The Black Death of financial collapse -
By James ***es,
former Australian ambassador to the European Union and Australian
representative at the United Nations.
11/04/08 "Asia Times" -- -- It is not just a "subprime" crisis; it is
systemic - affecting the entire financial system. It is also global,
affecting various countries in various ways but affecting them all. In
achieving a certain "globalization", we have been uniquely successful
in globalizing collapse, chaos and misery. It is a globalization
which, in our short-sighted negligence, we never envisaged.
In this crisis, even a country such as Australia is no more than a
subordinate, neo-colonial, financial and economic dependency. In
essence, we have reverted to what we were before and during the Great
Depression of the 1930s, when Whitehall, Westminster and the Bank of
England played the tune to which we jigged. Then, from 1945 to 1969,
for the first time, we played our own tune of full employment and
stable economic growth. Wild radicals such as minister Eddie Ward in
the governments of John Curtin (1941-45) and Ben Chifley (1945-49)
warned us to be wary of Wall Street.
The cynics might now say that Eddie, who died in 1963, was right.
After 1969, we forgot his warning. Indeed, the Americans themselves
forgot to guard against the chicaneries of Wall Street, where eternal
vigilance should always be the watchword. They forgot what the mania
of Wall Street can do to the reality of Main Street; and we shared
their amnesia.
From 1969 and especially from 1971, when the United States cut the
dollar link with gold, Australia surrendered any worthwhile
independence in its economic and financial thinking. We swallowed
American financial and economic formulae, whether we were academics or
policymakers, industrial entrepreneurs, banks or providers of
"financial services."
We did not entirely switch off tunes played by Britain, the more so as
its prime minister Margaret Thatcher formed her slapstick band with US
president Ronald Reagan to drum up sup****t for "free" markets, "free"
trade, privatization, globalization and the free flow of almost
everything, including speculative capital in unqualified pursuit of
private profit. Cor****ation and consumer greed marched in step towards
global disaster.
Rational economics based on real investment, productivity and
production died in favor of speculative and often Ponzi pretensions.
The cowboy junk-bond merchants of the 1980s metamorphosed into
respectable, mostly young and usually idolized financial wizards who
"perfected" sophisticated, highly complex credit devices. From the
1990s, these highly leveraged instruments took the form of
derivatives, private-equity, hedge-fund and mortgage securities,
abbreviated to CDOs, SIVs and the rest.
Allied with "free" markets, deregulation and the uninhibited flow of
all kinds of finance, those financial devices destroyed industries and
the jobs that go with them. With casual indifference, they also
destroyed the self-reliant working and middle cl***** until then
typical of robust free-enterprise economies.
Theirs was not Joseph Schumpeter's "creative destruction" but
wholesale destruction of their own economies and, eventually, their
own financial "system". They destroyed personal savings and created
massive indebtedness. They undermined the power and security of the
United States itself as they "outsourced" real economic strength and
stability to countries especially in Asia.
The Asian Tigers, China and others grew into "powerhouses" whose
creation, historically, would otherwise have taken them generations.
Our eminently creditable aim of peaceful change through development of
developing economies was distorted, largely through negligent
inadvertence, into financial, economic and social self-destruction.
Looming global collapse, with political and strategic uncertainties,
are our inevitable legacy.
Consumerism rages, industry gutted
The speculative, Ponzi mania spread especially to Anglo-Saxon
countries and to other developed countries in lesser degree. Australia
took to "free" markets, "free" trade, free-floating currencies,
deregulation, privatization, globalization, derivatives, hedge funds,
private equity, wildcat mortgages and leverage-without-limit as a duck
to water. Consumerism raged. Industry was gutted. Debts ballooned. The
value of the currency fell at home and abroad. Despite low-cost
im****ts, inflation flourished. In 2008, the Australian dollar can
perhaps buy as much in real terms as five or 10 cents did in 1969.
A situation in which real public and private investment was replaced
by "owner****p investment", massive leverage and speculative finance,
in which consumption grew and debts spread, could not persist, except
so long as ever more money flooded in to sup****t the insup****table.
Once the flood slowed or stopped, a Ponzi-type collapse was
inevitable.
But few saw it that way. Warren Buffet belatedly called derivatives
weapons of mass destruction; but most saw the financial devices as
belonging to a "new era". They represented a "new paradigm". Far from
being a threat to stable growth in a stable financial system, they
"spread risk" and made everyone more secure and of course more
wealthy.
The wealth effect was a particular feature of the residential mortgage
business. Funds were available from many new banking and non-banking
sources, including hedge funds and private equity, as well as pension
and mutual funds; and sources that, in their magnitudes, were new,
such as the carry trade. Funds marketed wholesale and retail
mortgages. Liability could be ****fted even or especially for debt in
the deepest sense sub-prime. Mortgages also enabled homeowners to
expand consumption through mortgage-equity withdrawals (MEW).
In a real sense, MEWs were symptomatic of multitudes of individuals -
and, in effect, whole societies - high-living it off their capital.
That enabled a process of growth that was both irresistible and
inherently unsustainable.
However, the Ponzi scheme to shame all others may yet be waiting to
deliver its coup de grace. One commentator has drawn attention to "the
bad news [which] is the US$500 trillion derivatives market". He says
that "This is an area that the general public does not even know
exists. Few professionals understand this market. There is no
regulation as government just let it go ... and go it did. You must
expect a 5% default problem. That is a $25 trillion number ... It can
create insolvent institutions all over the world ... It is the making
of the first global depression. The world is not ready."
Unprepared for depression
Australia is not ready either. Prime Minister Kevin Rudd told us late
in March that Australia's economic prospects remain "sound, strong and
good". The Reserve Bank of Australia shares that view. Eerily, they
echo US President Herbert Hoover in 1929 immediately before the stock
market crash of that year.
Australia's situation contains some positive features. High commodity
prices, it can be argued, are likely to persist, even though volatile,
at least in the short term. A member of Iceland's central bank board
recently said that "fears of a meltdown in my sub-arctic homeland are
vastly overblown. True, the current account deficit was 16% of GDP
last year, but that's an improvement from more than 25% in 2006. And
while net private-sector debt is about 120% of GDP, there is virtually
no public debt in Iceland. This is largely the result of unparalleled
political stability and continuity."
Australia's situation may not be as dire as Iceland's; or indeed as
dire as that of the United States or New Zealand; but all three of us
have some negatives like those of Iceland.
Like all booms of such size and speculative character, the Australian
housing boom must soon demand payment of its account. From their peak,
prices could fall 30% to 50%. Industry researcher BIS Shrapnel does
not agree; but we must expect that our housing boom, even more robust
than the American, will collapse along the same general lines as the
bust occurring right now in the United States.
The high "unaffordability" of housing for the average home-seeker, as
distinct from speculator, suggests that the bust will be savage. The
real-estate, building and associated industries will suffer severely,
with massive job losses. Simultaneously, profitable investment
op****tunities elsewhere may have vanished with the widespread collapse
of the "financial services industry".
How likely is such a collapse? So far, although some non-banking
financial institutions have gone to the wall, the four major banks
have seemed largely immune. "The take-up of the Australian economy is
still good," Rudd said last week in New York. Australia had "limited
exposure" to the subprime mortgage woes that erupted in the United
States last year, he said. "We have excellent balance sheets in terms
of our principal cor****ates and the banks themselves ... The default
rate in Australia is minuscule by Organization for Economic
Cooperation and Development standards."
We don't know how far banks and other potentially exposed institutions
have concealed their liabilities and to what extent and how soon they
will be forced to reveal whatever bad news there is. Within this broad
question, we also do not know how far they are exposed to losses from
the massive and still largely mysterious menace of derivatives.
In some measure, Australia's major banks have certainly been involved
in the wide range of structured securities - CDOs, SIVs, and the rest.
A re****t on April 4, 2008, that local councils in New South Wales have
lost US$200 million and perhaps up to $400 million on investments in
CDOs is a worrying sign that other and even bigger losses may yet be
revealed in a variety of institutions, including banks. It seems
scarcely credible that an economy which, for so many years, has
absorbed so much of American theory and practice - so much of the
American financial character - can be wholly immune from the penalties
inflicted on its American model.
The subprime crisis first hit the United States after a housing about-
turn that began as far back as 2005 or 2006. An unequivocal downturn
in housing in Australia has yet to check in; but non-bank lenders are
already withdrawing from the market. Wholesale mortgage lenders are
closing shop, perhaps as a prelude to a sharp housing decline.
The carry trade which has presumably provided funds for mortgages and
other financial services in Australia has been volatile for some time.
If it unwinds completely, that could not only intensify mortgage
problems but also impact on Australia's external balances.
Our deficits have so far tended to persist at a less healthy level
than the commodity boom might have encouraged us to hope. Our
aggregate private overseas debt is said to amount to the order of half
a trillion dollars. Against that background, the current depreciation
of the United States dollar might foreshadow what awaits our own
currency.
Lagging impact
Economic and financial change in the United States tends to have a
lagging impact on Australia. An acute awareness of the severity of our
crisis may consequently not emerge before the second half of 2008.
When it does, what will the Rudd government do? Currently, it seems as
unaware of the magnitude of the challenge it faces as the James
Scullin government was in 1929. So the present government might become
just as bewildered as Scullin and stagger just as blindly and
ineffectually when they are called on to act. In the 1930s, we
listened to the likes of Otto Niemeyer of the British Treasury who was
also a director of the Bank of England. Will the Rudd government this
time listen to the Americans and the likes of US Federal Reserve
chairman Ben Bernanke? If they do, catastrophic outcomes might not be
in short supply.
Our only real hope lies in clear, independent thinking by those not
too steeped in the flawed policies responsible for our current crisis.
We must see clearly that fundamental, comprehensive financial and
economic reform is imperative. We must adapt that fundamental reform
to our own needs, as the John Curtin and Ben Chifley governments did
between 1941 and 1949. As we did then, we must simultaneously try to
guide the international community out of the calamitous course that
has evolved since 1969, and return it to the goal of stable, peaceful,
global change which, as a primary objective, we pursued between 1945
and 1969.
While we embark on this journey, a high level of political volatility
in Canberra is inevitable. Rudd might succeed; but the Labor Party and
government might split two or three ways as they did between 1929 and
1932. Another Joe Lyons, prime minister from 1932 to 1939, might
emerge. Whoever he might be, the odds are that he will be even less
likely to find quick or easy solutions than Lyons was during the long
and bitter years of depression. Those years ended only in the even
deeper tragedy of world war.
--------------------------------------------------
James ***es is a former Australian ambassador to the European Union
and Australian representative at the United Nations. He is the author
of among other works The Human Mirror: The Narcissistic Imperative in
Human Behaviour.
|
