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Central Banks Fail to Solve Credit Crisis

Economics / Economic Depression Oct 16, 2008 - 12:57 PM GMT

By: Christopher_Laird

Economics Diamond Rated - Best Financial Markets Analysis ArticleDepression on the way - A few weeks ago, I mentioned that the central banks had put up collectively $3 trillion worth of stimulus/backing to financial markets. I also noticed that the big bailouts had about only a one day boost to the financial markets till they did a thumbs down.

Now, as of Monday Oct 13, the Europeans came up with a mammoth 1.3 trillion Euro bailout package (close to $ 2 trillion worth). The markets rallied for ONE day. Then, add another unlimited Fed dollar swap package to anyone (they trade dollars to central banks who need them for their currency because those central banks need dollars for people leaving foreign markets). So using my rough math, since August 07, the central banks have now put out over an astonishing $5 trillion plus worth of what is mostly short term liquidity (loans to financial institutions).

And, with all that money, the markets are down Wednesday across the world again? Only two days after the Europeans add almost $2 trillion worth of backing to their financial system? And the Fed had just added unlimited dollar swaps?

What the heck is going on?

Relentless deleveraging

What is going on is relentless deleveraging of over $1000 trillion of financial leverage (it's more than that but the figure gets the idea across. So, over a period of a year, the US and ECB /Europe alone have added $5 trillion worth of financial backing to the world, but that is against $1000 trillion deleveraging – the bailout efforts are simply miniscule compared to what is driving markets down – at a ratio of 1000 to 5 so far. The bailouts and liquidity injections simply cannot work.

And, the markets relentlessly tail down, even within a day or two of major new bailout announcements. I think this kind of makes the point. Which is that $5 trillion is not near enough to stop $1000 trillion from deleveraging worldwide.

Gold, USD, and oil here

And then, we see gold and silver and precious metals selling off big at times, but gold kind of holds its own. But basically, gold is being tugged between big selling for money for margin calls on big investors like hedge funds. Then gold comes back a week later. Gold is reacting most strongly to the credit crisis worldwide, as big investors flee into the most secure ‘money' they can find.

And even though the initial epicenter of the real estate collapse and the banking crisis is in the US, the USD is strengthening too. One reason is that people are selling emerging/foreign markets and repatriating that back to the US in dollars. Another is that the USD is still regarded as a safer haven than most. Just take a look at the Ruble and Russian markets – way way down, but last year regarded as a possible resource currency financial haven. Well, that sure proved wrong.

Resource sector

And then, the resource sector is just getting killed. And so are the resource nations stocks. And, get this, China is slowing markedly. Not to mention the China stock markets are WAY down from their highs, like 70% or so down from a year or two ago. But, didn't we hear that China and the emerging economies would carry the world economy if the US/West slowed? Well, I think that theory has been definitively debunked.

And, with this slowing in the West, and now about a year later in developing economies like China and Russia and South America, the resource sectors are getting creamed. Miners and also oil/energy stocks are getting creamed. But didn't we hear that these sectors were the new future and in the middle of a ten year plus bull market only a year ago?

I think a lot of this is simpler than that. Frankly, a year ago, we stated over and over that the imminent slowing of US and world economies would lead to a China slowdown, and a resource correction. But it was worse than that even. The collapsing credit markets (imploding is a better characterization, frankly) have put a choke hold on every imaginable economic activity.

And guess what, the next shoes to drop in the US, EU, Asia will be huge layoffs, as the economic stats will start to show big economic declines in consumer and business activity in coming months. In fact, those bad data are now showing up now.


And, when markets finally wake up to the fact that, despite new gigantic bailouts by governments, it's not working, it's definitely not working, and financial institutions are still afraid to loan money out. The realization is that it's basically over, the cake is baked.

Or, to be more clear, the markets are not going to recover, and are going down far more.

Now, after the totally unprecedented actions in the last two weeks, particularly the announcements Monday by the Europeans and the Fed, with another what $2 to 3 trillion thrown at the problem, the markets this week are just crashing.

And now we get back to the original point, that every time a new huge bailout is announced, all that money appears to be good for a mere one day rally in financial markets.

Of course, to be fair, the Fed and others say it takes time to get all that money out and working in the system. But, do we have the time now? And frankly, can the huge bailouts even work in the end?

It's already being stated that, even with the huge infusions to all these world banks and financial institutions, the financial institutions still won't lend but are merely holding on desperately to the money- Lest they be the next Lehman or whatever.

Central banks cannot replace the economy

 Now, Sarkozy and others in the EU are talking about a new Bretton Woods agreement. So now they want to replace /reform the entire world monetary system too? Do you think that will solve the problem? So, now after committing what is rapidly going to be $10 trillion and counting of public backing, which is not working, they will think up anything to try to stop what they fear, a total world financial collapse.

But, no matter what they try, no matter how big, nothing works. The reason is that the Central Banks cannot replace the economy. They can try to stimulate it, but they cannot even come close to replacing millions of people working, borrowing and lending.

And the way things are going, with every bigger bailouts (that European $2 trillion move Monday was amazing) it would seem they are going to bankrupt their own government finances along with their collapsing economic sectors. They will stop at nothing to avoid what they fear, a total economic collapse. And after that, comes the currency collapses? With the way they are handling this, that appears to be in the cards.

It's already being stated that the US fiscal situation has been severely degraded by all these bailouts. The USD is still holding, but till when?

Effects on the Euro

Then, consider the effect of all this on the Euro. First, when it became clear that there would be no EU wide consensus on a fix, the Euro fell. Then some of the big nations did come up with a $2 trillion backing Monday. But, the fact is, there is no real coordinated EU wide policy on this situation. Even if the Fed is acting wildly, it at least has a unified policy for the USD. But the EU is not so.

And this definitely calls the Euro in question. So then, we get calls for a new Bretton Woods agreement. (The Bretton Woods agreement was where the USD was used to back the collapsing European currencies during WW2. It stayed in effect after WW2 till the US went off the gold standard in 1971).

New world currency?

But, this time, the USD is not really able to back the world's currencies. Some new form will be invented. The trouble is, what currency is able to step into that gap? None that I can see.
So, will this relentless bailout mentality lead us all ultimately to a new world currency? A single new world currency, or one that the major economies subscribe to?

That may sound preposterous but I don't think it's quite that unlikely.

What really concerns me

What really concerns me is another Great Depression. And, we are actually closely following the script of that time. First, economic and financial crashes. Then big public bailouts. Then economic activity collapses. Then we have a grinding depression.

And, in a depression, we get huge unemployment, and even food shortages. In fact, I wonder if we will see something like what happened in Iceland this week, where the stores are running out of food and everything because there is no foreign exchange. They won't accept the Iceland Krona. So, Iceland can't import food.

Lest you think that problem is isolated to that island nation, in the Great Depression millions starved in the US and Europe and elsewhere, even in big food producing countries. One reason is that big food producers sell their food for foreign currency – ie export it. The natives be damned. That's what happened in Argentina in the early 2000's.

And, god forbid, there can be a big war after the depression. This is exactly what happened in the 1930's/40's.

So, batten down the hatches, and be super cautious. Don't believe the financial TV that seems to be always saying the bottom is here. I don't believe that for a minute. The credit crisis is just grinding away at the world economies like a big wood chipper. The next quarter or two, we will see big declines in economic activity, and also big layoffs all over the world.

By Christopher Laird

Copyright © 2008 Christopher Laird

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.

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