The famous American aphorism that "Turkeys don't vote for Thanksgiving" perhaps
needs little explanation to Asians, who are used to the notion of succumbing to
the inevitable as one goes about fulfilling whatever destiny has in store. The
saying is used sometimes to describe situations when people explain away the
misery that needs to be caused to some folks for the greater good. Usually, the
people who use this quote around me seek to justify the inevitable happening to
the clueless, in much the same way that an ax greets the startled turkey
concerned only for its next meal.
This idea of a forced restructuring is precisely the kind of situation that
developed countries such as the United States, Britain and others find
themselves in today as years of excess borrowing from poor savers in Asia and
elsewhere culminated in the epochal debt
crisis of today. Yet, as I wrote in my followup to the Group of 20 summit in
Washington this month, (Blind
leading the one-eyed, Asia Times Online, November 18, 2008), the
presumption of relevance among richer countries persists today, leading to the
comic situation of the turkey that is indeed voting against Thanksgiving.
Recently, the US government has continued its bailout of stricken financial
institutions, even as it mulls a wider rescue of incorrigible corporate
entities such as US automakers. While that particular rescue wasn't approved by
legislators last week, a lot of people appear to be betting that exactly such a
move is imminent in the first few weeks of the Barack Obama presidency in early
2009. This is shown in the market of esoteric credit recovery swaps on the US
automakers that have increased in value from 40 cents for every dollar to over
70 cents, implying that market professionals now expect the US government to
stand by its largest corporate entities.
With the recent rescue of Citigroup following its share-price collapse fueling
allegations too much attention was being paid to Wall Street, the Federal
Reserve has announced an $800 billion package targeted at making credit more
accessible to consumers, with $200 billion aimed at easing access to loans to
students, car buyers, credit-card borrowers and small businesses.
Not to put too fine a point to it, in the whole list of bad moves by the US
government in recent memory, the rescue of profligate and useless US automakers
would surely rank as the icing.
Of course, the list of people anywhere else looking to complain about that idea
is small. Certainly, no one in Europe can say much, what with the munificence
of European governments being the single source of sustenance for many a
bankrupt grandee. Neither can countries like Japan say much, given their system
of direct patronage as well as indirect pressure on banks to continue lending
to large corporate entities well beyond the time when such lending would be
considered imprudent anywhere.
The most pervasive argument is that since every other country apparently seeks
to protect its corporate jewels, why shouldn't the US; the difference can be
discerned in the superior equity market performance of the US against its
counterparts in the Group of Seven leading industrialized nations for the past
40 or so years.
Rather than profitability or cash flow per se, the most important argument that
sways investors towards the US is the notion that capital is almost never
misallocated, given the market dynamic of punishing poor performers rather
openly. This is also the reason that tax revenues of the US government remained
dynamically well adjusted across economic cycles as the incentive to innovate
out of trouble helped to turn companies and therefore the economy around
faster. Hence, there was sound logic to using the US government bond as the
global benchmark for a risk-free asset. We can safely say here that the
capitalist dynamic worked exceedingly well for the US.
That capitalist dynamic is what has been threatened by the ill-thought bailout
actions across the financial system and the corollary actions for non-banking
groups, including some of the world's hitherto largest companies. Almost by
definition, government bailouts will unleash the monster of moral hazard
wherein people are happy to fail because someone else absorbs losses while they
get to keep the profits.
None less than Nobel Laureate Paul Krugman makes the case that the US decision
to allow the failure of Lehman Brothers on September 15 marked the height of
irresponsibility on the part of the George W Bush administration and brought
about the dangerous collapse of the financial system, and with it the rest of
the global economy.
There is a comfortable fiction in all this, given that no one knows precisely
what would have happened if Lehman Brothers had been rescued. What would the
government have done when short-sellers surrounded the other US investment
banks - Merrill Lynch, Morgan Stanley and Goldman Sachs? Would the conniptions
of Citibank this week have been avoided altogether because Lehman was saved?
What about the large US corporate entities that have availed of government
funds such as AIG and General Electric?
What Krugman and others among the left-leaning elite appear to miss is that the
Lehman bankruptcy accelerated the process of risk awareness that we now see
across the world. People are unable to take dangerously risky positions because
their own capital has become constrained. In effect, the Lehman situation
merely brought to the surface what was inevitable, namely the deleveraging of
Group of Eight (the G-7 of the US, Japan, Germany, United Kingdom, France,
Italy, Canada plus Russia) economies, and at a speed far higher than they were
considering themselves. Perhaps what Krugman and others complain about is their
distress at seeing the gizzards of their own corporate entities on the global
menu.
It is interesting that we discuss the issue of deleveraging while somehow
bringing in the doomed turkeys. In his celebrated book Black Swan which
I reviewed this year (see
Of black swans and greedy oilmen, Asia Times Online, January 5, 2008),
Nassim Nicholas Taleb uses precisely the example of the turkey to describe the
fallacies of statistical data; namely that 1,000 days of being fed at precisely
10am for the turkey doesn't mean that it would be fed on the 1,001st day -
indeed it would be slaughtered on that day.
Any statistical model based on the individual turkey's experience would be
faulty, which is precisely what happened to the statistical models on
homebuyers' repayments in the US. Despite mountains of data, the information
was still sorely lacking global reference points, namely what happens when a
whole slew of buyers previously denied credit suddenly find themselves able to
borrow money for buying homes and the odd Ferrari or five?
The mistake made by statisticians and then absorbed by credit rating agencies
and Wall Street was to look purely at US housing data. If they had opened their
eyes to look at home delinquency data from elsewhere in the world, for example
emerging markets, they would have found that sharp collapses in asset prices
produced significant spikes in defaults. Going back to the turkey, data on one
turkey is pointless but time-series data on turkeys across various farms would
have confirmed the basic suspicion that the turkey would one day be
slaughtered.
In much the same way, those looking for the bailout of G-7 economies to follow
Keynesian practices are also barking up the wrong tree. This is because the
experience of Japan in the 1990s is more useful, namely that firms with
negative net worth will continue to repay debt even if interest rates go to
zero, rather than invest in new projects carrying operational risk. The same is
true of US homeowners and various others elsewhere in the world.
Debt reduction will in turn continue to cut the global economy's output. This
is the "cold turkey" treatment of debt being withdrawn from habitual borrowers,
much like taking away drugs from crack addicts. The rest of the world has no
reason to support the efforts of the G-7 in keeping their debt addicts in the
habit; indeed it has now become economically unviable for Asians to support
these borrowing habits across G7. That is what I called the
Fukuyama moment in finance (Asia Times Online, October 18, 2008), the
idea that the history of financial markets is largely irrelevant now,
particularly with respect to the building blocks such as what constitutes a
risk-free asset.
The only way out is for G-7 countries to support infrastructure building and
government spending in Asian countries, such as China, India and Southeast
Asia. These countries have the demographics and the profit potential to repay
today's borrowings, and certainly would provide a bigger boost to the global
economy than whatever can be achieved by throwing money at folks with negative
net worth in the US and elsewhere.
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