Saturday, 18 June 2011

Are we in 2008?

The title sounds at least weird, but this is exactly what occured to me quite recently. A few days ago I waited for my friend outside her office and I remembered the time when we met, during our internship at M********* Bank, it was in summer 2008. We looked back on those times and I put our memories into a broader, economic perspective. Then I discussed it with my colleagues at the office and they shared my observations. Three years have passed and economic situation is disturbingly similar to that in 2008. Just come to think of it...

There is a rally on commodities market, just like in 2008.
Rising prices of commodities have sent the inflation rising, just like in 2008.
Stock market has been underperforming for while, although scale of the correction is not as huge as in summer 2008 when the correction turned into a full-blown bear market.
Pace of GDP growth in developed economies is slowing down just like in 2008, there is a serious threat of double-dip recession in Japan and United States.

In 2008 world saw a spectacular turmoil on financial markets following the bankruptcy of Lehman Brothers bank. In 2011 we might witness a similar disaster. This time the biggest sore points are Greece and USA.

Problems of the former have kept us company from May 2010, when it transpired the country would be soon unable to roll over its debts. The default was somehow staved off with a huge bail-out package, but the issue remains unresolved and pain in the necks of European politicians and bankers is getting more and more severe. For the last 13 months Greece has been effectively a corpse, artificially kept alive by a drip of money flowing from the IMF and EU. If it hadn't been for those loans, the stricken country would have gone insolvent on 19 May 2010. This was fended off by the EU mostly because bondholders of the Greek government are mainly French and German banks, which had bought Greek gilts after collapse on sub-prime securities market, as government bonds were at that time deemed to be a risk-free investment. Those banks, if Greece defaulted on its debts would have to write off large sums of money, losses would deplete their equity, or even gobbled them up at all. To prevent a knock-on effect, governments would have to shore up capitals of those banks, but in 2011 it wouldn't be as easy as three years earlier. Then government bonds were treated as safe haven and so called "investors" were eager to help the governments meet their borrowing needs. Today, as government bonds are more or less risky assets, it would be impossible to finance another bank bail-out programme, or at least it would be hard, as potential debt buyers would require a generous rate of return. EU countries are bending over backwards to stave off the Greek disaster, but this looks unfeasible. If the next tranche of the EU / IMF funded rescue package is to be disbursed in July, Greece has to pass an austerity programme that would involve tax hikes and painful cuts in expenditures. Greeks, accustomed to welfare and bunking off, don't give a green light to the programme and the odds it will be carried out are getting lower. If Greece fails to meet requirements set by its lenders and the lenders don't give in and turn a blind eye on Greek governments fecklessness, the real bankruptcy is in the offing. And even if the next tranche is disbursed, problems of the country and its creditors won't be solved, but only postponed. Best case scenario for bondholders is soft restructuring, meaning write-downs on Greek government securities will bemade over time. And Greece itself is poised for a downfall, well-earned downfall... Grrece has long been effectively bankrupt. Everyone realises it, and everyone is afraid to speak it out.

USA are in a slightly better situation. For no apparent reason their debt is rated AAA, despite the fact the country is on its way towards a technical default. If the congress, where republicans have the majority, doesn't raise the debt ceiling by 2 August, the US government will have no money to buy back its treasury bills (by rolling over the debt), what means effective insolvency. Funnily enough, rating agency can downgrade US rating only if the debt ceiling is not increased. So if they keep on running up debts, triple-A rating would be reaffirmed. A farce? No, this is real, so the rating agencies grading US debt as prime investment are in for a disredit comparable to the one with sub-prime securities and Lehman rating. But United States have a way with its creditors that Greece doesn't have. USA can print as much money as they want and monetise their debt - this is the only way it will can be paid off, with the detriment to those hapless guys who hold US treasury bonds. I hope Barack Obama's face will adorn $10,000,000 banknotes and Ben Bernanke will deserve to look at Americans from a $100,000,000 note.

I'm looking forward to both imminent defaults. Both wretched Greece and wretched United States have worked hard to go default and there's no point in averting it. Of course many economists and probably all politicians would disagree with me and do their best to ward off the bankruptcies, as these bankruptcies would give rise to a turmoil on financial markets much bigger than the one following Lehman's collapse. Indeed, they would, but we need to suffer this stress to clean the air and finally learn the lesson from the crisis. Price for living beyond our means should finally be paid, conclusions should be drawn, bail-outs should become thing of the past, moral hazard should recede to the realm of academic discussions on economics.

But they won't...

And please don't ask me what the safe haven for money now is.
Government bonds - no longer
Stocks - will plummet
Commodities - will plummet
Bank deposits - why not, but given the current inflation profits in real terms are negative.
Gold - seems overvalued
Properties - somethign tangible, but don't expect the market value to increase in the coming years...


Stefan Kubiak said...

The conclusion isn't very optimistic, is it? Can you see any light in the tunnel?

student SGH said...

Fortunately, there's a light at the end of the tunnel.

Unfortunately, this is the light of an oncoming train...

Finance ministers of seven richest countries have agreed on another tranche of the bailout package for Greece, disbursement conditioned upon pressing ahead with austerity programme. Will the Greek government make it by mid-July with such social disapproval of the retrenchment?