Jun 3, 2010

Unavoidable Reapings

Wilfred HahnBy Wilfred J. Hahn
Eternal Value Review

According to policymakers and Wall Street pundits, everything is under control and the outlook continues to improve. The Global Financial Crisis (GFC) is long over … a forgotten aberration of history. Moreover, economists have learned from the experience of the 1930s and will not make the same policy mistakes that are blamed as the cause for the Great Depression. Great stock is put into the claim that Ben Bernanke, the head of the U.S. Federal Reserve, is one of the world’s greatest experts on this period.

The reality, of course, is quite different. Firstly, there has been virtually no fundamental economic improvement; only a re-ordering of symptoms and conditions. Secondly, the economic profession has learned virtually nothing about managing financial crises. Only a fool would accept the assurances of a seer that was not able to foresee the crisis in the first place. Nor could one put any confidence into the policy recommendations of a profession that never warned us about an approaching crisis.

Policymakers refuse to recognize that the mistake has already been made … that it cannot be undone by a mere wave of the wand of monetary policy or ramped-up government spending. Errors and excesses gave rise to the crisis in the first place. The ultimate consequences of these past mistakes cannot be avoided, no matter the extent of intervention, diversions or extensions.

The recent “Flash Crash” — a sudden market collapse which occurred on May 6th — should leave no doubt that the financial structure remains fragile and subject to further vulnerabilities. Securities regulators, though quick to assure everyone that markets are on a firm foundation, have yet to provide any answers as to why it happened in the first place. We have the blind leading the blind. Whom to believe?

Many analysts argue that prosperity is returning, citing recent economic statistics showing a pick-up in activity and spending. However, no attempt is made to connect these so-called improvements with the unprecedented interventions by governments around the world. Apparently, there is no difference between a recovery that is driven by money that is borrowed or one that is self-sustaining … self-fueling. No mention is made of the fact that any recovery is in fact based upon unsustainable factors.

What we mean by “unsustainable factors” are measures that are not self-replenishing and that must eventually come to an end. For example, if one is living off a credit card without ever paying it down, an unsustainable path is being chosen. The day will come where no more credit will be extended. And, on that day, a very sudden adjustment will occur to one’s lifestyle. It is inevitable … eventually.

Indeed, a similar scenario has been playing out on a macro scale. Governments around the world have hugely ramped up their spending in response to the GFC, plunging into more debt at an unprecedented rate. Supposedly, the greatest lesson learned from the studies of the Great Depression was that governments and monetary authorities at that time did not stimulate more … spend more … and flood the financial systems with more printed money. Given this diagnosis, authorities today have outdone themselves in engineering bail-outs, monetary malfeasance, and government spending.

As a result, government borrowing has soared at a rate that was simply unthinkable even a few years ago. Imagine that more than a few advanced countries have been running government budget deficits that exceed 10% of economic output (GDP) — i.e. the U.S., UK, Greece and others.

However, now comes the coup de grace … the inevitable result. Lenders (bond buyers) have finally come to the point where they no longer want to extend more money to countries that are showing no sign of reducing their borrowing. Lenders have come to the realization that they are not likely to receive their money back in full. This breaking point has occurred in the case of Greece, Ireland, Spain, Portugal and others.

What will be the result for these countries? Deep, deep economic recessions. Now, that they are limited in their access to new lending, they basically only have one option — cut spending … or possibly devalue their currencies if they indeed have that option. America will face the same scenario before long. It is an unavoidable reaping.

Finding the Scapegoats

Every bubble era or periodic financial scheme ends with its scapegoats. Once the scheme collapses, those that were once considered the financial magicians become the new pariahs. They are then run out of town … or made to do the “perp walk.” The invention of the wondrous junk bond ended with Michael Milken in jail. The corporate take-over bubble of the last 1980s gave us the defrocked icon of Ivan Boesky. The financial engineering wizardry of Enron, Worldcom and others produced the public images of Kenneth Lay and Bernie Ebbers. As always, the upside was joyously shared by many during the good times, yet only a select few are subjected to the ignominy of public vilification.

Who are the sacrificial lambs this time? To start, this time is different in that it represents a long-cycle inflection point. We are dealing here with the post-world war era coming to its end, transitioning to a new financial epoch (to continue for some time yet). We fear that a very difficult environment lies ahead comprised of desperate government actions, recriminations, revolts and protests. Stay tuned … and keep looking up.

Related Links

BILDERBURG 2010: Secret meeting of world's financial elite could decide fate of Euro... - Times Online
Europe's Debt Crisis Taking Toll on Manufacturing - FOX Business
G-20 finance officials begin global economy talks - AP
U.S. National Debt Tops $13 Trillion For First Time - CBS News
Global Financial Apocalypse Prophesied - Wilfred Hahn (Book)