Sep. 16th, 2008

peterbirks: (Default)
Well, the consensus on this blog a year ago was (brief cliff notes follow):

1) The crisis was systemic, not one of liquidity and not one of confidence,

2) The shit would really hit the fan in August this year.

In both areas this blog was at odds with most of the writers in the FT and everyone that I read in the other business pages. We were one month out on the shit hit prediction, and although Butler got the dollar call totally wrong (although in the medium term he is likely to be proved right, before in the long term being proved wrong again), in general, we've been more on the money than the mainline press.

Letting Lehman Bros fail was the right thing to do, even though it takes us into uncharted waters. One plus is that the transparency associated with bankruptcy will let us know a lot more of what was going on. A second plus is that we can see how close to meltdown it might bring us. If Lehmabn Bros had been bailed out, another problem would have appeared within weeks.

Or, indeed, within hours, what with AIG looking to be on the edge. It's all very well muttering that AIG has some sound businesses and, if it unloads those, it will be okay. But, well, why pay a few hundred million for a sound business today if you can pick it up for less than $100m next week after AIG has gone bust? That plan only goes wrong if someone else moves in to buy the business this week and AIG survives. But, then, hell, you are no worse off than you were before, and there aren't that many buyers out there.

The question will continually reappear "where did all the money go"? And the simple answer is that people in the US (and here) consumed more than they produced. As I said before, this "risky lending" was sliced and diced and split up and moved around, but the risk didn't disappear. And, more importantly, it wasn't really "diversified", as our honorary member for the banking community (Woodhouse, M) claimed.

On the plus side, that wealth hasn't disappeared. While the people in the US (and here) were consuming more than they were producing, the people in the Far East were producing more than they were consuming. Now it's payback time. The question is, will we pay back our debt?

And the answer here can go one of two ways. If it's "yes" (i.e., the 'honorable' thing) then we enter a deflationary spiral of protectionism and depression (see Japan, 1990s). However, if the answer is 'no', then we enter an inflationary spiral that effectively reduces the debt in real terms (because the US owes the Chinese in dollars, not yuan) and gives the borrowers a get-out-of-jail-not-very-expensively card. It's a bit like a poker debt that you pay off ten years late, at which point $10K isn't what it used to be.

Everyone knows that I've punted on the inflationary scenario, but the press still seems to be seeing the former as a more likely result. I don't know why. If the Fed cuts rates sooner rather than later, that just makes the inflationary likelihood even higher. Occam's razor comes into play here. A deflationary batttle against consumption excesses of the past would be harsh, while an inflationary battle would hit savers in China.

Pretty much of a no-brainer, I would have thought.

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