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GAMBLER’s HANDSHAKE: Fed and financial meltdown
October 2, 2008
GAMBLER’s HANDSHAKE: Fed and financial meltdown
Niraj Kumar
Long awaited hysterical moment of unraveling financial market is marauding the core state of world capitalism. Nouriel Roubini, the economics professor at New York University rechristened as Dr. Doom by the American media is having the last laugh. The U.S. government stands paralyzed over imploding financial institutions even before the commencement of four-yearly lame-duck session. George Bush has added another failure to his presidency and has now issued threat domestically to rescue Wall Street or else the unfurling crisis proves dangerous to general economy. The Treasury Secretary, Hans Paulson pleaded on bended knees before the Speaker of the House of Representative to pass the bail-out package to stave off the financial crisis, only to be rebuked later for faking as a catholic. The bail-out package was rejected. The Wall Street dream lies shattered.
Wall Street’s hara-kiri
New York‘s Wall Street is the financial centre of the world economy. The rise of structured finance i.e. pooling of credit risk from multiple borrowers into a different credit product a la’ Alan Greenspan’s loose monetary policy of unleashing massive liquidity into system at lowest interest rate, created an alternative financial system. Complex paper finances were generated through securitization and sold as derivatives in the global market. The investment banks and hedge funds profiteered from the simulacral system. There were five major investment banks-Merrill Lynch, Goldman Sach, Lehman Brothers, Bear Stearns and Morgan Stanley-that emerged as the pillars of America’s financial prowess. Sudden disappearance of these investment banks signal ominous potent for hamstrung America. IIM graduates in India hankered after coveted jobs of fudging and mathematical production of capital in Lehman Brothers. The company went bust without a blipper. Lehman had to file for bankruptcy after being shown the door by the U.S.
Government, other banks and hedge fund managers. Its CEO, Dick Fuld, who was recently eulogized by the Economist magazine for his charisma embodied inaction while his company collapsed. He was paid forty million dollar as annual salary and multiple times bonus to fickle with investors fortunes. Bear Stearns could avoid ignominy of filing for bankruptcy. Treasury Secretary arranged a backdoor deal for its purchase by JP Morgan Chase. Thence, Merrill Lynch surrendered. Again, Paulson was instrumental in Bank of America’s purchase of this investment bank. Goldman Sach and Morgan Stanley stood as a memorabilia of the erstwhile Twin Towers in the same city. They kept on issuing prognosis about growth and investment opportunities in emerging markets like India; while their own account went off-balance. In an emergency meeting called on a Sunday evening (21 September), Federal Reserve Chairman Ben Bernanke insisted to annul the investment banking system inspite of resistance from recalcitrant Treasury Secretary, who himself had been an important player in the Wall Street games during his earlier stint as the CEO of Goldman Sach. The end of ‘shadow banking system’ virtually closed the chapter of alternative banking system whereby investment banks were allowed to have a free run without collateral support of depositors after annulment of Glass Steagall Act, 1933 in 1999. Bernanke has been an expert on Great Depression of 1930s and he foresaw the bleak future of these remaining two investment banks – Goldman Sach and the Morgan Stanley. He forestalled the possibility of these two institutions sudden filing for bankruptcy which might have plunged the credibility of American financial system further downward. US government could not have afforded more mega bankruptcies otherwise panicky market would have made foreign creditors to lose further confidence in the system. Foreign central banks might have refused to lend the consumption-maniac nation. American public would have taken to street against their government and the subsequent centrifugal forces would have reconfigured new geopolitical map of scores of competing enclaves as a recurrent reminder to the collapse of the erstwhile sub-hegemonic partner, the Soviet Union.
American administration foresaw the nation’s future. To maintain the cartographic integrity of their territory, the administration transformed the moneto-graphy of the Wall Street. The Government has regained its regulatory functions. Investment guru Warren Buffet termed the turbulence as a financial Pearl Harbor. Analogous to the administration establishing a giant
Guantanamo (extensive surveillance society) within America on pretext of combating terrorism after 9/11-WTC attack, the ongoing crisis has subjected every financial transaction to extensive regulation and supervision. But, the effect of emerging regulations is debatable as investors and regulators are intricately linked. Every government move is prone to suspicion of selective bailouts and engagements. Paulson was instrumental in managing huge investment by Warren Buffet to bail out his old company. Federal Reserve Board member, Kevin Marsh had worked as a vice president in Morgan Stanley and he put his weight behind salvaging this institution from bankruptcy. Elizabeth Duke, another member of the Fed board, had worked as advisor in the Fannie Mac mortgage company and was influential in semi-nationalization of this institution.
Financial turbulence has evaporated investor’s confidence. Banks are desisting from inter-bank lending as evident from rising inter-bank rate two hundred basic points above the benchmark of Fed fund rate. Each institution is suspected as a potential Lehman Brothers Inc. Once credit facility and liquidity begin to decline exponentially, consequent impact over general economy will be disastrous. If economy does not grow, prices will rise thereby creating the specter of stagflation. The Treasury and Fed put forward Paulson plan to bail-out distressed institution with a support of seven hundred billion dollars. With this money, the Government planned to buy “toxic derivatives” so as to bring back confidence in the market. Earlier, the administration banned short selling of securities and issued SOS to central banks of Japan, Middle East, China, Canada and Europe.
The rejection of the bail-out plan is bound to erase the Wall Street derivative Halagus from global financial network. The Wall Street freaks who adopted greed, risk, credit and swap as the new mantras for post-production cowboy capitalism generated this financial black hole which has started swallowing institutions randomly. There has been no derivative bubble. Bubbles burst. On the contrary, US is witnessing implosion of credit, liquidity and pillars of the financial empire. Every law breaks down within a black hole. Law of demand, supply, performance, equity, mathematical models, and cycle theories have broken down. George Bush is wrong in blaming “massive amount of money that flowed into the US from investors abroad” for the conundrum. Rather, it is the inward pull of Wall Street’s own financial weight that has catalyzed internal collapse which threatens to engulf the entire global financial system.
Resurrecting sovereignty of the naked emperor
India‘s gross domestic production amounts to one trillion dollar. The US government is chalking out plans after plans to save irresponsible rich investors with double this amount during current financial year. Foreigners owned two trillion dollars of US treasury securities (June, 2007) and 1.7 trillion dollars of government-agency securities. Total public debt as on 31stAugust, 2008 stands at 9.64 trillion dollars. Since the sub-prime mortgage housing mortgage crisis last year, it has grown by an amount of $640 billion dollars. The House of Representatives has pushed to increase statutory debt limit from 10.615 trillion dollars to 11.3 trillion dollars that would provide a balance of 1.7 trillion dollar as of now. The budget deficit is expected to grow to $407 billion dollar this year. Trade deficit will soar to 800 billion dollar and current account deficit will hover around $700 billion. Federal budget amounts to one-third of the GDP. In such a fragile economic scenario, it is unimaginable as to how will the US manage such a huge bail-out?
The reason lies in the sovereign right to print the fiat currency, dollar. American economy breathes on the strength of dollar’s role as an international transaction currency. With the disintegration of Bretton- Woods structure during 1970s which was based on the pillar of dollar-gold convertibility, there is no statutory requirement of any liquid asset to print dollar. The US began to print and export dollar surreptitiously and import goods and services at the cheapest value from the whole world. US is the single nation which enjoy benefits of being a debtor in its own currency .It is virtually impossible that it can default on its international obligations as it can invoke its right to print own currency.
Dollar can maintain its present role only when it is strong. Every economic fundamental necessitated gradual weakening of dollar. But, the American President and the presidential candidates have been drum-beating ‘strong dollar’ policy for last few months as Americans are aware that their global hegemony thrives on primacy of dollar.
Declaring a hidden financial war
To reverse gradual slide of dollar, New York and London based Commodity Exchanges in collusion with the US Future Trading Commission and Wall Street speculators orchestrated a spike in oil prices worldwide. Oil bills are denominated in dollar. Therefore, every nation began to accumulate dollar. With increasing demand, dollar regained some strength. But, the spin off effect was worse. Russia is a major oil –exporting country. Putin demolished Russian petro–oligarchs and did not allow foreign companies to have a sway over its oil resources. Russia capitalized on windfall profit and accumulated huge forex reserve of 560 billion dollars. Russia paid back loans taken from the IMF and the foreign countries during 1998 rubble crisis. The bear let lose its maneuvers to break the geopolitical encirclement. Denmark and Canada were repulsed and Russia established supremacy over the Arctic sea. No sooner did Putin find George Bush deeply engaged in Beijing Olympics, he allowed his troops to bomb, humiliate and occupy Georgia, a frontline American ally in the Caucasus. The West being led by the US had to chew humble pie. After ensuring diplomatic defeat, Russia began to make fun of American prowess by dispatching bombers planes to Venezuela and naval warships to the Caribbean. Bush administration is so tied down in Iraq, Afghanistan, Iraq and Pakistan that any military rivalry with a rising Russia would have ripped apart the whole strategy of global primacy.
The US launched an aggressive financial war to bleed Russia. The price of oil plummeted from 150 dollar per barrel to 95 dollar per barrel. Russian stock market plunged. Russia could not have responded with its limited financial strength against this onslaught.
American action boomeranged. The temporary exit of speculators from the oil market exposed the vulnerability of investment bankers. When Lehman Brothers Inc. went bust and the Fed refused to bail it out, the Chinese government became nervous. If the US refused to bail out Freddie Mac and Fannie Mae, the mortgage giants, it would have been a nightmare for China. China had purchased more than half a trillion dollar bonds from these highly leveraged agencies. Hu Jintao, who was telephonically requested to let NSG waiver for India only a week ago, called the American President and warned that in case of failure of these mortgage giants, China might respond by losing confidence in American financial system and would desist from further financing the American profligacy. Two companies were immediately nationalized with a bail-out package of $200 billion.
Mainstream China holds huge forex reserve that amounts to $1800 billion. It has purchased American bonds of nearly one trillion dollars. If American market further falters, dollar would devalue reducing China’s hard earned saving and investment. US will enjoy advantages in both conditions. If dollar is weak, American debt will decrease and other nation’s holdings of American securities would dwindle. If dollar remain strong, that would attract investors. Each nation has a stake in maintaining a strong dollar. This explains the paradox of growing appetite for US treasury securities during ongoing crisis which has made dollar stronger. US is gobbling up global savings in the process apart from consuming global production. The economists blame high level of leveraging (ratio of borrowed money to own assets), the zombie financial institutions hold for the current turmoil without any hint at the way the US as a nation itself is highly leveraged that threaten to destroy the global prosperity. Global economic health is intimately tied to American fragility. To mask the inherent reality, hoopla of ‘decoupling’ is being circulated through the embedded media.
Lessons for India
Paradox of our Prime Minister’s recent visit to the US lies in his eulogy for the American investor’s interest in Indian nuclear industry while the host nation is reeling under acute financial turmoil. India was seeking attention of those FIIs who evaporated without a trace. With impending recession in the US and European markets, the SEZ policy lies in tatters. Now that the export sink is sinking, how can a latecomer like India pursue successfully an export-led growth? Recent demand for financial sector reforms has to be weighed carefully. Rupee future trading and currency-bond-derivative swapping has to be disallowed. FII investment in debt market needs to be significantly reduced. Now that the world over, nationalization of institutions of public interest is reemerging as new credo, the government needs to rethink upon its strategy of deregulation and anti-people, pro- rich reforms.
A weakening rupee when trade deficit has soared to $31.6 billion in April- June quarter is disastrous. The government should shed the policy of artificially pegging rupee with dollar at undeclared level of Rs.40. Our banks have suffered in recent downturns. The US government ought to pay back Indian investments made in bankrupt Lehman Brothers. India needs to develop own paradigm of bio-happiness- based development and not fall under the trap of voodoo economics of risk, credit and sign. Physical economy deserves more attention. Needs have to be prioritized and we need to prepare ourselves to face looming danger in the world economy.
Prolegomena on future crisis
Root cause of the ongoing implosion lies in excess availability of dollar pumped by the Fed during Greenspan era, which spurred credit culture and provided easy capital for risk profiteering. But, Ben-Paulson is trotting the same path. Providing easy credit and injecting more liquidity will merely postpone the general collapse. US is further embarking on the plan of ‘offshore-capitalization”. US has evolved ”off shoring’ as their grand strategy to balance nations, getting work done and projecting leaders. Now, major offshore saving nations will be requested to capitalize highly leveraged financial institutions. If they do not support, they risk losing their existing assets. To rescue those assets, they are required to constantly entangle deeper and deeper thereby increasing risk significantly. Fed’s handshake with risky investors raises moral dilemma. The investment institutions are microcosm of the Fed. Both works on the principle of manipulating other’s hard-earned assets.
Fed has announced that inflation will emerge as a major problem which is inevitable in the above mentioned circumstances. To handle the impending disaster, Fed has expanded agreements with other central banks that effectively will send dollars abroad and has increased this amount from $290 billion to $620 billion. Excess liquidity will put downward pressure on dollar. Asian Central Banks (ACB) will pursue policy to maintain a strong dollar vis-a vis their currency, so that these countries remain competitive and continue to follow export-led growth. ACBs will further purchase trillion of junk dollars and re-inject in American bond market that would balance America’s current account deficit. The corresponding release of local currencies in domestic market will spurt inflation. Excess circulation of dollar will lure speculators into commodity markets again. Prices of oil and other commodities will rise further. Americans will continue to import manufactured goods and export sign-good viz. dollar. They will enjoy fiscal stimulus and loose monetary policies. World will work hard, save more and still make costly purchases. Morally bankrupt American government will never encourage propensity to save, sacrifice and share. While pursuing policy of ‘privatization of profit and socialization of loss’, the US administration has made gambling and gobbling national pastime US has nationalized trickery and internationalized losses. Roubini’s United Socialist State Republic of America is a domestic transformation. Globally, it has morphed into a Gambler State of America. American policy of swallowing capital will lead to disappearance of capitalism itself. American war against suicidal terrorism has pushed the once powerful nation onto a suicidal orbit. Global economy cannot risk an intoxicated financial driver!
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October 2, 2008
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