Tag Archives: financial crisis

Did anyone predict the 2008 crash? Will anyone predict the next crash?

Summary: There are many who claim to have predicted the 2008 crash. Most (or all) in fact did not foresee the banking collapse that was at its center, that expanded a commonplace downturn into the worst global downturn since the 1930s. That tells us something important about our times, and what we an expect in the future.

Expect the unexpected: fish

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“Unless you expect the unexpected you will never find truth, for it is difficult to discover.”

— Heraclitus, the pre-Socratic “Weeping Philosopher” of Ionia

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An important message of the FM website is that the post-WW2 era has ended, starting an era of unpredictable events. It’s a message nobody wants to hear, ripping asunder our comfortable belief in the reliability and normality of our institutions. We see these things in the history of the 2008 crash, the worst since the Great Depression. Legions claim to have seen it coming; in fact few (perhaps nobody) predicted its nature.

I doubt the many (or anyone) will do better in the next crisis. This uncertainty is a fundamental aspect of our situation. We’re “off the map”, sailing through unknown conditions (that part of the puzzle I got right, writing about it as early as Sept 2008).

As an example of how this worked — and what we can expect in the future — a previous post looked at Steve Keen’s predictions of trouble for our financial system.  He saw the flaws in our financial system, the potentially ruinous fault lines — but not the distinguishing feature that in 2008 turned the commonplace bursting of an investment bubble into a global 1929-like crash: the collapse of banks in the USA and Europe.

Other economists, such as Nouriel Roubini, also saw the danger in broad terms, but not the fragility of the banks that brought so many nations to the brink of Depression. Many non-economists also saw it (though in less detail), such as myself (e.g., the housing bubble and unsustainable levels of debt). I doubt that the senior managers of the banks themselves saw the danger (although their blindness proved quite profitable for themselves, getting paid both to cause and clean-up the bubble).

Another prediction of the crash

Another description of a successful prediction appeared in Gideon Rachman’s review of Jonathan Kirshner’s new book, American Power after the Financial Crisis (Financial Times, February 9): “The fire of the crisis was extinguished at great cost, but ‘the firetrap remained.”

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Government economic stimulus is powerful medicine. Just as heroin was once used as a powerful medicine.

Summary: Today America passed an important fork in the road, an easy exit from the massive monetary stimulus running since the crash. If the economy continues its slow growth (well below the 2% stall speed) today might have been the last opportunity for an easy exit. Today also demonstrated the madness that infects us, as investors cheered the Fed’s bad news about the economy’s slower than expected growth — and bid up asset prices. This post attempts to provide a harsh but accurate perspective on our situation.

See the follow-up post: Different answers to your questions about the momentous Fed decision to delay tapering.

“Damn the torpedoes! Full speed ahead.”

— Paraphrase of Admiral Farragut’s orders at Mobile Bay (1864). A great naval leader; he would have made a terrifyingly bad Central Banker

Money Giveaway

Let’s do it every day!

Contents

  1. How did we get here
  2. It was easy. It’s always easy to get hooked
  3. About government stimulus programs
  4. About the winners
  5. Why end the fun?
  6. Pictures of the US money supply
  7. For More Information

(1) How did we get here?

The Fed balance sheet has grown from $800 billion before the crash to $3.6 trillion today, now under QE3 increasing at $85 billion per month. While necessary during the recession, this has a side effect, one found in a few other powerful medicines. We have become addicted. I (and many others) warned about this (the original brief version of this post was Dec 2009). Now we’re hooked. Unless we act soon (later this year?) probably much pain lies ahead.

See this excerpt from “Financial Heroin”, Don Coxe, Coxe Advisors, 16 December 2009:

… my father was a doctor in the Canadian Army in WWII, and served in the Italian campaign. He became greatly respected for his anaesthesia and pain management under battlefield surgery and rehabilitation conditions. He was cited after war’s end for perhaps having performed more anaesthetics under such conditions than any other Canadian doctor.

In discussing his experiences, he told me that he swiftly learned that the best — and frequently the only — reliable drug for the critically wounded was heroin. Soldiers who writhed in agony under other medications almost always responded to heroin. The problem wasn’t deciding whether to administer it: if morphine didn’t work fast, you didn’t waste time, you injected heroin.

The problem for the doctor came when the patient had begun to recover from surgery, and was receiving heroin. How quickly could the dosage be reduced and when would it be terminated? Although few soldiers were freed of heroin without experiencing pain and distress, it was necessary to take the drug away as rapidly as possible. Otherwise they would become addicts and their lives would be ruined — for soldiering and everything else.

… Zero interest rates are Financial Heroin.

This goes to the vital points, mostly misunderstood, about the massive fiscal and monetary stimulus governments have applied in response to this global recession. Government stimulus has several characteristics similar to heroin.

  1. It mitigates the downturn, minimizing the suffering,
  2. but it does nothing to fix the underlying problems,
  3. and it creates imbalances which must be removed when the economy recovers.

It’s medicine. Powerful when used correctly. But like all sharp tools it cuts both ways. Confusing first aid (emergency medicine) with long-term treatment can produce serious errors.

(2) It was easy. It’s always easy to get hooked

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This might be the turning point in the global financial crisis, when bold action puts us on the road to recovery

This could be the turning point in the global financial crisis (GFC) that began in Fall 2008.  Much like the August, when Mexico’s financial crisis (the climax of the long Latin American debt crisis) forced the Federal Reserve to loosen monetary policy, igniting the long disinflationary growth period that ran (with two light interruptions) until 2007.

We might see this soon on a global scale if a market firestorm forces the major Central Banks into large-scale and coordinated action to stabilize the world economy.  A change of policy in the ECB would be necessary, as it’s current policy is an incoherent mixture of tight and loose.

If governments remain paralyzed, or attempt to cope individually with a global event, then we might see ugly results.  (later addition:  Not good to start a recession with weak household balance sheets and 9%+ unemployment).

There will be people cheering for us to lose, advocating inaction with confident assurances that nothing can be done.  Let’s hope our leaders do not listen to them.  Schumpeter was wrong when he said that “A depression is for capitalism like a good, cold douche.”  (Douche in German means “shower”, but it is still bad advice.)

To see the full coverage of the GFC, go to the FM Reference Page Financial crisis – what’s happening? how will this end?

Never waste a crisis. That just makes the next one inevitable and probably worse.

In America today the truth is often easily seen:  statements of the obvious or about the inevitable attract the loudest criticism.  So it was at the start of the financial crisis, when  Rahm Emanuel, Obama’s chief of staff, told a  conference of top corporate chief executives in November 2008.

“You never want a serious crisis to go to waste. … Things that we had postponed for too long, that were long-term, are now immediate and must be dealt with. This crisis provides the opportunity for us to do things that you could not do before.”  (Source)

The opportunity to enact reforms provide a silver lining to the darkest clouds of a crisis.  People briefly recognize the necessity of change, however painful.  Iron-strong political coalitions become vulnerable.  The public briefly pays attention to our political plumbing.

In September 2008 I said we were on the brink of a disastrous crash in the US economy, and three things were necessary to prevent it (each link goes to a post with detailed recommendations).

  1. Stabilize the financial system.
  2. Stabilize the economy.
  3. Arrange long-term financing for steps #1 and #2 with our foreign creditors.

We did the first, but in a manner that I (naively) didn’t expect.  We provided no-strings aid — trillions of dollars in cheap loans, free guarantees, and asset purchases — to the financial sector.  With no reforms.  Now, as the recession fades, Obama attempts to make minor reforms — and finds this difficult.  We’ll have an opportunity to do better in the inevitable next — and similar — crisis.

We did the second, much as I (and others recommended), although on a smaller scale.  The major omission was to provide credit to small businesses; the failure to do so made this recession longer and deeper than needed.

The third recommendation was the most important to restore long-term stability to the system.  The global financial structure has many large, deep cracks.  To name just two: Continue reading

American States on the brink of financial catastrophe

In the third year of the worst recession since the 1930’s many States totter on the brink of catastrophe, after generations of imprudent management.  Ahead lie even greater challenges, as employees cash in on their insanely generous pensions.  A few charts tell the tale — showing America’s most profligate states — from “The State of California – the road ahead”, Barclays Capital, 17 February 2010:

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A great speech by the PM of Greece. How soon until an American President says similar words?

A great speech, more powerful and truthful by far than anything said so far by President Obama.  Truly the sight of the gallows focuses the mind.  How soon until an American President says such things?  Not long (and only if we’re lucky), unless we get smart and work together.  Note this was a speech not to the nation, but to his political party.

Greek Prime Minister says ready to fight off bankruptcy“, Reuters, 2 March 2009 — “Prime Minister George Papandreou on Tuesday told members of his ruling socialist PASOK party that the government was ready to pay the short-term political price of rescuing the country from bankruptcy. Here are highlights from his statement…”

International Impatience

  • “This government has been fighting for five months now a daily battle everywhere, and even if it sounds dramatic, this battle is not for the future, it is for today, it is for now, it is to save the country.
  • “We need to take tough decisions, decisions that can be unfair.”
  • “We would like to have more time in order for the results of our big structural reforms to be evident … But we don’t have this time today, the international conditions will not give us the time.

Europe Threatened

  • “Without brave decisions from us and from them (the EU) the whole of Europe and Europe’s economy is threatened.
  • “We have the responsibility to do what we can to win back our country’s credibility.”
  • “Our debt has reached the 300 billion euros, well above our country’s 240 billion euros GDP.”

Credibility

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News from the front lines of the economic wars

A brilliant and provocative but pessimistic analysis by Albert Edwards of Société Générale:  “To cut or not to cut? Actually it doesn’t really matter. We’re stuffed anyway!”, 12 February 2010.  With links to even better analysis by Richard Koo.  Must-reading for anyone seeking to understand this crisis.  Excerpt:

About Europe

My own view of developments, for what it is worth, is that any help given to Greece merely delays the inevitable break-up of the eurozone. But, for me, the problem is not the size of the government deficit and the solvency or otherwise of the governments in the PIGS (Portugal, Ireland, Greece and Spain we deliberately exclude Italy).

The problem for the PIGS is that years of inappropriately low interest rates resulted in overheating and rapid inflation, even though interest rates might well have been appropriate for the eurozone as a whole. Rapid inflation has led to overvalued bilateral real exchange rates (they do still notionally exist) for the PIGS and in most cases yawning double-digit current account deficits. With most trade done with other eurozone countries, the root problem for the PIGS is lack of competitiveness within the eurozone – an inevitable consequence of the one size fits all interest rate policy. Even if the PIGS governments could slash their fiscal deficits, as Ireland is attempting, to maintain credibility with the markets in the short term, the lack of competitiveness within the eurozone needs years of relative (and probably given the outlook elsewhere, absolute) deflation. Hence the PIGS public sector deficit will inevitably remain large as a direct consequence of this weak growth outlook.

In my opinion this will not be tolerated by the electorates in these countries. Unlike Japan or the US, Europe has an unfortunate tendency towards civil unrest when subjected to extreme economic pain. Consigning the PIGS to a prolonged period of deflation is most likely to impose too severe a test on these nations. And the political consensus within the PIGS to remain in the eurozone could falter in the face of another of Europe’s unfortunate tendencies: the emergence of small extreme parties to take advantage of any unrest. My own view is that there is little help that can be offered by the other eurozone nations other than temporary confidence-giving sticking plasters before the ultimate denouement: the break-up of the eurozone.

About the economic crisis of the developed nations

Note: A copy of this graphic appears in this report (earlier, by different author but same firm).


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