This is a very short note about the financial crisis, which deserves a book(line up with advances pl? write me, don’t all call at once 🙂 ).
The genesis: The ground for the crisis was laid when America went into a recession from the Dot com Bust in 2002. Suddenly a big group of foreign entities based in Asia and the Middle east had plenty of money (mostly US dollars) to spare because they were selling ,still, to an economy that had the demand to buy traded goods from them. In the short term, these entities(mostly governments and big foreign corporations) bought US Government T bills (which paid very little in terms of returns). In the long term, since the US had burst its dot com bubble, this money could not go into the stock market in the US, It went into other, less regulated US Assets.
Europe and Japan were doing worse than the US and Asia’s stock market did not have the capacity or the depth , post dot com, to absorb trillions of dollars in excess liquidity.The interesting question is : who made money here.
The pathology: The real estate market in the US looked good for many reasons. Low US Dollar Interest rates, coming off the dot com boom (Alan Greenspan monetary policy) , The Iraq war made US assets desirable,as uncertainty gripped the rest of the world. This was accentuated further by the Budget deficits in the US. America needed its Dollars back and the world was willing to give it back, mostly because it was scared by the Iraq war and consequences of NOT buying American assets. The US Economy had stopped growing and it was reluctant to shrink. This resulted in inflated asset prices, and when the domestic economy couldn’t pay for them, foreigners broke the doors in, and sometimes paid inflated prices for bad assets, The financial markets then, used these as benchmarks in pricing these assets. Classic bubble economics.The interesting question is: who made money here.
The numbers: Lets take a step back now and look at the numbers involved here.
America’s place in the world: In 2007, The US economy is 13 trillion dollars big. the world economy is about 55 trillion in US dollar GDP, although, if a hamburger in china were priced in US dollars instead of in rimnimbi, the World GDP would be thrice as much.( Europe has a $ 16 trillion GDP, Japan has $4 trillion , China 3 trillion and Brazil India Russia have about 4.5 trillion collectively). This means that , unlike in 2002 where the US had a third of all goods and services traded in the world, the world now the US accounts for only one in five US dollar buying and selling transactions in the world.
Foreign dollars: Foreigners holding of US dollars abroad is not a new phenomenon. this happened in the Bad old ’70s when OPEC created oil shocks. It used to be called Euro dollars.and there was an entire parallel world economy in Euro dollar, powered out of Switzerland, involving Arabic money and South American Soverign Debt. There was a big Latin American debt crisis very similar to the mortgage crisis then.
The current holding of foreign dollars is driven by two factors. Oil: Russia, the middle east and a few Latin American countries hold US dollars in vast quantities from High oil prices. Oil is settled in US dollars, and all surpluses are maintained in US dollars by these countries. This, to the Americans, is better than people doing Oil business in other currencies, thus diminishing the strength of the US dollar in the world economy. Saddam Hussein was deposed, partly because he was strategising moving of Oil trading to non US dollar currencies, to avoid the post gulf war I sanctions. Nations import about 13 billion barrels of oil a year (at 100 dollar / Barrel oil price, that is 1.3 trillion dollars in transfer of dollars to exporting nations, a third of it from the US. About a tenth of the size of the American economy is paid out as energy costs to Oil producers for Crude oil).
China , Asia and Trade : China has had a surplus in balances against the US forever. Non oil balances that the US bleeds out every year is about half a trillion dollars. About 350 billion a year of this is to Asia- China Japan Korea and Taiwan account for about 90% of this. Asia has always put its surplus dollars back into the US- in US Government treasury bills , initially, and then in other US Assets.
So Why the bust?
Because T bill returns were not good enough for people investing in the US. This is not greed. this is buy in into the rosy view of America from outside it. The reason people from outside the US invest in the US is that they think the US economy is better- more secure and more profitable than the rest of the world. Or china would invest in Japan and Russia in India, in real estate and in consumer goods, instead of sending US dollars back into the US.
The onus is on the US economy and the financial system to absorb this liquidity and channel it into profitable engines of growth. The US economy, however, has been growing of late, from Outsourcing its production and from defense spending.Neither has an income or wealth multiplier effect in the household economy. The problem was that corporate firms were doing A-OK from outsourcing, and the government was fighting a war,and could use all the global liquidity pouring in to the US and Households were not protected from their own greed.
Greed: IS what keeps wall street moving. It is the essence of the capitalist system. the greedier you are the more you protect what you own,and retain its value. the more you do this, the more your assets are worth, thus preserving capital and making people work to acquire more capital. The world would be a very different place if the crown Jewels of the British queen wasn’t so scrutinized and sought after, but that is a different conversation.
Greed is relevant to this conversation because Greed at the bottom of this crisis was entirely legal , legitimate greed. No one is to blame if you sell your bombed out property in inner city Detroit to a foreigner for twenty times the value, right? As it turns out, wrong. This is because of a few reasons. 1. foreigner’s losses have a way of finding its way back to losses inside America’s financial system. Citibank has Saudi Arabian shareholding, Bank of America and Morgan Stanley have Chinese shareholding. The British (Barclays) and the Germans (Deutche bank) the swiss (credit suisse) all are well invested in financial firms in the US in a way that, if foreign money made losses, it would directly impact these firms, and by extension , the US financial system. The lesson, I guess, is that in the globally interconnected system, If Money makes losses, it will hurt EVERYONE that caused the loss, even peripherally.
We then had a situation where 1. foreigners owned unregulated American real assets, and instruments based on them, 2. these were packaged and sold as US cash flows(and presumably had lower sovereign risk than say, shopping centers in Dubai) in derivative and pass through instruments,whose real risk no one could even begin to judge, because of the complexities in estimating such unregulated risks. 3. On top of this, US and world insurance companies went and sold portfolio insurance derivatives on these instruments.
Now, while pass through assets(assets whose cash flows are dependant on an underlying cash flow) are as risky as the capacity of the borrowers to pay, Derivative and Insurance on this pass through also depends on the added risk of whether the insurer can pay in case there is a loss. This is called a Market risk by Insiders. As Market risk increases, the chance of exactly what took place in this meltdown increases too.
Remember, even as people are cutting losses in this bad market, it also pays to remember who made money from this portfolio of bad assets. The Markets are a Zero Sum Game, meaning, if some lost money others gained the same amount of money.
Conclusion: We see therefore, how this crisis developed but this analysis , like most, raises more questions than it answers. At the very least the questions are : What happens after now, when the government has nationalized all the bad loans and recapitalized a Big American/ Chinese Insurance company(AIG) with its capital. What happens to all the surplus US Dollars in the world now? What happens to US as a center of World (not American, but World) financial system, given the waning influence ,as demonstrated by this crisis. and las but not least, what is the US response going to be to the emergance of Influential capitalist players in the world outside the US, that have shown that they can play the US financial system against itself, if they have to, and this article does not even begin to address the trillion dollar losses hidden away in foreign sovreign fund books and Hedge fund profits/ Losses.
But then the world has not ended, so Maybe we will think about this tomorrow,when the hangover from the partying has subsided.