It may not be self-evident but the turbulence we see in today’s stock markets is actually the price of progress and the peace dividend of the 1990s. In a sense Francis Fukayama was right to suggest that democratic capitalism represented the highest form of economic and political development. By 1989 the miracle growth seen in Europe, America and East Asia after 1945 was as clear to see as the economic and intellectual bankruptcy of the Soviet Empire. Hence when the Berlin Wall fell virtually every country, apart from the likes of Cuba and North Korea, adopted free market economics. As a result the last 20 years has seen the biggest rate of global economic growth in human history with literally hundreds of millions of people across the world pulled out of poverty.
This huge growth in global wealth meant that very suddenly there was a lot of money looking for a home. Arab oil states had so much money that even they couldn’t squander it all and Chinese workers began to deposit increasing amounts of money as their wages steadily increased. Arab and Asian states began to invest this money by lending it to Western Governments and banking institutions. As a result Western banks were suddenly able to lend to consumers like there was no tomorrow; loans to businesses and householders led to a consumer binge and inflated property prices. In short a dangerous bubble began to develop, but like all bubbles it seemed to many that it could expand forever. American and British consumers in particular began to rack up huge debit balances which were gambled against and infinite rise in property prices. It is also clear that the fiscal decisions by central banks and Governments acted to exacerbate the problem. Cheap Chinese goods helped to lessen the danger of inflation, for a short time at least, and traumatic events such as 9/11 and the dot com crash threatened to plunge the West into a recession. As a result interest rates were kept far too low for far too long and the West’s credit binge was allowed to expand indefinitely.
As happened in the 1920s, when consumerism really started to become established, the stock market became, to paraphrase Alan Greenspan, ‘irrationally exuberant’. Capitalism is not a utopian, perfect system, to be sure there can never be such a thing and the bubble had to burst. Such is the way of things.
As far as I can tell the state-backed mortgage lenders, Fannie Mae and Freddie Mac, used the massive increase in liquidity and subsequent property boom to lend to poor but aspirational Americans. Extending home ownership to the poor is a noble idea but Fannie and Freddie began to lend to people who patently could not afford to repay these loans. These toxic sub prime mortgages then began to contaminate the financial markets. As far as I can tell these debts became packaged up with derivatives and products sold by speculators in order to increase profits. These toxic debts should not have even been touched by supposedly responsible institutions and it was these greedy and irresponsible speculators who were mainly responsible for contaminating the market with Fannie and Freddies bad loans. Once banks began to realise that these toxic debts had contaminated the money markets, fear took hold and banks stopped lending to each other. Companies such as Northern Rock, which had expanded too quickly, could not raise capital to cover their liabilities became exposed and investors lost confidence. More recently we have seen institutions such as Lehman Bros again caught out when the liquidity demanded by their risky business models suddenly dried up.
It is impossible to tell what will happen to the banks over the coming weeks. It is clear that this is a global crisis which has affected the various strains of capitalism in America, Britain and Europe as well as the petro-markets of Russia and the Middle East. A temporary downturn in Europe and America was always on the cards as the housing boom began to subside and consumer demand dropped off. What is inevitable is that the real economy will begin to recover from its downturn, perhaps as early as late 2009. Capitalism has provided unprecedented economic growth for over two centuries and one should look at growth patterns over decades rather than months or years. What kind of banking system emerges from the turmoil remains to be seen although it is highly likely that banks and investors will follow much more cautious business models, which will inevitably result in slower economic growth. Financial services represent the engine room of the British Economy and are responsible for at least 10% of GDP; it is important that the industry recovers and continues to act as a world leader. If things go very well that the public may make a profit out of the bail-out plan; previous bail-outs such as the Swedish banking rescue plan and the US bail-out of Mexico and several private institutions in the 80s and 90s resulted in a profit for taxpayers and a quick sell-off. No-one can guess what precisely will happen next but there may well be big shocks to come, including potentia de-facto nationalisations of some of the big banks may be nationalised. This is not desirable but the only thing worse would be the break-up of one of our leading banks. Economist Thomas L Friedman put it succinctly when he said “This workout promises to be painful, complicated and protracted. Government will have to do its part. But it must regulate the excesses without smothering the underlying innovative, entrepreneurial and risk-taking attributes of our economy, which are what will ultimately bail us out — as they always have.”
For those with money to invest the crisis may also represent an opportunity, provided they can stomach the risk and look beyond time horizons of 6 months. Just as greed burst the bubble in the late noughties, irrational fear has now prolonged the current crisis. I consider it unlikely that the world will see a depression; on a purely anecdotal note the bars and cafes of London were packed to bursting when I visited the city this weekend. I simply cannot see the British economy succumbing to a depression rather than a recession. As a result of the panic gripping the markets however, shares can now be bought at rock bottom prices. Stock market supremo Warren Buffett has just invested a cool $8 billion in Goldman Sachs and General Electric.
“I have no idea what the stock market is going to do next month or six months from now,” Buffett told CNBC on Friday. “I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well.”
You could do worse than to take advise from Warren Buffett, just be sure to sell-up before the next bubble bursts.
2008-10-13 @ 04:57