Page 2 of 3 Bubbles, risk, crunch and war
By Cyrus Bina and Fernando Dachevsky
from the creeping asset bubbles that are momentarily gaining strength in the
Chinese financial market. The forecast for European growth, in 2008 and 2009,
is somewhere around 1.4%, compared with 2.6% in 2007. Africa and Latin America
are expected to maintain robust rates, yet disguised unemployment and creeping
inflation in energy and food sectors are the likely occurrences that lead to
abject poverty and intense class polarization. In the meantime, the global
economic growth is likely to weaken somewhere between 3.5% and 3.7%, from 5%
and 4.9, respectively, in 2006 and 2007.
The European Union is now trying to deal with the aftereffect of the US
financial debacle. European banks attempted to write down more than US$200
billion of debt obligation, following the
US mortgage defaults, thus revealing the tiny tip of the liquidity crisis in
view of tight credit market. To date, the write-downs for a few major banks in
Germany and Switzerland are some $23 billion, and they certainly will increase
by the time the dust settles.
FD: In your opinion, how effective will the ongoing economic stimulus,
such as decrease in the interest rate, be in preventing the economy from
slipping into recession?
CB: There is no question that the US economy is now in recession. The
added danger, however, is the banking crisis in the midst of collapse. On the
top of all this, there is a considerable decline in the value of the US dollar
relative to other global currencies. This decline is persistent and its
magnitude is consistently reflective of a significant increase in the price of
gold, metals, crude oil, and basic food staples - to name a few.
The US economy is sneezing in cold sweat but at this time - notwithstanding the
financial contagion - the world economy is not even uttering: "bless you." Here
is the belated distinction between the transnationalization and the so-called
Americanization in respect to today�s global economy - and, by
implication, the defunct American hegemony.
This crisis is symptomatic of the need for a clear distinction between the
ideology of neo-liberalism (and thus neo-liberal policies espoused by the US
government and its so-called Western allies) and the epochal meaning of
globalization as an all-encompassing structure beyond the conventional notion
of imperialism and/or nationalism. With this preamble, we now focus on some
concrete issues.
The US government proposal for refinancing US mortgages falls somewhere between
$300 billion and $400 billion. The Federal Reserve has already extended $30
billion to bail out Bear Stearns (the fifth-biggest investment bank), which had
about $33 debt for every $1 of assets it held. Wachovia, the fourth-largest US
investment bank, is also on the edge of unexpected loss. Write-downs at Merrill
Lynch amounted to $9.7 billion in conjunction with 4,000 layoffs just in the
first quarter of 2008.
The multiplicative effects of the subprime debacle appear to be wreaking havoc
with the financial system on a continuous basis. Lehman Brothers too had to
shave more than $2.8 billion from its books. The bubble also reached into the
oil futures as well - by dropping the US dollar and grabbing crude oil
virtually with fiat (by only 6% down) and no intention of keeping it as
transaction demand.
The Federal Reserve extended emergency loans to major Wall Street investment
banks. The Fed also offered $200 billion in Treasury securities to a select
number of investment banks known as "primary dealers" that are regularly party
to its open-market operation. What are the collaterals in certain of these
cases? They are hard-to-sell, privately issued, risky mortgage-backed
securities that for all intents and purposes are not worth the paper they were
written on. US subprime mortgages are about 21% of the total.
Defaults in this segment of the market have led to a potential default of the
mortgage-holding institutions and, in due course, to the underwriting of the
asset-backed commercial papers that had insured the amalgam of these collateral
risks in the first place.
All this has come full circle, first leading to a substantial decline in home
prices across the board, which translated into instant devaluation and thus
evaporation of equity all over the place, and then was passed on and spread to
the layered network of financial institutions that reluctantly had to
write-down hundreds of billions of dollars on their books.
The US financial system faces potential losses of well over $1,000 billion as a
result of the credit crisis. Hence, credit crunch is the form in which this
particular financial crisis manifests itself here in the US and throughout the
globe.
Finally, the market for real-estate is now beginning to exhibit its universal
effects on vanishing equity around the globe, from Ireland to India.
To treat the symptom of the crisis, namely the subsequent "credit crunch". the
Federal Reserve, under Ben Bernanke, cut the federal fund rate seven
consecutive times, from 5.25% to 2.0% by April 30, 2008 - a substantial
reduction of 62%. One might be reminded that further reduction in the discount
rate toward the vicinity of 1% (similar to the one, in 2004, under Greenspan)
should scare any economist who has written a PhD dissertation worth the paper
written on.
The unintended consequence can be the lack of interest-elasticity of investment
and the ineffectual monetary policy - which, in addition to the ongoing credit
crisis and banking debacle, are potentially the stuff of the Great Depression.
In the face of this, the Bush administration extended a $168 billion stimulus
tax-rebate in order to beef-up consumer spending. This package, which is too
little and too late, does not even extend the duration of unemployment
insurance, from, at present, six months to, say, a year, in order to cushion
the massive layoffs that are now beginning to take effect across the American
economic landscape. Besides, the bulk of money in this package is directed
toward business, in the hope that some day it will trickle down in the economy.
On the financial side, the new Treasury Department plan, the hallmark of which
is the merger of Securities and Exchange Commission and Commodity Futures
Trading Commission, is designed to primarily overhaul the competitiveness of
the financial system by focusing on Wall Street institutional investors rather
than on the well-being of the system as a whole, including the Main Street
investors.
Moreover, this plan is neither a measured prescription for safeguarding the
dominos associated with limitless fabrication and multiplication of risks nor a
deliberate remedy for regulating the epidemic distribution of derivatives and
their contagion across the global financial system nor even an immediate
response to the current crisis in which a huge number of ordinary people will
certainly go under.
FD: How is the crisis going to result in the magnitude of petroleum
prices? Will the prices keep growing?
CB: The transmission of the subprime crisis in the housing market has
resulted in default in the mortgage market and then through the collateralized
asset market wreaked havoc with the underwriters of such amalgamated risky debt
obligations in one sweep. The forced write-downs of these assets in the
investment banking sector, on the one hand, and the slowdown in the pace of
economic activity, on the other hand, stirred the US economy toward recession.
At the same time, the continuous decline of the US dollar since 2002 against
the euro and other significant international currencies revealed the structural
shift and moribund status of the United States relative to what it used to be
under the Pax Americana.
In the last meeting of the World Economic Forum at Davos, Switzerland, even
sympathetic liberals and social democrats realized, rather belatedly, that the
American economy is no longer functioning as the engine of the world economy.
Their lexicon was "decoupling", signaling rather aptly what I have already
foreseen, despite the pageantry of Reaganomics and the pomposity of "the only
superpower," well over two decades ago.
Meanwhile, Bernanke, as chairman of the Federal Reserve, responded to the
crisis (what is manifested as credit crunch) by cutting the short-term
(discount) interest rate, thus discouraging the inflow of portfolio
investments, curtailing the demand for the dollar, and consequently furthering
the decline in the value of US currency.
Fearful investors seeking shelter pushed the price of gold above $1,000 an
ounce, registering yet another decline in the value of the US dollar. An
increase in the price of metals more or less followed the same mechanism, thus
created tendency for bubbles in the market for these commodities. The price of
agricultural products (food) has also increased, in part due to the heightened
global demand and, in part because of competition between food and fuel -
thanks to the ethanol hype - that is now being recklessly promoted by the
populist governments and self-promoting interest groups in both the United
States and Latin America. The food crisis has already manifested itself in a
number of food riots around the globe, from Bangladesh to Haiti.
Finally, the global oil value - the long-run center of gravity around which the
market fluctuations tend to gravitate - has been set based upon the highest
cost oil region, the USA. However, the $130-plus oil and what is driving the
price globally have something to do with a combination of factors: (1)
continued demand from the United States (4.5% of the world population consumes
25% of world�s oil consumption), plus increasing global demand,
including China (with double-digit growth rate), and, somewhat similarly, India
along with the rest of the growing developing countries; (2) a tendency toward
speculation and propensity for asset-holding activities; (3) a sizeable decline
in the value of denominating currency, the US dollar; (4) political events of
relevant significance.
Concerning the last point, the very drumbeat of war by the Bush-Cheney
administration against Iran, despite George Bush's
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