And Bear begat Lehman. And Lehman begat Dubai. And Dubai begat Greece. And Greece begat Spain. And Spain begat Italy. And…hold on!
Who begat Hungary? North American markets tanked on Friday on a double barrel of strange and disappointing news. First was a comment from a spokesman for the Hungarian president that the country faced a “grave” economic situation. Debt begat that.
But the 3.15% fall in the Dow Jones Industrials and the 3.44% fall in the S&P 500 were generally blamed on a disappointing U.S. jobs report. That report showed that the U.S. economy added 431,000 jobs in May, which seems like a lot of jobs. But the median forecast from, ahem, economists was for exactly 536,000 shiny new jobs.
The more discouraging news was that the private sector added only 41,000 jobs in the month, and that’s assuming the numbers are accurate and can be trusted. All the other jobs were related to temporary census workers in the U.S. working on the Federal dole. That’s not much cause for encouragement.
The bigger weekend story is that Europe and America are at odds over whether they should continue spending money they don’t have. That is, according to news reports, U.S. Treasury Secretary wants countries like China and Germany – countries with current account surpluses – to unleash private sector demand! Spend money, he says, because we Americans are flagging, and already have too much debt.
The Europeans apparently knocked Geithner back on the suggestion. This prompts the question: has official Europe really chosen the route of austerity?
And if so, will they stick to it? Will their populations let them if it means lower growth and higher unemployment and fewer government services? It will be a very stern test for public finances in a modern democracy. And in the meantime, the Euro is getting sicker against the dollar (which may not bother German exporters too much).
Geithner reportedly told the Europeans that the road back to public sector fiscal sanity is long and winding and that they could put off the journey for a day or two. We didn’t see him anywhere advocating larger public spending and stimulus. But still, in the sense that he sees aggregate demand as the key to a global recovery, Geithner flew the flag of Keynes in South Korea this weekend.
The result is a policy stalemate, at least if you were expecting a coordinated global economic strategy, complete with a tax on banks. Come to think of it, that isn’t a bad result after all, is it? It’s certainly welcome in Australia, where the locals have argued the banking sector is better regulated and capitalised than in the North Atlantic economies.
It looks to us like the global bank tax is the developed world’s way of getting the developing world to pay for bank failures. So it’s no wonder it was opposed by China, Brasil, and Australia. Mind you, we have our own reservations about the quality of bank assets domestically. And it’s clear that no matter how sound Australia’s financial system may be, it would be affected by a capital crisis in Europe.
“Australia’s banks are reliant upon global capital markets to fund a significant share of their balance sheets, including rolling over growing volumes of maturities. In 2009 around two-thirds of bond issues by Australian banks were into the offshore markets,” says’ Westpac’s Chief economist Bill Evans in today’s Australian. Bloomberg reports that cost of insuring Australian corporate bonds from default went up the most in two weeks.
Evans say that, “The inevitable response to an extended tightening of global liquidity will be tighter domestic credit conditions. Proposed new regulations through the G20 on liquidity and term funding must be scaled back considerably if Australia and New Zealand are to avoid a credit crunch.”
Hmm. According to the chart below from CMA Market last week, the next most urgent stage of Europe’s debt and credit crisis is the East. The largest widening spreads, an indication of credit deterioration, were in Austria, Hungary, Slovenia, and Romania.
But Evans point is well taken. The Australian government correctly argues that in comparison to other countries, the debt and deficit-to-GDP ratios here are small. That’s true. But for the country, the total level of household and private sector debt is large and growing. And a lot of that borrowing is done overseas. Take it away, and what do you have?
You have a much higher cost of capital and another credit crunch. The flow of credit to small businesses and households would be the most affect. Big firms might have trouble selling bonds (hence the higher credit default swap rates). They could, assuming investors are not spooked about sovereign risk, sell equity as they did last year.
But you can see that Australia IS affected both directly and indirectly by what happens in Europe. And that’s just Europe! Ultimately, we reckon the biggest bubble of them all is in the U.S. bond market. But we’ll save that analysis for another day. Until then.
By the way, in the beginning, before the great credit deluge of fiat money, the nature of the business cycle was not boom and then bust. It may not have been a Garden of Eden. But the cost of capital was set by the market, with a natural rate of interest. Bad investments were made and the loan losses were taken by the lenders, with the prudent surviving and the reckless perishing.
In this economic paradise, capital moved from weak and inefficient and wasteful hands into strong ones. Recessions were short and sharp. Growth was slower in the absence of credit above the rate of available savings. But money was sound and investments could be valued.
It’s hard to say if John Law was serpent or merely a scoundrel. But he succeeded in convincing the French regent to open a national bank whose primary capital was government debt. It was the birth of modern central banking, where the government effectively sells the right to print (not coin) money to a private corporation or cartel in exchange for reliable lending at favourable interest rates.
How Law turned the debt of the French government into the equity of the Mississippi Company is also a story for another day. But in his ability to convince the investing public that liabilities and promises to pay are the same thing as real money, Law Begat Greenspan and Greenspan Begat Bernanke. And to channel the Mogambo Guru, we’re all begatted now.
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