The following activities of the worldwide financial institutions, motivated by the sole motive of maximizing profits, created the biggest financial bubble in the history of the world :
- Lending money to borrowers (individuals, corporates and governments) who had insufficient income or assets to pay off the loans undertaken.
- Engaged in and encouraged massive speculation in the currencies, bonds, equity and commodities exchanges.
- Use of leverage in the form of Derivatives and High Frequency Trading to game the process of price fixing on electronic exchanges.
The fall of Lehman Brothers in 2008 triggered a chain reaction which led to the world economy into a global recession. The governments and central bankers around the world, who are controlled by the financial institutions, (http://www.marketoracle.co.uk/Article32741.html) panicked and engaged in the process of bailouts to the tune of trillions of dollars to the very financial institutions which created the crisis in the first place. They transferred the losses of the banks to the books of the central bankers so that the losses were borne by the taxpayers and not the institutions responsible for creating them. The influence of the bankers on the rule making process ensured that whatever laws were laid down to curb the high risk activities of the banks were watered down or postponed in the future so that they do not hinder the speculative activities of the financial community today.
After almost five years since the crises began, today, Wall Street is engaging in the same activities that they engaged in before the crises began though on a much larger scale which is evident from the growth of the derivative market size in the last five years. They continue to enjoy compensation and bonuses which are thousands of times more than an average working person’s salary. A recent study released by the Pew Research Centre (http://www.bloomberg.com/news/2013-04-23/wealthiest-americans-only-winners-in-recovery-pew-says.html) states that households having a net worth of more than $500,000/- boosted their networth by 21.2% after the recession whereas the rest of America lost 4.9 percent of household wealth from 2009 to 2011
The Real Economy
While the world leaders are scrambling to arrange bailout funds to save the financial institutions, the real economy around the world is slowing down at a remarkable speed. The recent readings of the manufacturing indexes of the developed countries like U.S., U.K., Eurozone as well as those of the developing countries like India, China, South Korea and Taiwan are indicating either stagnation or have entered contraction since last few quarters. Unemployment is rising world wide and the Food Stamp Recipients in the USA are hitting lifetime highs month after month. The true extent of slowdown in the world economy can be judged by the data points which are not subjected to adjustments by the government. Eg. Change in Electricity and Fuel consumption, Ratio of working population to the total population of a country, Miles driven, Baltic Dry Index, Change in commercial Rental Rates etc.
Export dependent countries like China and South Korea are facing falling orders due to the Eurozone crises and the slowing US economy which are in turn leading to falling demand of raw materials from commodity exporting countries like Australia. The funds being given to the banks in order to save them are not being lent back into the economy due to lack of creditable borrowers and the need for funds by the banks to fund the losses already in their books. Moreover the banks are using these funds to speculate in the currency, bond, stock and commodity markets which give them better profits than lending money to the real economy at low interest rates.
The global financial crisis is getting bigger and unmanageable on a daily basis because the real cause of over debt ness is not being addressed. The democratic governments around the world find the process of raising taxes or taxing the rich and implementing austerity measures on the middle class and the poor a Herculean task which no politician is in a position to undertake. The prime reason why this task is so difficult is because the rich are the sponsors of the politicians that help them to get elected and the voters vote for them. Will the rich sponsor a politician that works for the benefit of the country ignoring their needs and increase taxes imposed on them or will a voter vote for a politician who decides to cut expenses by implementing austerity measures which will lead to hardships for the majority of the population. Moreover the solution of the global crises will result in reduced GDP which would reflect poorly on the performance of the politicians. This is leading the political class to the next best solution which is to indulge in postponing the problems into the future through hiding losses and bailing out organizations which should not be in business due to their incompetence. The postponement of the problems comes at a very high cost due to the slowing real economy and higher interest payments for the country and higher taxes for its citizens.
Effects of Saving Wall Street at the cost of the Real Economy
- There was no economic recovery after the 2008 crises. Central Bankers and the Governments around the world just threw good money after bad without doing anything to solve the real reasons of the crises (excessive debt, speculation and out of control derivatives). Their only goal was to push the can down the road which would be dealt by their successive leaders even though the problems in the future would be multifold.
- Countries around the world continue to take on more debt without any fruitful attempts to curb their expenditures. This has resulted in a much more fragile and artificially held up financial system which is on a much shaky ground than it was in 2008. In 2008 companies failed due to excessive leverage and debt and now countries are likely to default because they took on the same bad debt on themselves so that the bankers can continue to gamble in the commodity, stock, bond and currency markets with other people's money and enjoy ever increasing bonuses and pay packages for themselves.
- The incomes of the middle class are falling because the politicians elected by them make rules for the benefit of and work for the real rulers of the world, the top richest 1% of the population and the major contributors to their election fund. They bail out the bankers and the rich corporations (who should not be in business because of their incompetence) without even changing their previous management because they fund the election campaigns and also place them in their organisations at exorbitant salaries once they leave office. This class along with the rich individuals pay the minimum amount of tax while getting the maximum benefit of the tax collected from the rest of the population in the form of bailouts.
- The banks are fined a few million dollars for their crime in which they have earned billions of dollars in profits, without admitting to any wrongdoing. This process encourages excess risk taking and speculation with the savings of a majority of the population.
- The commodity prices worldwide are being driven up by speculators armed with cheap money provided by central bankers and super fast computers. This is causing havoc in the lives of rest of the population and pushing them towards poverty as they can no longer afford the basic necessities of life. Regulators are either hand in glove with the market operators or are too slow to react and take ages to identify and take measures to solve the problems.
- The stock, commodity and currency exchanges have been reduced to gambling dens whereby the more powerful traders with deep pockets move the markets to maximize their own profits at the expense of the remaining not so powerful players. The big boys have enormous money power to move the markets in the direction which results in maximum profits for themselves. They effectively use the media to lure the other players in the market to a position where they would incur maximum loss. While executing their regular business if they do end up making a loss, their friends, the elected politicians are always there to bail them out with tax-payers funds and even if that is not sufficient they can always borrow more. The debts taken in the name of the country will have to be borne by the rest of the population in the form of higher taxes and austerity measures.
- The stock markets in the USA are at their life time highs despite a slowing economy and the stock markets in the Eurozone are surging ahead despite their contracting manufacturing and services sectors and their economies are in deep depression since last two years. Even Germany which is supposed to bailout all the other countries in the Euro-zone on the basis of promises of implementing austerity measures is facing a slowing economy. The world equity markets P/E multiples for a majority of the stocks traded are at nose bleed levels based on their actual earnings. Japan’s stock markets too have skyrocketed more than 50% in last six months due to yen depreciation even though their exports are slowing down. The latest quarterly results reinstated that the sales growth of companies are declining as compared to previous years and there is a limit to which the companies can improve their earnings per share by cutting costs or buying back their shares.
A majority of individuals, corporations and governments have spent years of their future incomes by taking on debt. Now it is time to pay the bill. So now for years to come they have to service their debts on reduced incomes. Moreover all the borrowings by the governments are being spent to save the banks instead of focusing on job creation which is the only way the world economy can recover. There is unlikely to be an economic recovery in the foreseeable future because all the efforts of politicians, government, central banks etc are focused on saving banks instead of targeting job creation which is the only way economy can recover. Jobs can be created in the developed countries by initiating the following measures :
- Replace the top management of the too big to fail banks, put the existing ones in prison and charge them with fraud and misrepresentation. Break the banks into smaller ones so that they are no longer a risk to the whole financial system. Implement the Glass Stegall Act.
- Use the reclaimed billions of dollars from the arrested bankers and use them to improve the infrastructure of the country. This would create jobs instantly and the improved infrastructure would give the confidence to the small businessman to hire more people.
- Tax the richest 5% of the population heavily as they no longer create jobs in the country but outsource the jobs to the low cost developing nations.
- Stop completely the funding of election candidates by corporates and rich individuals so that their influence on politicians to make rules beneficial to themselves is clipped.
- Stopping speculation and derivatives in commodity markets would reduce their prices substantially which would be beneficial to the majority of the population. This would lead to a better standard of living for the middle class families and they would go out and spend helping the revival of the economy.
Failure to prevent Deflation
All the money being printed by Central Bankers around the world is not causing inflation because it is not reaching the masses in the form of growth in the economy or loans to businesses. The money printed is sitting in the banks and is being either used to speculate in the commodity, currency and equity markets or being used to fund previously incurred losses.
I think deflation is more likely because
- The world economy has been in an inflationary environment for last many decades and the probability of deflation is higher for the next no. of decades. Normal economic cycle.
- The credit outstanding in total is shrinking and the velocity of money changing hands is slowing down much faster than the central bankers are printing money.
- If only printing money led to inflation you would have already had hyperinflation in Japan which has being doing so since last more than two decades. The only thing they have to show after so many years is high debt and recessionary economy. What makes them think that more of the same treatment will give different results?
- Banks are evaluating the assets in their books on the basis of cost price (rather than on cost price or market price whichever is lower) which helps them to portray a much stronger balance sheet than actually is thus hiding losses.
By Akhil Khanna
I am an MBA Finance from the University of Sheffield, 1992 and have more than 20 years of experience in the field of Financial Management. I am a keen student of the Flow of Money around the World and enjoy studying the fields of Currencies, Stock markets, Commodity Markets and Bonds and my book “Let’s Talk Money” has been recently published by the Times of India Group. http://www.letstalkmoney2012.in/
© 2012 Copyright Akhil Khanna - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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