Op-Ed

Causes of the Renewed Financial Crisis Go Much Deeper

Thursday, August 11, 2011

By Anthony Rowley in Tokyo

Tokyo- (PanOrient News) Global financial markets are in turmoil again, just a couple of years after the US sub-prime mortgage triggered a global financial system meltdown. Why are financial crises coming in so thick and fast nowadays compared with the more leisurely pace of recent decades?

Does it have to do with the decision by rating agency Standard & Poor's (S&P) to downgrade its rating of US sovereign debt, or a worsening of the situation in the eurozone; the onset of a double-dip economic recession in the US - or is it just the fault of a long, hot summer?

All of these may have contributed somewhat but in truth the causes of the renewed (not new) financial crisis go much deeper than any single factor such as the S&P downgrade.

It is, of course, debt that is at the root of both the current crisis and the one in 2008/09, and we are not talking just about government debt. It has as much, or more, to do with private debt and is a product as much of profligate monetary policy as it of lax fiscal policy.

In the myriad commentaries penned since the latest crisis erupted, few if any have identified the vital link between the sub-prime mortgage crisis and the current fiscal crisis, and nor have they sought to trace the roots that both have in over-borrowing.

Growth and expansion (rarely contraction, unless forced) are part of the American psyche - born probably of the sheer size and resources of the country that an initially small population inherited. That growth has always been financed by borrowing. Buying the fruits of the future today.

The trouble is that borrowing feeds upon itself and outruns the capacity to repay until a correction occurs and cuts consumption. This is what happened for decades, until former US Federal Reserve chairman Alan Greenspan began buying off needed corrections through the "Greenspan Put."

His repeated monetisation of private debt led to the sub-prime debacle and ultimately to the global financial crisis of 2008. When the US monetises debt that effectively does the same for the rest of the world, given the fact that dollar liquidity fuels the global economy.

Banks collapsed like ninepins during the crisis. Not just US banks but also those in Europe that had emulated their US counterparts in a bid to get rich quick and let the inflationary consequences (in the shape of asset inflation) go hang while also ignoring a massive debt build-up.

It couldn't last and of course it didn't. Collapse came and then someone had to pick up the pieces. That someone was governments, in the US and in Europe. Their fiscal debts soared and in the case of the US an equally permissive Fed chief, Ben Bernanke, bought that debt furiously.

Financial markets are not always very rational - least of all when in herd or panic mood - but they were intelligent enough to see that a colossal burden of bad debt in the banking system has simply been shifted to the public sector. So, they began targeting government debt for attack.

That was the point, two years or so ago, that the rating agencies ought to have stepped in and sounded their warnings that there could be no such thing as a painless bail-out and that government debt especially that of the US, could soon be worth less than the paper it is written on.

Instead, the rating agencies, like almost everyone else, preferred to believe that a debt-financed bail-out by governments of the debt-financed consumption binge that triggered the 2008 crisis would magically restore economic growth and set all to rights.

Now that the inevitable sequel to the 2008 crisis - let us call it Act 11 of the same drama - is upon us, there is still a further act to come. This will be where Bernanke and European central banks are forced to bailout governments in the way that governments did banks.

After that, follows hyper inflation. Gold knows this and has been looking on from the sidelines, not "soaring" in price as many commentators suggest but simply doing its job as a centuries-old store of value. The epilogue will be deep recession and reversion to a lower global economic base, before the game starts all over again.

Some market practitioners have tried to pin the blame on S&P for the latest debacle but the fault lies as much with the markets themselves as it does with S&P.

It has long been obvious to those blessed with any degree of percipience that US government debt was on an unsustainable track and indeed Philip Suttle, chief economist at the Washington-based Institute of International Finance, was among those who said so a couple of years ago.

The market chose to ignore such warnings, while S&P, Moody's Investor Services and other rating agencies sat on their hands, apparently hoping that somehow or other the rot in the US fiscal position could be stopped. It was not, and instead things moved to a crisis.

S&P argues that Congressional agreement to cut government spending and to consider raising revenues was too little, too late, and so took the plunge and downgraded the US. It was right to do so: the agreement allows more borrowing, with spending cuts and revenue raising to be decided later.

Neither S&P nor Moody's had any qualms about downgrading Japan's sovereign debt rating several years ago when government debt began to pile up there. And that debt is held almost exclusively within Japan unlike US government debt to which there is huge international exposure.

All this has to be seen in a changed international context, one in which the financial supremacy and stability of the US can no longer be taken for granted. This has emboldened rating agencies and others to take actions and offer criticisms that they hardly dared contemplate before.

For decades, the IMF made searching probes into member country's fiscal and financial health in forms such as Article 1V consultations or Financial Sector Assessment Programmes (FSAPs) but stopped short of presuming to do the same in the US where the Fund is located.

Then came the global financial crisis with the US at its centre. The Group of Twenty (G20) was born, embracing emerging and advanced economies and with this new group at its helm the IMF was emboldened to question the finances of its erstwhile masters including the US.

S&P has probably drawn courage from this more open environment and declared, finally, that the emperor has no clothes. This has sounded a retreat for the dollar and Federal Reserve Chairman Ben Bernanke' pledge to hold interest rates down for two years will accelerate that retreat.

S&P's rating action did no more than acknowledge a reality that was already blindingly obvious, which is that the governments of many advanced economies -the US, Japan and some in Europe -are basically bankrupt and can meet their debt obligations only if these are monetised to a large extent.

Anthony Rowley is a long-standing expert on East Asian economic and financial affairs, resident in Tokyo.

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