<blockquote>...
You Know The Banking System Is Unsound When..... Here are those points:
<blockquote>
24. There is roughly $6.84 Trillion in bank deposits. $2.60 Trillion of that is uninsured. There is only $53 billion in FDIC insurance to cover $6.84 Trillion in bank deposits. Indymac will eat up roughly $8 billion of that.
25. Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where is the rest of the loot? The answer is in off balance sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds where debt is amazingly paid back with more debt, and all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30-1 or more. Those loans cannot be paid back.
-- Mish,
FDIC Chairman Sheila Bair Is Out Of Control, July 24, 2008</blockquote></blockquote>
*** We interrupt regular programming to announce that the United States of America has defaulted...<blockquote>'
...Walter Wriston, then chairman of Citigroup, opined that: "Countries don't go broke". In 1982, shortly after this statement, Mexico, Brazil and Argentina defaulted inflicting near mortal losses on Citibank.
Sovereign debt crisis, especially in emerging markets, are characterised by high levels of debt, especially foreign borrowings, poor fiscal policies, persistent trade deficits, a fragile financial system, over-investment in unproductive assets and a sclerotic political system. Arturo Porzecanski (in Sovereign Debt at the Crossroads (2006)) noted that: "Governments tend to default specifically when they must increase spending quickly (for instance, to prosecute a war), experience a sudden shortfall in revenues (because of a severe economic contraction), or face an abrupt curtailment of access to bond and loan financing (e.g. because of political instability). He further observed that: "governments with large exposures to currency mismatches and interest rate or maturity risks are, of course, particularly vulnerable."
Can the status quo continue? The US must ultimately pay the piper. So what must the US do to remedy the problem? In 1989, John Williamson described certain economic prescriptions - the Washington Consensus – that became a "standard" reform package promoted for crisis-wracked countries by the IMF. The controversial, much criticised package includes: fiscal policy discipline; redirection of public spending from subsidies; tax reform; market determined and positive real interest rates; competitive exchange rates; trade liberalization; liberalization of inward foreign direct investment; privatization of state enterprises; and deregulation. Resolution of the problems facing the US requires adopting many elements of the standard IMF economic reform package for emerging markets.
...
Increasing foreign investment is politically sensitive in America. Surveys show that most American would prefer key businesses to remain in American hands. Public concern about investment by Sovereign Wealth Funds ("SWF") reflects this financial xenophobia.
The "adjustment" may be under way. The dry measured economic prose of the Washington Consensus does not capture its human elements. It will require reductions in US real wages and living standards on a scale that those who have not experienced it first hand cannot understand. Just ask the average citizen of many Asian countries (post the 1997/ 1998 monetary crisis), Argentina and any other country that has taken the IMF’s "cure".'</blockquote>
"We interrupt regular programming to announce that the United States of America has defaulted …" Part 2By Satyajit Das
24.07.2008
SourceHigh levels of debt are sustainable provided the borrower can continue to service and finance it. The US has had no trouble attracting investors to date. Warren Buffett (in his 2006 annual letter to shareholders) noted that the US can fund its budget and trade deficits as it is still a wealthy country with lots of stock, bonds, real estate and companies to sell.
In recent years, the United States has absorbed around 85% of total global capital flows (about US$500 billion each year) from Asia, Europe, Russia and the Middle East. Risk adverse foreign investors preferred high quality debt – US Treasury and AAA rated bonds (including asset-backed securities ("ABS"), including mortgage-backed securities ("MBS")). A significant portion of the money flowing into the US was used to finance government spending and (sometimes speculative) property rather than more productive investments.
The real reason that the US actually has not experienced a sovereign debt crisis is that it finances itself in it own currency. This means that the US can literally print dollars to service and repay it obligations.
The special status of the US derives, in part, from the fact that the dollar is the world’s major reserve and trade currency. The dollar’s status derives, in part, from the gold standard that once pegged the dollar to the value of gold. The peg and full exchangeability is long gone. The aura of stability and a safe store of value based on the strength of US economy and military power has continued to support the dollar. In 2003, Saddam Hussein, when captured, had US$750,000 with him – all in US$100 bills. The dollar's favoured position in trade and as a reserve currency is based on complex network effects.
Many global currencies are pegged to the dollar. The link is sometimes at an artificially low rate, like the Chinese renminbi, to maintain export competitiveness. This creates an outflow of dollars (via the trade deficit that in turn is driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase US debt with dollars to mitigate upward pressure on their domestic currency. The recycled dollars flow back to the US to finance the spending. This merry-go-round is the single most significant source of liquidity creation in financial markets. Large, liquid markets in dollars and dollar investments are both a result and facilitator of the process and assist in maintaining the dollar’s status as a reserve currency.
The dominance may be coming to an end. There is increasing discussion of re-denominating trade flows in currencies other than US$. Exporters are beginning to invoice in Euro or Yen. There are proposals to price commodities, such as oil and agricultural goods, in currencies other dollars. Some countries have abandoned or loosened the linkage of their domestic currency to the dollar. Others are considering such a move.
Foreign investors, including central banks, have reduced investment allocations to the dollar. The dollar’s share of reserves has fallen from a high of 72% to around 61%. Foreign investor demand for US Treasury bonds has weakened in recent times. Low nominal (negative real) rates on interest and dollar weakness are key factors.
Foreign investors may not continue to finance the US. At a minimum, the US will at some stage have to pay higher rates to finance its borrowing requirements. Ultimately, the US may be forced to finance itself in foreign currency. This would expose the US to currency risk but most importantly it would not be able to service its debt by printing money. The US, like all borrowers, would become subject to the discipline of creditors.
For the moment, the US$ is hanging on – just. This reflects structural weakness in the Euro and Yen based on deep-seated problems in the respective economies. The artificial nature of the Euro is also problematic.
The dollar is also a beneficiary of the "too big to fail" syndrome. Foreign investors, especially central banks and sovereign investors in East and South Asia, Russia and the Gulf, have substantial dollar investments that would show catastrophic losses if the US were to default. The International Monetary Fund ("IMF") estimated that Gulf Cooperation Council (Saudi Arabia, the United Arab Emirates, Qatar and other Gulf States) may lose US$400 billion if they decide to stop pegging their currencies to the dollar.
Every lender knows Keynes’ famous observation: "If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours." In history’s largest Ponzi scheme, foreign creditors must keep supporting the US. As the old observation goes: "The only man who sticks closer to you in adversity than a friend is a creditor."
Does any of this matter? Walter Wriston, then chairman of Citigroup, opined that: "Countries don't go broke". In 1982, shortly after this statement, Mexico, Brazil and Argentina defaulted inflicting near mortal losses on Citibank.
Sovereign debt crisis, especially in emerging markets, are characterised by high levels of debt, especially foreign borrowings, poor fiscal policies, persistent trade deficits, a fragile financial system, over-investment in unproductive assets and a sclerotic political system. Arturo Porzecanski (in Sovereign Debt at the Crossroads (2006)) noted that: "Governments tend to default specifically when they must increase spending quickly (for instance, to prosecute a war), experience a sudden shortfall in revenues (because of a severe economic contraction), or face an abrupt curtailment of access to bond and loan financing (e.g. because of political instability). He further observed that: "governments with large exposures to currency mismatches and interest rate or maturity risks are, of course, particularly vulnerable."
Can the status quo continue? The US must ultimately pay the piper. So what must the US do to remedy the problem? In 1989, John Williamson described certain economic prescriptions - the Washington Consensus – that became a "standard" reform package promoted for crisis-wracked countries by the IMF. The controversial, much criticised package includes: fiscal policy discipline; redirection of public spending from subsidies; tax reform; market determined and positive real interest rates; competitive exchange rates; trade liberalization; liberalization of inward foreign direct investment; privatization of state enterprises; and deregulation. Resolution of the problems facing the US requires adopting many elements of the standard IMF economic reform package for emerging markets.
Some elements, such as fiscal and monetary discipline, are politically difficult if inevitable. Reform of farm subsidies must overcome deep-seated resistance.
Markets are restless for action and do not wait. The US dollar has weakened and is likely to fall further.. This helps exporters, tourism and will ultimately attract inwards foreign investment.
Foreign investment has been slow. Weak economic growth and concerns about the US financial system have offset the effects of a lower dollar. Despite this the "closing down sale" of US assets - real estate, companies and infrastructure assets - has begun. InBev, a Belgian based brewer has launched an unsolicited bid of US$46 billion for Anheuser-Busch, the brewer of Budweiser, the quintessential American beer. Abertis Infraestructuras, a Spanish infrastructure company teamed with Citigroup, submitted US$12.8 billion, the largest bid, for the right to lease the Pennsylvania Turnpike for the next 75 years.
Increasing foreign investment is politically sensitive in America. Surveys show that most American would prefer key businesses to remain in American hands. Public concern about investment by Sovereign Wealth Funds ("SWF") reflects this financial xenophobia.
The "adjustment" may be under way. The dry measured economic prose of the Washington Consensus does not capture its human elements. It will require reductions in US real wages and living standards on a scale that those who have not experienced it first hand cannot understand. Just ask the average citizen of many Asian countries (post the 1997/ 1998 monetary crisis), Argentina and any other country that has taken the IMF’s "cure".
In the twentieth century, the US and the dollar overtook Great Britain and the Pound Sterling as the pre-eminent global economic power and currency. A similar epochal tectonic shift in global economic order may be commencing.
The shift is not inevitable. There is much to admire about the US. It remains wealthier than other nations including the new titans - China and India. America remains a science and technology powerhouse. It accounts for 40% of total world spending on research and development, and outperforms Europe and Japan. For example, between 1993-2003 America’s growth rate in patents averaged 6.6% a year compared with 5.1% for the European Union and 4.1% for Japan. America's relatively fast-growing population, secure property rights and well-developed financial markets have been attractive to investors.
However as Warren Buffett in his 2006 annual letter to shareholders[
www.berkshirehathaway.com] observed: "Foreigners now earn more on their U.S. investments than we do on our investments abroad … In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience ‘reverse compounding’ as we pay ever-increasing amounts of interest on interest. …. no matter how rich you are, borrowing on top of borrowing is not a great long-term financial plan. I believe that at some point in the future, U.S. workers and voters will find this annual 'tribute' (of interest payment on the debt) so onerous that there will be a severe political backlash … How that will play out in markets is impossible to predict – but to expect a 'soft landing' seems like wishful thinking."
The US faces a challenge to reestablish its economic credentials. Without drastic and radical action, America’s ability to continue to borrow from foreign investors to meet its financing requirement is likely to become increasingly difficult.
The mass hysteria and panic that followed the broadcast of Orson Welles The War of the World played on fears about an attack by Germans. It is interesting to speculate whether a broadcast on a default by the US on its sovereign debt would play on the secret fears of global markets triggering a similar panic. "We interrupt regular programming to announce that the United States of America has defaulted on its debt!"
© 2008 Satyajit Das All Rights reserved.