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The crisis of confidence when Capitalism has no further currency

Sanity, calm and resilience in the face of the greatest test of the global economy since the Great Depression – that’s the message we should be hearing from all sides.

Instead, listening to some asset managers now, it is even the time to buy. I am told that such rhetoric prevailed during the 1929 Crash as well. It’s too early to tell. What is certain is that this comparison is being forced upon us.

We are witnessing a great destruction of wealth, of nations and even that of the smallest man. And I am very angry that it has come to this.

According to Wikipedia Encyclopedia a handful of reasons are advanced for the causes of the Great Depression:

• Debt 
  • Consumers and business relied heavily on cheap credit and in the sudden deflationary environment after the crash, defaulted, cut spending and lowered demand. Massive layoffs occurred as businesses failed and demand dropped even further. Bank runs were sparked as banks failed in large numbers. A vicious cycle snowballed to ensure that credit dried up even further exacerbating the above problem.
• Trade decline and the U.S. Smoot-Hawley Tariff Act 
  • Political instinct sought protectionist policies which led to retaliatory trade tariffs for farm commodities and the failure of the agricultural sector in the midst of a severe drought. Banks failed in the American Heartland.
• Increase in federal income tax rates 
  • Hoover increased the marginal tax rate to 63%
• U.S. Federal Reserve and money supply
  • That money supply shrank by a third and liquidity dried up after the crash is blamed on the Federal Reserve and regulatory limits of credit backed by gold. Private hoarding of the metal reduced the availability of credit permitted. Private ownership of gold was later made illegal.
• Austrian School explanations 
  • The expansion of the money supply in the early 1920’s that led to an unsustainable credit-driven boom is also blamed on the Federal Reserve. To assist Britain to return to the gold standard, the United States artificially inflated the money supply. Ineffectual intervention by the Federal Reserve both before and after the crash failed to restore faith in the banking system. Consumers hoarded cash as banks held on to reserves to stave off potential runs
• Business 
  • Big business was blamed for bursting the bubble. Enter the era of regulation, concessions to labour and increased corporate taxes
• Deficit Spending 
  • Massive government infrastructural spend, rather than corporate spend, slowed rather than sped recovery
• Inequality of wealth and income 
• To quote Marriner S Eccles,
  “As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery.”

It is a terrible fascination that many of these circumstances exist in their own way today. 

It is also true that all the above explanations are valid and the solutions to that crisis lay in addressing the actual problems at the core. This was something that was not always clear at the time.

In a cruel double entendre the great depression epitomized a massive loss of confidence in the banks, the financial markets, and finally government. This crisis in confidence created a consumer led spending slowdown.

The Great Depression threatened the social fabric and created the pathological aberrations that spawned the last great World War.

Each country experienced its own particular agony; South African agricultural and mineral exports fell badly on lower world growth, and black labour became a competitive necessity.  Government changed on a vote for a floating currency and budget that lowered taxes.

The Great Depression only came to an end with the onset of the Second World War.

Compare the analysis above to the views of Nouriel Roubini in the following article, “The world is at severe risk of a global systemic financial meltdown and a severe global depression”

The recessionary period that the world has now undoubtedly entered has the potential to become deep and long, in other words a depression, unless market confidence can be restored very quickly.

We are seeing this paralytic seizure as banks come to the brink and fail, only to be mopped up by the sponge of spectacular central bank interventions.

If government interventions are to succeed then full cognizance must be taken not only of what lead to this crisis, but also that the same mistakes in dealing with the 1929 crisis should not be made again.

Perhaps this is the opportunity for a new world order.

Please read this fascinating article from Klaus Schwab, Founder and Executive Chairman, World Economic Forum, “Brave New World”

Indications abound that the meltdown in global markets continues unabated. There is however the growing realisation that a multi facetted approach has to be followed.

Hence it is important to provide emergency liquidity, guarantee savings, guarantee interbank loans, drop interest rates, reduce debt, and provide credit to business and consumers as well as bolstering global trade.

It remains to be seen what the effect and extent of the present global financial crisis will be on South Africa.

We are not immune to the contagion ravaging the world and all indications are that we are in for very tough times ahead.

Investment is leaching from our economy too as direct investment has quickly become foreign direct disinvestment and our exchange rate has tanked as a result.

The horse has already bolted and the MPC keeping the interest rates at their present level will not necessarily have the immediate effect of attracting foreign investors.

Iceland is bankrupt. Can the same question be asked of the US and other previously global economic superpowers?

Iceland is a good example of how unearned credit benefitted a country’s people without concomitant regard for the risks involved.

What more proof do we need that the global market economy needs better global regulation?

It is pure irresponsibility that allows national economies to act independently as if their actions do not have any impact on other nations.

I was reminded of this the other day when ITInews published an article by Werksmans on the background to Basel II.

Two questions need to be asked of the present situation:

1. What is the use of regulating the banking sector if bad debt can be created in a non-transparent shadow financial banking system?
2. Is present regulation sufficient to address global issues?

The global village needs a global policeman.

We need to look for new leadership in the world markets and in other trading partners. No more can we allow the global economy to pander to the avarice of richer nations.

Successive failures of trade talks over the past decades have made increasingly obvious the one sided nature of trade negotiations, where protectionism benefits wealthy states and marginalizes developing economies, creating a form of neo colonial slavery.

Here is an interesting video also from Nouriel Roubini, Chairman, RGE Monitor and Professor of Economics, Stern School of Business, New York University that explains the current situation and what has to be done to solve the crisis.

Video ID: 4801

Immediate concerns and implications

Commodity prices will retreat in the absence of speculation and lower growth expectations – it is likely that deflation could become a much bigger concern than inflation.

Slackness in demand relative to supply implies that the corporate sector is going to be diminished. Growing unemployment may lead to labour costs being controlled.

We can ill afford socially, economically and politically the threat of increased unemployment and it may be opportune to extract labour reforms that preserve and grow jobs and create the flexibility for business to do so.

Can we support exports and industry without indulging the temptation of making them less competitive by protecting our own industries artificially?

Above all we should not panic – there is after all no real place to hide.

Spare a thought for Zimbabwe as we contemplate the dire consequences for ourselves.

It is perhaps fitting that I end this newsletter with the words of Eccles yet again:

"Instead of achieving that kind of distribution [of wealth], a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped."

We definitely need a war on greed. What we especially need is a war on stupidity.