Australian Money Forum

[wulfgar]

It appears we are on the verge of the greatest deflation in world history. So far in this decade world liquidity has been on an inflationary bent. The mechanics of this are quite simple. Prior, the greenback was the only world reserve currency. Then the Euro showed, the first currency large enough to challenge the greenback since the demise of the pound sterling as world reserve in the 1920's and 30's.
So the world's Central Banks are moving to a "mixed basket". Primarily this means a Euro set of monopoly money has been thrown into the world money basket with the already existent greenback monopoly money.
So when in the past, there was a greenback dollar competing for goods on the world market. There is now a Euro dollar as well. The results are seen in world trade prices as they are bid up on scarce goods like oil.
This is all fine and well. Governments seldom complain about a bout of inflation.
But what happens if the greenback snuffs out? That is the greenback falls out of the world trade basket? Then the world is chasing the Euro alone. We then have the classic dollar shortage of deflation.
The only way the greenback could survive is if the plan started in mid 2004 was continued. That is raise the cash rate on the greenback 2% per annum until early next decade. Of course this would a dramatic curtailing of the easy life for the US, which has proved politcaly unpaletable.
So "helicopter Ben" halted the program early in 2006 and Fed is talking about lowering rates. The greenback is toast! It seems the Americans are so unwise as to think a bout of high interest rates are worse than their loss of the world printing press. They are very mistaken!
At some point in the near future the world will panic out of the greenback. The only thing that keeps the greenback going, is China and Opec buying excessive amounts of US T-bonds. They can't keep this up forever. And post Chinese olympics will see the practice come to an end.
Japan formerly the great backer of US T-bonds, ceased net purchases in mid 2004. Now the Japanese market is beginning to rid itself of the oversupply of T-bonds. This will be replicated everywhere else.
Post 2008 will see the greenback burn for a few years, until it is no more. Until the greenback is purely the domestic currency of the US, only kept alive internally by exchange controlls.
This thing has happened before. The 1920's saw the inflation created by the pound and the greenback together. Then beginning in early 1929 months before the Wall street crash, the pound began to wink out.
The greenback almost collapsed once before, in August 1979. Then the competitor was gold. Europe and Japan rescued the greenback back then. Otherwise we would have had the depression of the 1980's, rather than the recession!
One can conceive of the printing press staving of deflation. But what happens is one day the inflated product is rejected and ceases to be liquidity. Then you get the deflation!

[wulfgar]

http://www.telegraph.co.uk/money/main.j ... bis124.xml
Money | Telegraph



BIS warns of Great Depression dangers from credit spree

By Ambrose Evans-Pritchard
Last Updated: 9:02am BST 25/06/2007

The Bank for International Settlements, the world's most prestigious financial body, has warned that years of loose monetary policy has fuelled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood.

"Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a 'new era' had arrived", said the bank.

The BIS, the ultimate bank of central bankers, pointed to a confluence a worrying signs, citing mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system.
advertisement

"Behind each set of concerns lurks the common factor of highly accommodating financial conditions. Tail events affecting the global economy might at some point have much higher costs than is commonly supposed," it said.

The BIS said China may have repeated the disastrous errors made by Japan in the 1980s when Tokyo let rip with excess liquidity.

"The Chinese economy seems to be demonstrating very similar, disquieting symptoms," it said, citing ballooning credit, an asset boom, and "massive investments" in heavy industry.

Some 40pc of China's state-owned enterprises are loss-making, exposing the banking system to likely stress in a downturn.

It said China's growth was "unstable, unbalance, uncoordinated and unsustainable", borrowing a line from Chinese premier Wen Jiabao

In a thinly-veiled rebuke to the US Federal Reserve, the BIS said central banks were starting to doubt the wisdom of letting asset bubbles build up on the assumption that they could safely be "cleaned up" afterwards - which was more or less the strategy pursued by former Fed chief Alan Greenspan after the dotcom bust.

It said this approach had failed in the US in 1930 and in Japan in 1991 because excess debt and investment build up in the boom years had suffocating effects.

While cutting interest rates in such a crisis may help, it has the effect of transferring wealth from creditors to debtors and "sowing the seeds for more serious problems further ahead."

The bank said it was far from clear whether the US would be able to shrug off the consequences of its latest imbalances, citing a current account deficit running at 6.5pc of GDP, a rise in US external liabilities by over $4 trillion from 2001 to 2005, and an unprecedented drop in the savings rate. "The dollar clearly remains vulnerable to a sudden loss of private sector confidence," it said.

The BIS said last year's record issuance of $470bn in collateralized debt obligations (CDO), and a further $524bn in "synthetic" CDOs had effectively opened the lending taps even further. "Mortgage credit has become more available and on easier terms to borrowers almost everywhere. Only in recent months has the downside become more apparent," it said.

CDO's are bond-like packages of mortgages and other forms of debt. The BIS said banks transfer the exposure to buyers of the securities, giving them little incentive to assess risk or carry out due diligence.

Mergers and takeovers reached $4.1 trillion worldwide last year.

Leveraged buy-outs touched $753bn, with an average debt/cash flow ratio hitting a record 5.4.

"Sooner or later the credit cycle will turn and default rates will begin to rise," said the bank.

"The levels of leverage employed in private equity transactions have raised questions about their longer-term sustainability. The strategy depends on the availability of cheap funding," it said.

That may not last much longer.

[wulfgar]

The orginal post was from before the cracks in the financial system came into public view. The Northern rock troubles showed in August and were then replicated in every part of the world.
So the BIS wasn't sounding it's alarm for no reason. All appears calm at the moment, but in reality the cracks are getting bigger.
The smart will be dumping stocks. This ride will get worse as each year passes.