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Wednesday, 21 October 2009

Comments from a 'lay-economist' on the Credit Quake of 2008 - 2009

More debt cannot solve the current debt crisis!

All we are doing is buying time, (in essence restructuring the principal debt burden) and deluding ourselves that the fundamental problems have been solved. Which of course is not the case.

I think Paul Samuelson defined economics in one of his textbooks as “...the study of scarcity...”

Yes, the crisis was born out of the scarcity of liquid funds or assets, but a large contributor that became a key driver which exacerbated the crisis was regulatory driven, especially the misconstrued IASB (International Accounting Standards Board’s) IAS39 Financial Instruments: Recognition and Measurement standard.

Remember, money or monetary values (currency) only act as a proxy or crude measure for the ‘real economic’ measurement of value and output. At a basic level we have been experiencing a large equilibrium shift away from the traditional factors of production (land, labour, capital and technology & innovation) and the holders or owners of these factors of production, to a fairer distribution and access to these factors of production.

When the equilibrium cannot be maintained at a specific unsustainable level we experience some form of ‘discontinuity’, such as the current crises we are experiencing.

In the old Western oriented G8 or now G20 democracies (and one or two new monarchies throw in together with a quasi-communist regime for good measure), the old G8 leaders thought they were immune against the odd banking crisis . Recall here the Asian Crisis of 1997-1998, the Russian Financial Crisis of 1998, the Argentinean default of 1999; all minor disturbances in the developing economies which did not affect the West.

However, with ‘The Great Moderation’ (thank you Ben Bernanke for that one) so recently behind us, the Great Credit Quake of 2008 – 2009 suddenly meant that the entire G20 club and beyond were dragged into the quagmire.

Therefore, my belief or opinion is that we are still in the midst of a major equilibrium adjustment and the ‘step down’ or up from the previous level will continue to be uncomfortable for many years to come. Asset classes will continue to try to find their new sustainable equilibrium valuation levels, and the stoking of the fires by governments with sovereign debt will only continue to contribute to dragging on the crisis for longer.

Ultimately, the market mechanism did not fail, but a few key players within those markets failed spectacularly. Pumping more liquidity into the system will NOT heal the moral hazard created before and now supported by the current interventions.

Growth is rightly touted as one of the mechanisms by which we get ourselves out of this crisis, but I can see two other unpopular tools at our disposal, one being raising tax burdens generally and the other lesser of the two evils being inflation.

Shall we jump, or wait to be pushed?

The Market Soul © 2009

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