By Ambrose Evans- Pritchard
July 21, 2008 - It feels like the summer of 1931. The
world's two biggest financial institutions have had a heart attack. The global
currency system is breaking down. The policy doctrines that got us into this
mess are bankrupt. No world leader seems able to discern the problem, let alone
forge a solution.
The International Monetary Fund has abdicated into schizophrenia. It has upgraded its 2008 world forecast from 3.7pc to 4.1pc growth, whilst warning of a "chance of a global recession". Plainly, the IMF cannot or will not offer any useful insights.
Its "mean-reversion" model misses the entire point of this crisis, which is that central banks have pushed debt to fatal levels by holding interest too low for a generation, and now the chickens have come home to roost. True "mean-reversion" would imply debt deflation on such a scale that would, if abrupt, threaten democracy.
The risk is that these same central banks will commit a fresh error, this time overreacting to the oil spike. The European Central Bank has raised rates, warning of a 1970s wage-price spiral. Fixated on the rear-view mirror, it is not looking through the windscreen.
The eurozone is falling into recession before the U.S. itself. Its level of credit stress is worse, if measured by Euribor or the iTraxx bond indexes. Core inflation has fallen over the last year from 1.9pc to 1.8pc.
The U.S. may soon tip into a second leg of this crisis as the fiscal package runs out and Americans lose jobs in earnest. U.S. bank credit has contracted for three months. Real U.S. wages fell at almost 10pc (annualized) over May and June. This is a ferocious squeeze for an economy already in the grip of the property and debt crunch.
No doubt the rescue of Fannie Mae and Freddie Mac - $5.3 trillion pillars of America's mortgage market - stinks of moral hazard. The Treasury is to buy shares: the Fed has opened its window yet wider. Risks have been socialized. Any rewards will go to capitalists.
Alas, no Scandinavian discipline for Wall Street. When Norway's banks fell below critical capital levels in the early 1990s, the Storting authorized seizure. Shareholders were stiffed.
But Nordic purism in the vast universe of U.S. credit would court fate. The Californian lender IndyMac was indeed seized after depositors panicked on the streets of Encino. The police had to restore order. This was America's Northern Rock moment.
IndyMac will deplete a tenth of the $53bn reserve of the Federal Deposit Insurance Corporation. The FDIC has some 90 "troubled" lenders on watch. IndyMac was not one of them.
The awful reality is that Washington has its back to the wall. Fed chief Ben Bernanke thought the U.S. could always get out of trouble by monetary stimulus "à l'outrance", and letting the dollar slide. He has learned that the world is a more complicated place.
Oil has queered the pitch. So has America's fatal reliance on foreign debt. The Fannie/Freddie rescue, incidentally, has just lifted the U.S. national debt from German 'AAA' levels to Italian 'AA' levels.
China, Russia, petro-powers and other foreign states own $985bn of U.S. agency debt, besides holdings of U.S. Treasuries. Purchases of Fannie/Freddie debt covered a third of the U.S. current account deficit of $700bn over the last year. Alex Patelis from Merrill Lynch says America faces the risk of a "financing crisis" within months. Foreigners have a veto over U.S. policy.