Trade war may be brewing between China and the US

How times change. Just last year, China was being hailed as this decade’s economic miracle. Growth was in double-digits, the stock market had morphed into a cash machine, and just about the only cloud on the horizon was inflation caused by the soaring price of pigs.

But a short 14 months later, property prices are plunging, stocks have plummeted by two-thirds from their peak and all that growth’s grinding to a halt.

The Chinese authorities are getting more and more jittery. And their reactions to the downturn could deliver the next big hit to a crumbling world economy...

China’s lesson in economics for America

In October last year, the IMF concluded that for the first time in modern history, China was about to overtake the US in its contribution to the planet’s economy. In expanding by 10%, the country would pump more money into the global system than would poor old Uncle Sam with its paltry 1.9% growth.

For the Shanghai stockmarket, that proved to be the peak - almost to the day.

Although the IMF’s thinkers had factored in a likely economic slowdown in the ‘developed’ world, they were wrong to assume that China would be able to “de-couple” from the West.

Now, with exports collapsing, China’s suffering just as much as Europe and the States. And this week, China’s top men have been telling US Treasury Secretary Hank Paulson exactly where he went wrong.

Our Hank has taken a break from his efforts to ‘save’ the US financial system for a two-day jaunt – sorry, “strategic economic dialogue to discuss long-term bilateral issues” - in Beijing. But it’s no cakewalk. Poor Mr P walked into what the FT’s Geoff Dyer calls “a new lecture about US economic fragilities”.

“Over-consumption and a high reliance on credit is the cause of the US financial crisis”, said Zhou Xiaochuan, governor of the Chinese central bank. “The US should adjust its policies, raise its savings ratio and reduce its trade and fiscal deficits”. And vice premier Wang Qishan urged the Americans “to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US”.

Why China wants a stronger dollar

The Chinese may have nailed America’s financial problems. But the trouble is, they aren’t quite as keen to see the US actually stop spending. Because America’s profligacy, and heavy spending on Chinese goods, has been one of the main factors driving China’s economic boom.

With the US consumer out of the picture, China’s domestic economy is getting hammered. President Hu Jintao has warned that China is “losing competitive edge in the world market”. The manufacturing sector has seen its steepest decline since records began, and Chinese workers are not only losing work, they’re getting very angry about it. There have been violent protests in Guangdong due to the mass closure of factories making toys, textiles, and furniture.

So after more than three years of the Chinese currency appreciating some 20% against the US dollar, i.e. making American goods cheaper, the game has now changed.

Twice this week, the Chinese central bank has lowered its ‘dollar band’, including allowing the biggest drop in the renminbi against the greenback since the dollar peg – a fixed exchange rate since 1997 - was ditched in 2005.

This may sound of interest only to currency exchange students. But it isn’t. It means the Chinese are now prepared to start depreciating the renminbi against the dollar. And it has the ammunition, with nearly $2,000bn of foreign exchange reserves, having last month overtaken Japan to become the largest foreign holder of US government debt.

By dropping the value of their currency and so making their goods cheaper, the Chinese hope to gain further export share abroad. And at the same time, they’ll be losing less money on all those US Treasuries they hold.

China’s plans could set off a dangerous chain of events

Yet there’s a very big snag. Any currency policy reversal “risks setting off conflict with Barack Obama’s incoming team”, says Evans-Pritchard. “Obama called China a ‘currency manipulator’ during the election campaign, a term that carries penalties under US trade law”.

In short, just when the planet doesn’t need any extra trouble, a lot more is brewing up. So what does it all mean for investors?

The futures markets are already ‘pricing in’ a 6% renminbi devaluation over the next year. “I really believe we’re on the brink of a very ugly period for trade relations”, says Professor Michael Pettis at Beijing University.

But worse, any slight flickers of reviving manufacturing growth in the West could be snuffed out by a fresh flood of cheaper Chinese imports. China's policy switch could set off a dangerous chain of events, says Hans Redeker at BNP Paribas: “If they play this beggar-thy-neighbour game, it will cause a deflationary shock for the whole world”.

Hardly the ideal recipe for stock markets. But it sounds like it could be well worth hanging onto those government bonds for now. For more on deflation – and what might follow it – read this week’s issue of MoneyWeek, out today.

Turning to the wider markets...


Unimpressed by the Bank of England's big interest rate cut, the FTSE 100 finished down 6 points yesterday to close at 4,164. Financial stocks, though, did take heart. HBOS rose 7.4%, Legal & General was up 6.4% and hedge fund Man Group climbed 5.5%. Housebuilders also had a good day, with Barratt up 9.4%. Miners, however, performed badly, with Xstrata down 7.7% and BHP Billiton down 7%. For the latest stock market news and charts.

Over in Europe, the Paris CAC 40 lost 5 points to end at 3,161; the German Xetra Dax, meanwhile, fell 3 points to 4,564.

In the US, Wall Street ended the day on a low note after concerns about US employment figures. The Dow Jones Industrial Average slipped 2.5% to close at 8,376, while the wider S&P 500 lost 2.9% to 845. The Nasdaq Composite lost 3.1%, ending at 1,445.

In Japan, the Nikkei 225 closed down 0.1% at 7,917 after a very volatile day. The Topix index fell 0.4% to 786. Banks were among the biggest losers, with Mitsubishi UFJ falling 5.4% and Mizuho falling 6.7%.

Brent spot was trading at $41.13, early today; and in New York, crude oil was at $43.90. Spot gold was trading at $767 an ounce, silver was at $9.51 and platinum was at $803.

In the forex markets this morning, sterling was trading against the US dollar at 1.4719 and against the euro at 1.152. The dollar was trading at 0.7829 against the euro and 92.13 against the Japanese yen.

And this morning, the credit crunch has hit Formula 1 motor racing as Honda announced they are to quit, dealing a major blow to the sport. Honda said it could no longer bear the $500m a year cost to run the team. The pullout has raised fears that other teams such as Toyota could also be rethinking their position.

Courtesy : Money Morning

Saving China, rescuing India

In 1949, said the speaker from Shanghai, Communism saved China.

He was, of course referring to the 20-year civil war in China and subsequent ascension of Chairman Mao as the ruler of China.

In 1982, continued the speaker, Capitalism saved China. He was, no doubt, referring to the fact that the Red Book of Chairman Mao had resulted in China joining the ranks of India and Africa as economic basket-cases of the world. Communism - as in Soviet Union and China - had failed to deliver the promised goods.

In 2008, ended the speaker with a flourish, China is being asked to save Capitalism.

He was, no doubt, referring to the fact that the world increasingly looks to China to save it from the economic crises that keep popping up everyday.

On November 26th, the Indian stock markets zoomed in the last hour of trade. Alas, this was not because the CPI (M) and other forms of communists that exist in India had decided to give up their effort to save Communism. But, rather, it was because China has announced that its key lending rate will drop by 1.08% to 5.58%. This, notes the Bloomberg article excitedly, is less than 3 weeks after China has announced a 4 trillion yuan (USD 586 billion) stimulus package.

As this news hit the wires, the European stock indices reversed their earlier decline and surged 2% to try and crawl into the positive territory. China may end up saving Europe, figured the punters


Under the sheen

But maybe all that China is really doing is trying to save itself!

Over the past two decades, as China’s factories churned out clothes, microwaves, stuffed toys, and television sets to be exported to the rest of the world, its humming factories needed workers. In response to promises of higher wages and some basic amenities, hundreds of millions of labourers have moved from the countryside to urban areas.

On the way up the economic steps of the golden export ladder, that was good. China’s industrial miracles gave it over USD 2 trillion in foreign exchange reserves. While that is one measurement of success, consider the potential harm from the unwinding of this export-led economic boom.

Says Bloomberg: ‘China, the world’s most populous nation, is targeting growth of 8 percent a year to provide jobs for workers moving to the cities from the countryside. A decline in economic growth to even 8 percent would be tantamount to a recession, said Tao Dong, chief Asia economist with Credit Suisse AG in Hong Kong.

The outlook for jobs next year is "grim", said Yin Weimin, head of the Ministry of Human Resources and Social Security said last week. Two thirds of small toy exporters closed down in the first nine months of this year, the customs bureau said this week.

About 1,000 police and security guards attempted to break up the demonstration as sacked toy company workers overturned a police car, smashed four police motorbikes and broke equipment in southern China’s Guangdong province yesterday, Xinhua News Agency reported.’

If 100 million people - out of jobs - have to move from urban China to rural China that will be a Great Leap Backward. If another 100 million people cannot see opportunities in urban China and are forced to stay back in rural China, then that requires an alternative economic activity to be created for them.

The Chinese economic miracle needs to be juxtaposed with a "quality of life" factor. The monetary wealth created by paying higher salaries and increasing incomes to hundreds of millions of its citizens was at the cost of a lower quality of life - a problem faced by all countries when they are trying to break out of poverty. The people tolerated bad air, poisoned products, and lack of freedom because there was a monetary compensation - and a promise of good times. Much of that monetary wealth is under threat of evaporation - but the qualitative negatives still hang in the air.

What China is seeking to do is rescuing itself. Not from a disaster but the possibility of a disaster if their own economy slows down further.

Reducing interest rates and giving banks the flexibility to lend out more money (by reducing the reserve requirements) is in the hope that domestic consumption will increase. If factories stay occupied, jobs will be retained. China will be rescued.

India needs to build

And India, with its hundreds of millions of unemployed and under-employed, is also in a rescue mode. Luckily for India, the export-led boom was more limited to a few industries and to the mass export of human talent from subsidised institutes of higher learning.

The hysteria of the 8% GDP growth story excited - in an unlimited way - to the stock market and the finance companies, four million investors, and segments of the media that covered the Incredible !ndia stories.

Like China, India needs to find a solution - a visible solution - that will take hundreds of millions of Indians up the economic ladder. And find a way to climb the quality-of-life ladder. Not an easy task. Particularly when you have terrorists and politicians to deal with. But there is a way.

India’s job creation - and higher economic activity - can be led by infrastructure. The building of power plants, roads, bridges, railway lines.

True to form, there are a lot of announcements of infrastructure projects including the plan to double up and invest USD 500 billion for the five year period ending March 31, 2012. Well, we are 30% of the way there in terms of time, but are we likely to achieve that target?

Not that infrastructure is an easy thing to start. If you build dams and power plants, bridges and roads, there are environmental and social issues that need to be considered. Rightfully so - otherwise these "costs" come back to haunt you exponentially in the future.

India has the challenge of dealing with federal governments, state governments, and local governments - and political parties of all shades of the spectrum. Each one "represents" someone - or something. Each voice demands to be heard.

So it is with this similar challenge of finding jobs for hundreds of millions that China and India will write - and should write - their economic policy.

As countries, they begin from very different starting points. But, let there be no mistake. Neither China nor India can save the world - they first need to save themselves.

It is the failure of the "greed-capitalism" which has forced both countries to look within and start the more difficult work of building truly wealthy societies. And not be distracted by rankings and labels linked to market cap.

So - with apologies to the speaker from Shanghai - neither India nor China can save Capitalism or the global economy. But it is possible that the failure of "greed capitalism" will force both countries to look inward - and save themselves.

Courtesy: Ajit Dayal’s The Honest Truth, Equitynaster
http://www.equitymaster.com/ht/detail.asp?date=12/4/2008&story=1

More cutbacks and job losses are on the horizon

British retail sales last month fell year-on-year for the first time since April 2005. The drop was just 0.1%, but it’s a sign of things to come. As Helen Dickinson of KPMG put it: “A fall in the value of total sales is extremely rare. There is no doubt retailers will need to resort to heavy discounting.”

The news from the housing market was no better. The Royal Institution of Chartered Surveyors reported that the average number of sales completed per surveyor has fallen to 10.9 over the past three months. That’s down by 53.6% on a year ago. It’s also the worst figure since records began in 1978. London was worse still, with just an average 6.4 sales over the three months.
The one piece of good news – for now – was that raw material prices are collapsing. Input prices fell by 5.6% month-on-month in October, while output prices fell by 1%. They are still well ahead of last year (up 6.8% and 13.8% respectively) but with commodity prices continuing to fall, inflation is likely to follow suit.

Of course, the collapse in demand also means that profit margins are going to come under pressure. Even if producers manage to pass on some of the earlier rises in raw material costs to their customers, as Paul Dales at Capital Economics put it, “the deepening recession will force retailers to absorb higher costs in their margins.” Pressure on margins means cutbacks and more job losses.

Credit card lending conditions are set to tighten further in the US

So it was a pretty grim day in the UK. But across the Atlantic, things were a lot worse. Electronics retailer Circuit City filed for bankruptcy protection. It’s the largest retailer in the US to file so far in this crisis. The company has 700 stores and 40,000 staff. It will shut 175 of these and cut 17% of its staff in the next two months. What’s the big problem? A lack of credit of course.

The company makes about 75% of its sales on credit cards, but as chief financial officer Bruce Besanko put it, “Over the past several months, consumers have been unable to borrow funds through credit cards, let alone home equity loans.”

It wasn’t the only big company suffering. Parcel delivery group DHL is shutting down its domestic express delivery service in the US. That move will see 9,500 people lose their jobs. Deutsche Post, DHL’s parent company, has decided that the business has simply become too expensive to keep.

Of course, both of these events have a silver lining for somebody. Circuit City’s main competitor Best Buy will benefit, while FedEx and UPS will be happy to see DHL’s US business shrink. But for the time being, they’ll be competing for slices of a pie that’s also shrinking.

Credit card lending conditions are likely to get even tighter. American Express has been given permission by the Federal Reserve to become a commercial bank. The credit card giant made the move to gain access to funds from the central bank. But loan losses are rising sharply, which means they need to keep more money aside. And at the same time, sales of bonds backed by credit card payments have frozen up – as Bloomberg reports, “October marked the first month since 1993 that card companies were unable to sell bonds backed by customer payments.” So Amex needs to be able to sell them to the Fed instead.

That’s not great news for the American taxpayer. But they probably won’t kick up a fuss. Because they’ll be too busy wondering where the money to bail out insurance giant AIG is coming from. The Fed has now extended its “existing credit line to AIG to a staggering $150bn” says FT Alphaville. That’s from the original $85bn.

As Alphaville points out, AIG is now essentially part of the US government’s bail-out apparatus. The money is going towards propping up the credit default swap (CDS) contracts (insurance against bonds defaulting) which were written by AIG on various risky assets, such as CDOs (the packages of dodgy loans that have caused so much trouble). AIG is now planning to start buying these CDOs back off the banks too.

Investors start to worry that the US won't repay its debts

As Randall W Forsyth points out in Barron’s, all these bail-outs don’t come for free. “What happens if the requests begin to strain the credit line of the world’s most creditworthy borrower, the US government itself?”

Forsyth points out that the yield curve is getting steeper. All that means is that the yield on short-term US government bonds is much lower than that on long-term US government bonds. This would normally suggest that investors expect a recovery in the future, as economic growth picks back up again and interest rates start to rise to more normal levels. But at the same time, the cost of insuring the US Treasury’s debt via CDS has also risen sharply, which in short, means that investors are getting worried that the US may not be able to repay its debt.

This suggests that investors are demanding a much higher payback on long-term government bonds not because they expect a recovery, but because they suspect that the US government will try to inflate its way out of trouble, or even – unthinkable though it may be - default on its debt.

“All of which,” as Forsyth puts it, “suggests America’s credit line has its limits.”

We may well find out what they are before this crisis is over. Regular MoneyWeek contributor, Tim Price, has more on government bonds and inflation in the latest edition of his Price Report newsletter. At the moment, we’re offering the chance to get hold of The Price Report, and all of MoneyWeek’s other newsletters, in a very special deal – but it only lasts until Friday. Find out more by clicking on the advert above.

Turning to the wider markets…


Courtesy : http://www.moneyweek.com/?utm_source=newsletter&utm_medium=email&utm_campaign=Money%2BMorning

America’s financial meltdown: lessons and prospects

The international debt crisis symbolised by the collapse of Lehman Brothers and the forced sale of Merrill Lynch exposes the failure of the world's financial architecture. Ann Pettifor, whose openDemocracy article predicted the crisis in 2003, explains and looks ahead.
(This article was first published on 16 September 2008)

http://www.opendemocracy.net/article/america-s-financial-meltdown-lessons-and-prospects

The collapse of Lehman Brothers and the forced sale of Merrill Lynch which took shape over the weekend of 13-14 September 2008 have confirmed the scale and gravity of the global financial crisis. The difficulties at the insurance company AIG are a glimpse that there is more to come. But the extent of the wreckage makes it ever more important to analyse correctly what has gone wrong. For just as a faulty medical diagnosis can harm the patient, so a flawed economic diagnosis can lead to wrong conclusions and bad solutions.

In this respect, orthodox economists continue to be part of the problem that Lehman Brothers and Merrill Lynch (and, before them, Northern Rock, Bear Stearns, and Fannie Mae and Freddie Mac) represent. For so long they turned a blind eye to the finance sector, to privatised credit-creation and its role in fuelling asset-bubbles. In so doing they revealed their inability to predict, understand or offer solutions to a consuming crisis.

This article looks at how such failures took hold in the context of the deregulated global financial system of the 2000s, and why the predicted collapse of this system begins in the United States.

The deregulated economy

The former chairman of the Federal Reserve in the United States, Alan Greenspan, has himself said that what is happening to Lehman Brothers and Merrill Lynch is a "once-in-a-century" event. Yet the way many orthodox economists characterise Greenspan's own role in the global "debtonation" of the post-9 August 2007 era reveals how far they remain trapped in the rituals of evasion (see "Debtonation: how globalisation dies", 15 August 2007).

The key argument these economists make here is that the current crisis has been caused by the low interest-rate monetary policy Greenspan presided over after 2001. This case permits a twofold diversion - for it pins the blame for the crisis on interest rates (not deregulation of credit-creation) and on central bankers (not the private-finance sector). The policy implications of this focus neatly avoid proposals for what is clearly and urgently required: re-regulation of the finance sector.

But the argument that makes interest-rates a fundamental cause of the crisis is wrong even in its own terms - not least as it can lead to a recommendation that higher interest-rates are a way out of the mess. The crisis facing banks and individuals - indeed whole economies - buried under mountains of debt and threatened by an intractable deflation makes this a truly deranged proposal.

The phenomenon of "deleveraging" as a way of managing these mountains of debt helps explain why. Deleveraging means paying off (or more accurately writing off) the crazy amounts borrowed on the back of tiny amounts of real money - say the $1 million borrowed (or leveraged) on the back of $1,000 of sound collateral; deleveraging that debt would entail paying off / writing off $999,000. The inevitable result in many cases is bankruptcy, part of a wider deflationary momentum in the economy.

Debtors of all kinds - official, corporate, individual - are already struggling to repay at the current high real rates of interest. That is the core element of the debt crisis (or "credit-crunch"). To prescribe higher interest-rates would turn crisis for many individuals, companies and banks into catastrophe.

Here, the context of Alan Greenspan's post-2001 role is relevant in understanding the global economy then and now. For his policy of lowering interest-rates was a reaction to the bursting of the dot.com-bubble - which, like the property-bubble which burst in 2007, was fuelled and inflated by easy, unregulated and privatised credit-creation. Moreover, these low interest-rates in the early years of the 21st century were more a function of the new global capital markets than of the powers of central bankers to set low rates.

The result of deregulation (i.e. "globalisation") in the 2000s was and is that capital can flow free and untrammelled around the world. The accompanying collapse of the Bretton Woods system (which contained mechanisms for curtailing the growth of imbalances between nations) meant also the growth of large balance-sheet contrasts (massive deficits in the United States and Britain, huge surpluses in China and Japan, for example). The countries in surplus - China most of all - exported their excess capital to the US.

This flood of capital lowered rates of interest in the US - to the chagrin of Alan Greenspan, who by this time was trying to raise rates. Greenspan could have done this by erecting barriers to the movement of capital - capital controls - thereby preventing China's surplus capital from having an impact on US interest-rates. Instead, he preferred to pretend that he was impotent in the face of a mysterious "conundrum".

An Alan Greenspan or any other central banker armed with controls over the movement of capital would be able to switch a key lever of the economy: the rate of interest. That is, not just the "policy rate" or the "official rate" (often known as the "bank rate") but all rates - safe and risky, short and long. Where central bankers abandon such controls, and delegate powers over interest-rates to private bankers, they are impotent in the face of capital movements that affect the yields on bonds, and therefore of interest-rates within their domains.

The sharecropper society

The momentous news of the collapse of Lehman Brothers and the sale of Merrill Lynch - part of the larger process unfolding since "debtonation day", 9 August 2007 - brings all the failings of the seven years that preceded it into even sharper focus.

In 2003, as part of a team at the new economics foundation, I edited a book intended to "shadow" the International Monetary Fund's "world economic outlook", which we believed was based on the delusions of orthodox economics (see The Real World Economic Outlook, Palgrave, 2003). An article in openDemocracy at that time - five years ago almost to the day - heralded the "provocative new research ... which argues that the ‘first world' is approaching a major debt crisis... The reckless financial policies of leading western powers in the last two decades make it likely that the next seismic debt crisis will be in America, not Argentina" (see "The coming first world debt crisis", 1 September 2003).

The book and article explained that the current, post-Bretton Woods international financial architecture ("globalisation") was so structured as to enable the United States to "hoover up" money from the rest of the world, and use these resources to live beyond its means. I wrote then: "It is this financial system which makes US financiers so confident that the rest of the world will continue to finance their nation's extravagant spending binge. In the words of David Goldman, head of debt research at Bank of America Securities: ‘America is at little risk for the foreseeable future, simply because the world's capital has nowhere else to go' (Wall Street Journal, 13 August 2003)".

The fall of Lehman Brothers is final confirmation that the world's capital does now have somewhere else to go. This event thus marks the beginning of the collapse of today's international financial architecture, which has rested on very shaky foundations since Richard Nixon's administration unilaterally dismantled the Bretton Woods system in 1971 and began to shape the new.

The reason why the Lehman Brothers collapse is historic is that this institution expected until a very late stage to be saved by the state-run Korea Development Bank (KDP). But Seoul looked at the books and had other ideas: on 9 September 2008 - to the astonishment of Lehman's shareholders and investors - this ever-so-reliable ally of Washington refused to fund a bail-out.

The fact that such sovereign wealth funds as the KDP are no longer willing to finance reckless US institutions is of itself of the greatest significance. It implies a lack of confidence in the solvency of US financial institutions, and indeed of the United States as a whole. This will lead to a fall in the dollar, which will have profound economic implications for the global economy, and for globalisation as a whole.

The billionaire investor Warren Buffett wrote a letter to shareholders in March 2005, in which he predicted that by 2015 the net ownership of the US by outsiders would amount to $11 trillion. "Americans ... would chafe at the idea of perpetually paying tribute to their creditors and owners abroad. A country that is now aspiring to an ‘ownership society' will not find happiness in - and I'll use hyperbole here for emphasis - a 'sharecropper's society'."

Buffett was and is right. The collapse of banks and investment funds, and of the international financial system - a consequence of the unpardonable folly of the powerful - is serious and dangerous enough. But what is even more to be feared is the emergence of a sharecropper society, angry at its downfall. Thus will America's problem become the world's.

What’s Behind the Financial Market Crisis?

The financial crisis is not over. Neither tax rebates nor low interest rates nor higher or lower exchange rates can do the job of reviving an economy that is burdened by debt loads that are too high. On the contrary: the policy measures that the US authorities have been applying will prolong the agony. Be prepared for the challenges of extended financial turmoil and economic stagnation.

Early this year, the US central bank decided to manage the debt crisis in the light-hearted belief that a few aggressive rate cuts would “unfreeze” the banking system. Yet as of the end of the third quarter of 2008, the arteries of the financial system are still cluttered, and the financial system has moved even closer to total collapse.

Those banks and brokerages that haven’t yet failed have been kept alive by emergency monetary transfusions from the US central bank. The Fed has cast away all restraints of economic rationality and is acting in a purely political way. The Board of Governors of the US Federal Reserve System is pursuing the goal of getting the financial system through the mess — at least until the end of the year, no matter how high the costs will be thereafter.The American central bank has adopted the financial equivalent of the military strategy of scorched earth. The economic philosophy of the current chairman of the US Federal Reserve System can be summarized in the slogan, “No depression under my rule!” He resembles a military leader who stubbornly declares, “No defeat under my rule!” the more the chance of victory is slipping away, and defeat can be denied no longer.

The current economic disaster is the result of the combination of negligence, hubris, and wrong economic theory. For decades, an economic and monetary policy has been practiced based on the illusion of, “It doesn’t matter.” At first it was, “Deficits don’t matter.” From that, the policy of “it doesn’t matter” got extended to money creation, the credit expansion, the stock-market bubble, and the housing boom. Now, we’re being told that buying financial junk by the central bank to beef up banks and brokerages also doesn’t matter.

As a byproduct of this mindless economic and monetary policy, financial market operators, too, have lost their heads. Trusting the official cheerleaders, investors hold on in the trenches until they will have lost their last shirt. Economic weakness is spreading around the globe. There is no new spurt of economic growth in sight. Yet many investors stay put because they have been conditioned to believe that government will bail them out.

The current financial crisis is not of a cyclical nature. The financial turmoil is the symptom of the structural imbalances in the real economy. Over decades, expansive monetary policy has gone hand in hand with implicit and explicit bailout guarantees, and this has distorted the process of capital allocation. Under such perverted conditions, those investors will win most who cast away the restraints of prudence. It is a game that can go on for a long time — up to the point when the irrationality has become systemic.

The behavior of the investment community reflects the incentive structure that has been put in place by the authorities. Investors have learnt to dance to the tunes of the pied pipers at high places. After all, the individual market player could see from those who were ahead of him in the abandonment of prudence how money is being made. In the wake of this, financial companies have become overextended and are now in need of deleveraging. Yet the core problem lies in the imbalances of the real economy.

In the Austrian theory of the business cycle, the distinction is made between the “primary” and “secondary” depression. The secondary depression is what catches the eye: the turmoil in the financial markets. Yet the underlying cause is the distortion of the economy’s capital structure: the primary depression.

The simple fact is that the US economy is burdened with a highly lopsided capital structure as the consequence of a wide discrepancy between consumption and production, which, in turn, is the result of monetary policy. Persistent trade imbalances are the symptoms of this discrepancy. This means for the US economy that lower interest rates and government incentives aimed at boosting consumption work as pure poison. Instead of more consumption, more savings, less consumption and fewer imports are needed.

The current financial crisis reflects that many debtors have reached their debt limit and that creditors are lowering that limit. From now on, business and consumers, governments and investors must work under the restraints of lowered debt ceilings.

Economic policy as it is currently practiced is in a fix: lower interest rates may temporarily help to alleviate the financial crisis, but they exacerbate the fundamentals that are the cause of the financial crisis. Equally, a lower dollar would make imports costlier for the United States, while a strong dollar comes with lower import prices. But while a low dollar would help to expand exports, a strong dollar impedes export growth. Therefore, the United States will have high trade deficits as long as the economy does not fall deeper into recession.

Without an adaptation that would increase savings, decrease consumption, and reduce imports, the US economy can only go on in the old fashion with ever more debt accumulation. But the limit of debt expansion has been reached. The financial crisis has reduced the willingness of domestic and foreign creditors to extend loans.

Foreign creditors are getting ready to reduce their holding of US debt in a more drastic way. The governmental takeover of the mortgage agencies Fannie Mae and Freddie Mac bailed out the monetary authorities of China, Japan, Russia, and other foreign countries that hold agency debt. As a result of the socialization of the so-called government-sponsored enterprises, the Treasury opened a window of opportunity for these countries to unload their US assets at subsidized prices, all at the cost of the US taxpayer.

A profound restructuring of global capital has become unavoidable. Such a process is quite different from a recession in the traditional sense. In contrast to a sharp and typically short-lived recession, when, after the rupture, business as usual can go on, the restructuring of a distorted capital structure will require time to play out. Rebalancing the distorted capital structure of an economy requires enduring nitty-gritty entrepreneurial piecemeal work. This can only be done under the guidance of the discovery process of competition, as it is inherent in the workings of the price system of the unhampered market.

Anticyclical fiscal and monetary policies are of no help when it comes to the daily toil in business to work towards reestablishing a balanced capital structure. The so-called income multiplier won’t work, and lower interest rates won’t stimulate spending. On the contrary: these policy measures only make the task of the entrepreneur harder.

The difficulties ahead arise from the problem that business as usual cannot go on under conditions of a credit crunch, which has its roots in the distortions of the economy’s capital structure. Thus, even if the financial market turmoil were to settle, there won’t be the simple resumption of the old ways of doing business. The belief that, after the financial crisis is over, the real economy can reemerge unscathed, is probably the greatest error that many investors share with the policymakers.

As a result of the bailouts and the socialization of the mortgage agencies, the financial system is now fully infected with moral hazard. The disastrous effects of these government interventions will show up soon. The major task of bringing the capital structure in order is still ahead and more pain is in the waiting.As long as governments and central banks continue to focus on the monetary symptoms of the “secondary depression” and continue to ignore the structural aspects of the “primary depression,” they act like quacks. Ignorant of the lessons of the Austrian School, the authorities will most likely continue with their disastrous policies.

From http://www.prisonplanet.com/whats-behind-the-financial-market-crisis.html

Lessons of US financial crisis

Developments over the past fortnight are proving that the financial troubles originally brought on by the United States' sub-prime housing loan crisis, are worse than all but the most pessimistic were predicting when it first began making headlines about 18 months ago.

Last week Washington outlaid a huge expenditure for bailing out government-sponsored mortgage lenders Fannie Mae and Freddie Mac. Monday's tumble of the New York Stock Exchange of over 500 points on the heels of news that one of America's largest investment banks - Lehman Brothers - was declaring bankruptcy, and another, Merrill Lynch, was being sold to Bank of America, made it the worst day since Sept 16, 2001, the first day the NYSE opened for business after the World Trade Center attacks. All in all, it was estimated that about $700 billion in real value had been lost by market investors. The losses continued into yesterday, when the Federal Reserve Board was scheduled to meet to discuss strategies to staunch the bleeding.

Certainly in this age of globalisation the damage will not be confined to the United States. Trading yesterday was sharply down in all Asian financial market.

Former head of the US Federal Reserve, Alan Greenspan, said on Sunday that the US was now in a "once-in-a century" financial crisis, the worst he had seen in his career, and likely still had a long way to go. Eighteen months ago, Mr Greenspan was predicting that the US economy would weather the storm without a major fallout.

The US government has been playing with interest rates and applying tax revenues judiciously to try to avoid what many are now admitting is a real danger of financial collapse. What is most discouraging is that in these 18 months there has been very little done to address the real cause of this mess - the deregulation or lack of regulation of new sectors of the banking industry.

The term "sub-prime" literally means less than optimal, but many of the practices embraced by mortgage loan firms were just plain irresponsible. These included "balloon mortgages", where the borrower pays only interest on the loan for 10 years, at which time an accumulated payment comes due; and "liar loans", where the borrower is not required to submit documentation to verify reported income; and other devices to qualify just about anyone and everyone for a home mortgage loan.

These lending practices played a large role in the US housing industry boom, now just a memory, and played a large role in keeping the US economy in a growth phase. As more and more people came to the end of their "grace periods", the predictable wave of defaults and foreclosures gathered strength and took their toll on the economies of the US and the world.

Economist and New York Times columnist Paul Krugman was one of the first to sound the alarm about the situation. And in a column printed in the NYT on Monday, he warned about what has been described as a shadow banking system that goes far beyond just the housing mortgage sector and which has escaped the scrutiny of the federal government.

One reason for the lack of regulation is that few lawmakers have the sort of understanding Mr Krugman does for the very complicated issues involved. Another is that historically - as in Enron, the 1980s Savings and Loan scandal, etc - those who make their fortunes by playing loose with the rules are rarely the ones to bear the brunt of the economic hard times that follow.
Courtesy: bangkokpost

Who or what caused this financial crisis?

Investors and readers are no doubt aware of the benefits of the free enterprise system as practiced in the United States: entrepreneurship, innovation, ingenuity, dynamism, risk taking, wealth building, and commerce are chief among these benefits.

But readers also know that corporate capitalism has its drawbacks, including (but not exclusively) financial crises that have resulted in devastating economic and social upheavals.

1893, 1929, 1987, 20??

Moreover, despite technological change, productivity increases, and massive increases in wealth, it's remarkable how similar both the crises and the public policy responses have been over the hundred-plus year period: excesses occur, bad debts mount, some regulatory changes are implemented by the U.S. Government (and sometimes by state governments), and then corporate capitalism resumes.

Further, whether it's due to America's culture, its vast natural resources, something innate in Americans, human nature in general, or some other factor, or a combination, every time a crisis occurs, the American people, by and large, reach the same conclusion regarding what caused the crisis or problem: bad decisions or incorrect decisions. Basically, that people, mainly executives and other business leaders (sometimes federal/state regulators), made mistakes or bad decisions.

But we're in the globalization era now, with a myriad of changes, hence there's no guarantee that the changes the American people favored, say, 20 years or 80 years ago, will be the changes they support now.

In the months and quarters ahead, federal officials, and others, will be weighing a series of reforms, but keep in mind they're not likely to implement changes the public does not support, so it makes sense to find out what investors and readers think.

In your view, what caused the current financial crisis? Was it:

a) Bad decisions/mistakes
b) Bad/incompetent executives
c) Flawed economic system -- the economic system needs to be fixed.
d) A combination
e) None of the above/something else.
Courtesy: http://www.bloggingstocks.com/2008/09/18/who-or-what-caused-this-financial-crisis/

Pain of Loving you

In the middle of my life I had nothing to lose
No one to love now it's you I'm thinking of
You're a little of heaven to me
You're all I need it's my concern
There's a lesson to be learned
I thought I had the whole world at my feet
Now I know That I was dreaming
I fooled around and lost the only one made for me
And now I'm sorry, oh so sorry

Loving you isn't worth the pain of losing you
Losing you isn't worth the pain of loving you
Loving you isn't worth the pain of losing, losing your love

You can label a man worth having it's up to me
This heart of mine has to live a second time
Take a little of your love from me
And I'll be gone
You're love to me is like honey to a bee
I stand accused of being what I am
I'm a fool and now I know it
This episode is ready to unfold
How can I begin to write a brand new story

Loving you isn't worth the pain of losing you
Losing you isn't worth the pain of loving you
Oh loving you isn't worth the pain of losing you
Losing you isn't worth the pain of loving you
ohhh...I...

1.40AM IST.

In the middle of my life I had nothing to lose No one to love now it's you I'm thinking of You're a little of heaven to me You're all I need it's my concern There's a lesson to be learned I thought I had the whole world at my feet Now I know That I was dreaming I fooled around and lost the only one made for me And now I'm sorry, oh so sorry Loving you isn't worth the pain of losing you Losing you isn't worth the pain of loving you Loving you isn't worth the pain of losing, losing your love You can label a man worth having it's up to me This heart of mine has to live a second time Take a little of your love from me And I'll be gone You're love to me is like honey to a bee I stand accused of being what I am I'm a fool and now I know it This episode is ready to unfold How can I begin to write a brand new story Loving you isn't worth the pain of losing you Losing you isn't worth the pain of loving you Oh loving you isn't worth the pain of losing you Losing you isn't worth the pain of loving you ohhh...I...