehman die — that the US government would no longer indulge in megabuck bailouts of ailing financial firms – was quashed after only two days, when the Treasury used the Fed to stump up $85 billion to prevent the world’s biggest insurance company going bankrupt and taking most of the financial system down with it.
It is actually possible to make a valid case for each of the decisions taken by Treasury Secretary Paulson and Fed Chairman Bernanke (and rubber-stamped by Mr President) over the course of the debt crisis, since it began in July 2007. But taken together, they show a consistent pattern of a) being reactive rather than proactive; b) acting in a sporadic manner, without having thought through what their wider implications were; c) the absence of an overall plan to address the widening, deepening and intensifying crisis; d) failing to communicate effectively with either the markets (‘Wall Street’) or the general public (“Main Street’) – let alone the wider global community.
The result was a steady erosion of confidence, until the tipping point was reached with the AIG bail-out on Tuesday night. Once that happened, the system went haywire. Inter-bank interest rates shot up and the flight to the perceived safety of Treasury bills was so massive that the yield on three-month bills fell to zero. For those unwilling to consider even Treasury bills as a safe haven, there were few options: The Swiss franc is compromised by the wobbliness of the once-mighty Swiss banks and the euro has always been seen as tainted. That left gold – which duly recorded its largest-ever daily rise during Wednesday and kept pushing up on Thursday, despite the efforts of the central banks to restore stability and functionality to the world’s money machine.
For many years now, supposed weirdos (like Warren Buffet…) have been warning that the financial system was being abused and warped from within, a process that would ultimately lead to disaster. Well, ultimately, here we are.