Ross Gittins has done an excellent job of explaining why this global crisis is no ordinary crisis, and in terms that are relatively easy to understand.
And unfortunately the last time we faced a crisis of this magnitude was in way back in the 1930’s, as Gittin’s explains:
we haven’t seen anything so life-threatening since the Depression of the 1930s. That’s what’s so different this time.
Here’s a quick break down of recession types and causes that usually underline economic downturns as Gittin’s explains them:
Type One – Wage Inflation
Your classic post-World War II recession is a wage-inflation recession. The economy booms and unemployment falls below the “non-accelerating-inflation rate of unemployment”.
In a situation of labour shortages, wages rise excessively thus feeding a wage-price spiral. The authorities become alarmed by the growing inflation pressure and start applying the brakes – raising taxes or, more likely, raising interest rates to discourage borrowing and spending.
Type Two – Asset Boom
The second type of recession is an asset-boom recession. You start with a boom in a market for assets such as shares, residential property or commercial property.
Asset prices go sky-high because the boom is being fed by borrowing. You end up with a bubble – prices that are far higher than is sensible, matched by ever-growing levels of debt owed by households or businesses.
The authorities worry that asset-price inflation will start translating into ordinary, goods-and-services price inflation, so they jack up interest rates.
Type Three – The Global Ponzi Financing Boom Led By The US
The crisis that arose from the failure of Lehman Brothers in mid-September last year was like a global heart attack. For a while the heart stopped beating, credit stopped flowing and we went perilously close to a global financial collapse that would have wreaked untold destruction on economies around the world.
Point is: that doesn’t happen in every recession. In fact, we haven’t seen anything so life-threatening since the Depression of the 1930s. That’s what’s so different this time.
You might have noticed that much of what is being reported around the globe, is in fact, an overlapping of types two and three. That’s because that’s exactly what is happenning.
If I were to further elaborate on what we are seeing and experiencing I’d be tempted to go with Soros’ super-boom hypothesis and the credit expansion theory, which of course has been caused by a global market system that be can best be described as a ‘rogue system‘ . Soros explains:
Globalisation allowed the US to su k up the savings of the rest of the world and consume more than it produced. The US current account deficit reached 6.2 per cent of gross national product in 2006. The financial markets encouraged consumers to borrow by introducing ever more sophisticated instruments and more generous terms. The authorities aided and abetted the process by intervening whenever the global financial system was at risk. Since 1980, regulations have been progressively relaxed until they have practically disappeared.
The super-boom got out of hand when the new products became socomplicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility.
Everything that could go wrong did. What started with subprime mortgages spread to all collateralised debt obligations, endangered municipal and mortgage insurance and reinsurance companies and threatened to unravel the multi-trillion-dollar credit default swap market. Investment banks’ commitments to leveraged buyouts became liabilities. Market-neutral hedge funds turned out not to be market-neutral and had to be unwound. The asset backed commercial paper market came to a standstill and the special investment vehicles set up by banks to get mortgages off their balance sheets could no longer get outside financing. The final blow came when interbank lending, which is at the heart of the financial system, was disrupted because banks had to husband their resources and could not trust their counterparties.
The central banks had to inject an unprecedented amount of money and extend credit on an unprecedented range of securities to a broader range of institutions than ever before. That made the crisis more severe than any since the second world war.
And what does Gittin’s article conclude?:
Punchline: as everyone from the International Monetary Fund to the US Federal Reserve chairman, Ben Bernanke, has warned, until the Americans fix their blocked banking system, no amount of fiscal stimulus or interest-rate cuts will make any difference.
Our economy will remain in trouble until they do.
Over to you
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