x Abu Dhabi, UAEWednesday 24 January 2018

Who needs reasons when you've got debt?

Henry A "Hank" Paulson just lost what was left of his nerve, and as near as I can tell, just fumbled the entire global financial system right down the toilet.

"At or around this time, we made a healthy, informed, democratic decision to get back on drugs as soon as possible." Trainspotting, 1996

Henry A "Hank" Paulson just lost what was left of his nerve, and as near as I can tell, just fumbled the entire global financial system right down the toilet. Declaring that the US Government will no longer buy troubled assets from financial institutions, Paulson said Washington will now spend its $700 billion in future debt buying up the country's banks, complete with their troubled assets, and bailing out consumers with credit cards and car loans. Wow. This pulls the rug out from under any investor that cannot count on a government bailout, i.e. non-bank financial institutions, individual investors and foreign governments. With no floor under this vast universe of securities, they are now effectively turned into worthless garbage, and what was a somewhat disorderly traffic jam of de-leveraging with Washington serving as traffic cop will now become a nightmare of unpoliced gridlock. The rescue has thus moved from an effort by Washington to save the global financial system to a completely selfish, nationalistic effort to save the US economy alone. The drawbridge has been pulled up, the moat filled. Anyone who is not a US consumer is now on their own. The dollar will rally powerfully for a time as markets react to this, then collapse to reflect the growing US deficits. The only bright side to this latest twist is that bailing out the consumer may actually be good for exporting nations, but it only delays the inevitable and ongoing collapse of the system. One might argue that this was inevitable. Once Washington rushed in to inject equity into banks, it put even healthy banks at a discount. Congress was apparently frustrated that banks were taking money from Uncle Sam in return for bad ones and then not lending their new liquidity out. This was, as I have written, an inevitable problem with a bank bailout. Normally (or at least in a typical bailout, though nothing about a bailout is normal or even typical) the purchase of bad assets needs to precede a government purchase of banks, with the purchase of bad assets putting the market back into motion and forcing banks to find private equity injections or else fail, throwing them into the arms of the government. The purpose of buying up bad assets isn't to stave off a recession by getting banks to lend, it is to stave off a failure of the banks and avoid nationalization of the financial system. Instead of doing this, Washington jumped the gun and started buying up still-healthy banks. Now amid the political fervour over the imminent failure of GM and increasing foreclosures and job losses, it has switched to nationalizing the entire economy. It is a strange move for a lame-duck, Republican administration, to be sure. Better would have been to keep promising to buy toxic assets, slowly recapitalize the banks and then let the Obama administration come up with its own package for bailout out consumers - even if that meant borrowing yet more money to pay for it. As it is, the dollar seems doomed, particularly now that there is no floor under asset prices. In fact, there seems to be no bottom in sight for markets at all now, except for perhaps bank stocks and consumer durables. Barring a wave of suicides or a global pandemic, people will still need to eat. The US Government will now be making sure American consumers can continue not only eating, but pimping their SUVs and buying up whatever other junk they buy with all those credit cards. All those dollars will now be spent indirectly propping up automakers that long ago demonstrated they weren't competitive and preserving an unsustainable American lifestyle of excessive consumption. Governments elsewhere will now have to follow suit and buy up their own banks or watch them go under. I can't imagine the global interbank market will respond well to this move. Any bank that doesn't have explicit government guarantees will now be rendered a pariah. And who do we have to thank? Mr Gordon Brown, who set the ball rolling by nationalizing the UK's banking system and forcing Europe and the US to do the same. The problem here is that the architects of the bailout have to walk their dogs in the same neighborhood as the spendthrifts they're bailing out. In fact, they are the spendthrifts. In previous crises, the bailouts were orchestrated by IMF mandarins sitting in Washington who, if they were influenced by anyone, were influenced by big creditor banks who stood to lose a lot of money if developing nations defaulted. Pain was no obstacle to insuring the creditworthiness of those countries. But now overseeing its own rehab, the US junkie has decided that giving up on addiction to debt is just too painful. Better to just remain doped up. The people whom it owes the money - China, Japan, the Gulf, et. Al. - don't vote. The Gulf needs to jump ahead of what will undoubtedly be a steady slide by the global economy towards oblivion. Behave now like the balance of payments crisis is already here. De-peg, jack up interest rates and start nationalizing banks. Oil remains the one element of leverage for getting repaid the money the Gulf lent Washington. Denominate it in dirhams, or riyals.