This is a departure from my recent biological posts and a temporary return to topical economic issues. Two things have prompted this: 1) news of further problems with European debt; 2) a recent announcement by the Securities and Exchange Commission (SEC).
The news of a downgrade in Spanish and Italian credit ratings, the second this week for Italy, is hardly surprising. It is part of a slow unraveling of the Eurozone monetary system which has been in progress since 2008. While I have had great hopes the European Union would offer an alternative to cultural homogeneity and a unique experiment in pluralism which the world badly needs to learn, I have come to the conclusion the present system is unworkable. This is not altogether damning. The American experiment with Articles of Confederation was not the end of the line for our constitutional democracy. Our constitution could not have been written until (almost) everyone was convinced the preceding confederation had failed. Financial integration was the driving force behind American federalism.
The present Eurozone system plan of unified monetary policy with separate fiscal policy resembles an automobile designed with one gas tank and a steering wheel for each wheel on the ground. This has the advantage of removing any distinction between drivers and passengers, and a slight disadvantage for attempts at going in any particular direction. One must also expect disputes over filling the tank.
It worked surprisingly well while conditions were good, during the build up of a bubble, (though we now know the gas gauge was measuring air as well as petrol.) The catch comes when conditions are indisputably bad.
At present arguments over whether or not Greece will default are largely academic exercises. If my understanding is correct, (and this is a tricky business,) the current restructuring of sovereign debt owed by Greece amounts to paying off about 50 cents on the Euro borrowed. Half the money is effectively gone beyond recovery.
The impact of this, and the danger of further default, has pushed shares in the Benelux/French bank Dexia down fast enough to cause exchanges to suspend trading temporarily. Dexia, for those unfamiliar, took a big hit in the 2008 contraction, requiring a massive bailout (compared to the size of the economies) by the governments of Belgium and France. Sovereign debt owed by Belgium is already in danger of causing a downgrade by rating agencies. This puts that country in a dilemma: if it goes further into debt, to save a major part of its financial industry, it could lose its top rating -- forcing it to pay more to service debt already outstanding.
Spain and Italy are already in such a situation. With economic projections virtually flat, the question of where additional revenue (to pay for servicing that debt) will come from is tricky.
Piled on top of this burden, we find central banks facing increased risk, and raising reserve requirements for other banks. This means those banks must keep more capital on hand to prevent a run on a bank from destroying liquidity -- a bank failure. This money must simply sit there to offset that risk. It is being sucked out of economic activity outside the banks.
The Bank of England just conducted another round of "quantitative easing". This means buying assets from other banks to free up more liquid capital. Unfortunately, this is a weak measure, when other actions, like lowering interest rates, are not practical. Interest on loans between banks is down to almost nothing. The problem for industry is that risk aversion is causing banks to simply avoid lending to anyone who actually needs a loan, due to risk of default. Nobody knows how to tell good risks from bad ones, except by checking on the size of bank accounts. No collateral seems especially solid.
All these things amount to a standard prescription for economic contraction. Europe needs a massive infusion of funds, but -- barring divine intervention or extraterrestrial contact -- there is no obvious source.
Now, back to the U.S. SEC. This agency has decided that 10 credit rating agencies singularly failed in their primary responsibility during the 2008 crisis. As books explaining in considerable detail how they did so have now passed into mass-market paperback editions, this bulletin must be considered a lagging indicator. To have averted the 2008 collapse, those rating organizations would have had to act in 2007, which means any correction to their operation by the SEC should have taken place earlier. The lag is about 5 years. This is not exactly proactive.
We badly need some clues which will make financial management less risky than a market in celebrity marriage futures. Without better indicators, any models based on the behavior of rational investors must favor survivalist supplies.
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An Autodidactic Lesson
Blog entry posted by anciendaze, Oct 7, 2011.