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Credit Crisis Meltdown Is a Prelude to Global Economic Depression

Economics / Recession Nov 15, 2007 - 12:42 AM GMT

By: Christopher_Laird

Economics

Best Financial Markets Analysis ArticleMonster Western credit crisis – prelude to a depression

  • The present contraction of credit
  • Gold in this situation

Present contraction of credit
The West (US,EU, Canada) is in the midst of a gigantic and spreading credit crisis that may well to lead it into a depression, if it is not fixed soon. So far, Central bank infusions (Over $1trillion worth in a few months since July!) have been the only thing that has stopped a massive bank liquidity crisis from shutting down commerce. But the damage to credit markets thus far is so huge, and worsening rapidly, that a very bad outcome seems assured. Gregory Peters of Morgan Stanley said there is a better than 50% chance of a systemic banking crisis that will hammer credit markets at this time.


So far, equity markets have barely reflected this turmoil to the degree it should. That is going to rapidly change. Central banks have been doing backflips to stem the crisis, and I think, things are rapidly spinning out of control. They have barely been able to stem a collapse in interbank lending, which would halt credit markets. The damage a paralyzed credit system will do to our credit dependent economies is going to be staggering. It would appear that much of the crisis is hidden from view, but the way it will inevitably reveal itself will be in falling corporate earnings, and collapsing consumer and business spending. In a few short months, we will see if I am right. So far, stock markets have not priced in falling earnings that we expect to appear in coming months, as contracting credit markets constrain all manner of spending and investment.

Genesis of collapsing credit

As late as July of this year, a crashing housing market appeared to be something that could be weathered by other growing sectors of the US/Western economies. Then, the inevitable credit dominoes started to fall, after the first one fell, the mortgage delinquencies. Next we entered a scary August and September world credit crisis, as huge forms of liquidity, formerly seeming of endless supply, rapidly dropped to nothing. That would be the securitized credit markets.

Rapidly, the emerging losses in securitized credit, from CDOs, MBS and such (packages of loans such as mortgages sold off as securities and derivatives) caused a cascade of falling confidence in our banking sectors. All of a sudden, the credit crisis spread from the mortgage derivatives markets to the commercial paper markets in an almost instantaneous fashion, after BNP Paribas, France's largest bank, had to freeze redemptions on two hedge funds that had losses in mortgage derivatives . In about a week from that announcement, the entire European commercial paper market froze, as banks were afraid to roll over each other's commercial paper, not knowing who else had $billions worth of exposure to the huge mortgage derivatives market. This was in August.

The credit market damage is so severe that the largest banks in the US are at risk of losing much of their capital. Citibank alone said it needs to raise $30 billion in capital. If the 5 largest banks in the US are already in crisis mode, and other major banks in the EU too, and don't forget Canada, England and so on, things look incredibly negative. And the losses have only just begun to pile up. There are many more to come, as we will partly discuss. Bernanke stated that 450,000 mortgages reset each quarter in the US in the coming year. But this is not all about just mortgage resets and the housing market. This is about the spreading damage to other key sectors of the credit markets.

Since July, the West's commercial paper markets (CP) have contracted by hundreds of $billions worth, as banks and investors refused to roll over CP of 270 days or less maturity. The ECB (European Central Bank), and US Fed, and other western central banks had to step in and offer short term money to cover the shortfalls, or else a massive world banking liquidity crisis would have emerged. 

As it is, interbank lending is quite bad, and Central banks have not been able to stop either the continued shrinking of the CP markets, nor the ever increasing losses stemming from a collapse of the securitized debt markets. Central banks have had to step in as lenders of last resort to keep the banking and financial system from imploding, and there is little progress on this front to date. The $75 billion SIV bailouts arranged by the US Treasury department is on and off again. The key banks involved may not be able or wish to complete it. Citi, for example has to raise $30 billion in capital to cover the mess that has emerged since July.

Next big credit domino

Now, other huge credit markets are about to fall in turn. The next one is the credit insurance market. Credit insurance is an essential part of any credit market. Lenders can buy credit insurance to help cover the risk of loss when they lend. Credit insurance is a key component rating agencies use to asses credit risk of bonds and such, and assume that if any of the bonds that have credit insurance default, the credit insurers will pay off.

But, the amount of securitized credit loss is so huge at this time, losses on CDOs, MBS, and other securitized credit vehicles, that the viability of credit insurers is now in question. Credit insurers will have to start paying off in the next several months. They will be reporting big losses. That will affect the credit ratings of every security they insure.

This means that all the securities these credit insurers insure will be downgraded by rating agencies – if the credit insurer becomes insolvent. 

This crisis has spread to Money Market funds for various reasons. First, many money market funds have a large part of their capital invested in short term commercial paper that provides a slight yield bonus. Since much CP is not rolling over, MMFs are having trouble rolling forward those maturities. Also, MMFs have invested heavily in the securitized debt (mortgage derivatives like MBS and SIVs and CDOs) all of which are in deep trouble.

I have had readers email me stories of being put off from redemptions from many money market funds since August. These are from major name institutions. I have been told of games like telling people to fill out forms and not executing what people wanted to do in their fund. Those stories still come in as I write this. It is very important that you read the disclosures about your MMFs, and know that these are generally not FDIC insured. The same goes for other nations MMFs and their deposit insurance.

How this crisis develops

First, US mortgages default, Jan to June 07. Then, the credit securities back of them collapse in value July 07 to present. Then the banks and others holding these have to take huge losses/writedowns. Then those institutions have to raise capital. Then credit insurers have to pay off (coming in the next several months). Then as they go bankrupt, all the rated securities they insure will be downgraded, as the supposed insurance that was purchased is now worthless, as the insurer is insolvent. Then a new cycle of losses as the newly downgraded credit securities have to be marked down.

Then…here is the rub – banks and such have to stop lending, and you get a system wide freeze of new credit. We are right in the middle of this part. HSBC, for example, has stated they are going to pull back lending in the US, as they have been badly hit in the mortgage markets. Consider this, and see credit contraction in the US increasing across lenders. As I said, Citi stated they need to raise $30 billion of capital.

Main source of credit now totally dead

What's more, the source of most of the credit in the last 5 years, securitized credit, is literally disappearing. As that entire sector becomes discredited, the source of most of the money coming into the world's bubble economies, securitized debt, is drying up.

As banks are forced to raise capital and stop lending, consumers find new credit hard to get or not available at all. The same goes for businesses. You then get system wide credit collapse, and the resultant collapse in economic growth. And if no recovery is made quickly, you get a depression. Not a recession, a depression, due to collapsing economic demand.

Gold in a real world stock collapse

So far this year, we have had about 4 major world stock sell offs. Gold has sold off in these, but rapidly recovered later. It is not clear how gold will react if we saw a real world stock crash however, on the order of 50%. 

Gold showed two types of behavior this year in stock sell offs. The first was flight to cash, and as institutions had to cover margins, sold gold in stock drops. But, also, at one point in the August-Sept credit crisis, flight to safety caused gold to rise, even in the midst of the stock declines. 

So, we know that in this kind of environment, gold has shown resiliency.

That would not likely be the case of other commodities however. In spite of the new paradigm Asia growth model, I don't think Asia will escape major economic contraction should the West have a severe economic recession. Since China is the largest consumer of many commodities, any significant contraction by them will cause high commodity prices to plummet. Gold should be excepted because it is a central bank reserve asset, unlike your other commodities.

New Chinese Foreign investment restrictions

Just consider that many Chinese economic sectors have huge overinvestment, and that China just instituted economic restrictions on new foreign investment in many sectors they consider over invested. That being the case, they would not do well if a large part of their export markets contracted, should the west (EU,US, etc) have a severe economic contraction. 

Gold right now is in a very speculative phase with a lot of volatility. Japanese speculators are all over it, and it is said that when Japanese speculators get into gold, it is late in that particular bull run.

We at Prudent Squirrel are long term gold bullish, as Western central banks will likely attempt to flood money to keep markets afloat, and are lenders of last resort to the credit/banking system. The US fiscal prospects are terrible in coming years, and we expect gold to be well over $1000 in coming years. The rest of the West, EU, Japan, are not much better off.

However, in the intervening time, if financial markets finally recognize the damage to the credit markets, and consumer spending and corporate earnings finally reflect economic contraction, stocks will fall precipitously. Gold likely would sell off quite a bit initially in that. But longer term, we believe gold is still the best place to have part of your liquidity. 

Stocks at this time are presently recovering (one day since Tuesday, anyway), but we feel that the potential for a systemic banking crisis and the contracting credit will soon be reflected in stock markets. So far they have not reflected the severity of the credit situation as much as they should.

The Prudent Squirrel newsletter is our financial and gold commentary. Subscribers get email market alerts mid week as needed. We put out an alert Oct 30 that a general market selloff was imminent. Stocks sold off hard soon after worldwide. So far, we have predicted 4 major world stock sell offs by up to two days this year. We also predicted the USD was about to bounce in Sunday's newsletter, which it did Monday. The USD is still shaky though.

Stop by and have a look. 

By Christopher Laird
PrudentSquirrel.com

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

Christopher Laird Archive

© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Ron Minor
10 Apr 08, 20:08
Economic Depression

I think your anlaysis and explaination of what is happening is very alarming and very accurate in your assessment. I think too a depression is coming. I wanted to cut and paste your website address to send it to others I know, but had

some problems with that. I have read that just prior to the 1929 depression a Sir Wilson Babcock told a meeting of bankers and businessmen what was coming. They laughed then but not a year later. He told them that their technicians

were looking at themometers on the wall, but if you wanted to know what the temparature would be later on, you needed to go down in the boiler room. He said when over 50% of people are dishonest bad times are ahead. I don't have his quote in front of me, so I just paraphrased it.


Prof. Raju M. Mathew
19 Feb 09, 03:28
The Great Depression II - Strategies

STRATEGIES FOR

SURVIVAL AND GROWTH IN THE AGE OF

THE GREAT DEPRESSION II

DR. RAJU M. MATHEW

Al Ain University of Science & Technology,

Abu Dhabi, UAE

This is the Great Depression II

The crisis that we are now facing can rightly be called The Great Depression II of 2009 . And it is several times severe than the Great Depression I of 1929. It is not mere a financial meltdown; not mere a credit crisis. It is not a recession to disappear within two years. The dimensions and intensities of the Great Depression II are quite different from the early one. Who had brought out the present crisis and where had gone all the money or credits that were available before a few months back, are the two questions that the general public is asking?

Who has brought it?

Almost all banks had been lending five to ten times more than what they had, by the principle of 80/20 or even 10/90 in the age of electronic cash and e-banking or e-commerce, without bothering the repayment capacities of the borrowers that ultimately resulted in the credit crisis and crushing of the stock markets. Unfair business practices and high level frauds and corruptions had made every thing very complex.

The heavy expenditure on armaments incurred by almost all nations and terrorist organizations had aggravated the crisis. By siphoning off billions from the accounts of the big corporations and millions of individuals, especially the elderly, the terrorist organizations made money for their operations. Governments borrowed heavily to meet their defense and other expenditures. The undue growth of the defense industries is possible only by jeopardizing all the other industries and sectors. It is one of the major contributing factors for the present global crisis.

Terrorism and the Poor

Every terrorist attack creates new demand for sophisticated weapons and almost all governments are forced to set apart a sizable amount for defense that ultimately affects the weaker section of the population. There exists a nexus between the defense industries and terrorist organizations. The only beneficiary of terrorism is the arms traders and the defense industry. Whatever may be the slogans and causes, terrorism adds miseries of the common people and its causes are lost ultimately. For terrorism, governments have to cut both developmental activities and welfare schemes by spending more on weapons. Neither the killers nor their victims gain anything but the weapon traders. Terrorism makes governments more tough and oppressive.

Fast to Slow

After high and fast growth and booms now it is the turn of gloom, recession and depression. There is a limit for speed and growth. Development based on aggressive marketing, consumerism and globalization, ignoring the vast majority, cannot go on very long. Recessions and depressions are self correcting mechanism for the maladies of a society that strives for unlimited growth at a high speed. No human being or economy can run fast for very long. Now, Information Technology and the Modern Management Techniques do not have any answer for the present crisis. So also are the cases with IMF, WTO, ADB and the World Bank that are on the verge of collapse. These are the basic lessons that the Great Depression II teaches us.

Everybody has been running fast. Fast life style has become the rule, As a result, nobody has any time even to dream, imagine, think and learn. Knowledge and scholarship have been pushed back for data and information; learning has been reduced into an exercise for scoring of higher grades or marks; reading has been neglected for the sake of scanning and extracting from the internet. Critical thinking and creative ideas or works have been denigrated; superfluous analysis and mimicries have been dominated in the place of sound theories and strategies.

In the fast life, even young men and women could not find time for romance and love making other than fast sex, that too without the botheration of child birth. The greatest causality is the family life, the cordial relationships between wife and husband and between parents and children. Even in religion, faith in God and love of human beings are pushed back by the harsh and rigorous practices and rigid interpretations, without any element of mercy and forgiveness. Materialism dominates over spirituality even in religion. After a period of fast life, everybody has to go back to slow life.

The Basic Reasons

The value and importance of rural life, especially agriculture are withered away for the over projection of the glory of urban life and the service sector. But cities could not survive without farming and rural sector. Urban sector is depending too much on the rural sector rather than the villages relaying on cities, because most of the villages could be easily made self sufficient with regard to the basic necessities of life.

Service sector of an economy could not flourish when its agricultural or industrial sectors are weak. Information Technology and Modern Management Techniques could not survive in the age of crisis; they are only catalysts for boom when the economy is sound and healthy; they are the catalysts of doom or bust when the economy is weak and sick. The inter-sector imbalances with regard to growth and wage or salary structures and the striking disparities with regard to the standard of living of the people of the various sectors are the basic reason for the present global crisis.

How Long It Will Be?

The Great Depression II, now in its first phase, would continue for a minimum period of five years, sometimes ten years, in a more rigorous way. It brings about a crisis of faith in technology, money power, managerial talents and the entire banking and insurance sector, besides the money and stock and share markets and the credit system. The highly acclaimed economic and business wisdoms and formulas are crushed and shattered. A good majority of the Business Schools and Management Consultancy and Software Companies will be wiped out. A sense of helplessness and even meaninglessness are to dominate in the thinking and behavior of not only of the common people but even the professionals and top executives. Everybody, including the top billionaires and technocrats and the most trusted business houses, has become vulnerable.

Gone are the Ages

We have to accept, though painful, that the age of consumerism and the dominance of the service sector over the agriculture and industrial sectors are over. So also is the case with cities over the villages. The age of malls and supermarkets and multi-billion dollar advertisements and promotional activities are over. The unreasonably over-salaried CEOs and other executives have become an extinct species mainly for their greed, corruption and illegitimate high bonuses coupled with their inefficiency and lack of social commitments. The age of pomp and extravagancy is finished. The simple reason is that humanity could not afford consumerism any longer. Gone are the ages of the Great Business and Financial Gurus and Advisers, because of their visions and foresights.

Who Could Save Us?

Men of ideas, vision, scholarship, theories and strategies and multi-disciplinary backgrounds could alone solve the present crisis. The only agency to deal with The Great Depression II with long term strategies and policies is the Governments that must be strong enough and duly functioning. No single country or government could tackle it; instead, global efforts and strategies are required. No savior will come to save us; we must be our own saviors. The UN must be made strong enough to act globally for dealing with the Great Depression II, chalking out the area of international cooperation. It must act on a war footing

Threat to Peace and Democracy

History teaches us that every major crisis or revolution is followed by dictatorship or war. Fascism was the offspring of the Great Depression I of 1929. Crisis in the Old France led to the French Revolution; October Revolution was the consequence of the socio-economic crisis in the Czarist Russia. Unless the present crisis are dealt immediately, millions of hard hit and unemployed people, besides the angry debtors will march towards the streets and the capitals and capture the power that invariably leads to dictatorship and then the war. It will also lead to clashes between people of different regions or interest groups and ultimately civil wars. Mass burglary or looting will become the rule and billions will die out of hunger, epidemics and civil wars. The Great Depression II shall be the greatest threat to peace, democracy and rule of law.

Time to Act

Now we are in the early stage of the Great Depression II and as such the people and the governments are in a riddle or puzzle to grasp the crisis. In the next stage they will be in an absolute shock to realize the losses and damages that they have to encounter; over 80 per cent of the jobs will be wiped out; a good majority of trade and business people will turn bankrupts. . At this stage, so many people will commit suicide or reach on the verge of mental brake down. This is the stage of total crisis of faith; people will loose faith in every thing and they will be ready to anything. This is the most dangerous situation that will lead to revolutions, mass crimes and lootings and even civil war. In order to avoid all these situations, we have to act urgently; the governments, international agencies, governmental and non-governmental and world religions must work together to deal with it in order to avoid greater miseries.

Immediate Relief Measures

The UN must set up The Great Depress II Relief Fund to help millions of people who lost their job and income consequent on the Great Depression II. UN must make all major religions and other organizations, besides all countries, to get involved in these tasks. The Fund shall be operated in such a way that its benefits must reach to all the needy at the right time. The UN and various international agencies must be ready to take some drastic steps including cutting the salary and other benefits to the extent of 30 to 40 per cent of all its employees, including the top executives and also limiting other expenses.

On the basis of the UN guidelines, all government must come forward to make a salary cut to the extent of a minimum 30 per cent and to put an upper limit for the salary and other perks of all those who are employed, including in the private or corporate sectors. Actors, singers, players, models and people in the show business must be ready to cut their remuneration by taking into account the global crisis. Nobody should be allowed to make overnight fortunes. We have to realize that the undue growth of a particular entity or sector or region or a country must be at the expense of the others and it should dealt as cancerous growth affecting the entire global society.

Cutting the cost of production as well as the cost of living is the only way for survival and growth in the age of The Great Depression II and thereafter. All nations must be ready to cut their defense expenditure to the extent of seventy to eighty per cent and a joint global strategy against terrorism must be launched as no nation can be made free from it. Other wise, the crisis will prolong and millions will dies out of hunger.

Ineffectiveness of the Keynesian Strategies

The Great Depression II could not be dealt with a set of conventional monetary and fiscal policies as have been suggested by the Keynesians or the Neo-Keynesians that have become totally ineffective for their over-doze or over-saturation. There is a limit for technology and management techniques, including marketing in this regard. Now what are required are a massive behavioral change and a new way of life, freeing from consumerism and fast life style, a byproduct of materialism, on the part of the society as a whole. Greater cooperation and mutual support between nations, even at global level, are the only means for survival and growth.

Re-creation and Re-learning

The Great Depression II brings life slow. It is the time for re-creation and re-learning and acquiring new knowledge and skills. It is the right time for creative works and above all reinventing the basic human, family and religious values coupled with humanism, spirituality and cooperation. It is the time for baby booms. It is the time for the re-birth of rural and farming sector. People find new meaning in agriculture and country life. Now, it is unproductive to make heavy investments in cities and high technologies and the service sector. Religions have to play a very important positive role by developing mutual respect and cooperation rather than rivalry and aggressive fundamentalism that bring Terrorism, as a by-product.

Long Term Strategies

The best long term strategy to deal with The Great Depression II is to invest heavily on the rural and the farming sector and develop their infrastructures along with making heavy investment in education, especially basic science and engineering, social sciences and humanities. Learning must be encouraged by developing libraries and encouraging the overall reading habits of the people. Cost effective Open Learning-- Open Schools and Open Universities or Virtual Universities, even in Science and Technology must be set up or developed to make education reach in the hands of millions all over the world.

These strategies are equally applicable to both the East and West, developing and developed nations, including GCC countries. Nobody, including the young and dynamic American President, Barrack Obama, has any magic stick to deal with The Great Depression II, other than following the above noted term strategies and policies. It is high time to realize that no affluent nation can survive by keeping a large number of nations or people poor and depressed and selling arms and defense equipments and following consumerism. It is high time to realize that terrorism and religious fundamentalism add miseries and sufferings of the humanity and bring hell on earth, for they are the tools in the hands of Satan who wants to bury down the peace and happiness of the humanity.

From Dooms to Booms

When implementing the above policies and strategies, people will come out with savings, innovative ideas, plans and strategies and to put them in agriculture, industry and service sectors within three years. All these will push up economic activities, including global trade and business. International cooperation between developed and developing or underdeveloped societies and nations would emerge so as to ensure a minimum development and standard of living for all. The people, especially the young, will dictate their terms of peace and co-existence over the Governments, Religions, Political Parties and the Terrorist Organizations. There is no doubt, the humanity would withstand the crisis and enter in the New Age of Peace and Development for the bold and honest efforts of the youth. This is not the end of the world, but the beginning of a New Dawn for the young, provided they are ready to act for the well being of the entire global society without sidetracking anybody.

About the Author

Dr. Raju M. Mathew is a strategist and theoretician with strong background in Economics, Cybernetics, Education and Information Science & Technology with long years of experience in teaching and research, including directing a major research project and supervising ten doctoral works. The Netherlands based FID nominated him as one of the twelve international members for its Committee on Research on Theoretical Basis of Information Science in 1983.

Dr. Mathew formulated two basic theories of knowledge consumption and knowledge production that got published jointly by the FID and the USSR Academy of Sciences in 1985 in the work, ‘Theoretical Problems of Informatics’. Now these theories are known in his name and have become the field for doctoral research.

In 2005, Prof. Mathew proposed Knowmatics and Knowledge Technology as the two Post-Information Technology disciplines for processing and handling knowledge so as to develop knowledge industries. He also set up the International Forum for Knowmatics & Knowledge Technology (IFKT). Some of his works are available in the site: www.ifkt.net

Dr. Mathew is on a mission of making the world aware of the impacts and intensities of the present crisis, the Great Depression II of 2009 and persuading the governments and international agencies to formulate correct strategies and policies and implement them urgently to deal with it and make an early recovery from it, so as to save the lives of millions, especially the young. Dr. Raju M. Mathew can be contacted by e-mail: rajoocyber@yahoo.com. Some of his other works are given in his site: www.ifkt.net

(It was originally prepared on 25th Jan. 2008).


Abdul-Gaffar Borokini
22 Mar 09, 11:10
Co-operation

If there is co-operation within the leaders.they would all have the ability to fight the crime over the terrorism and other issue that are yet to occur.


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