Fri Jan 25th, 2008 at 07:07:40 PM EST
In Asia Times Online, the inestimable Henry C. K. Liu lays out the terrifying reality of where the world financial crisis is headed. In a lengthy article entitled, The Road To Hyperinflation, Fed Helpless In Its Own Crisis, Liu responds to the former U.S. Federal Reserve chairman Alan Greenspan's defensive but arrogant article in the December 12, 2007 edition of the Wall Street Journal, in which Greenspan blamed the current world financial crises on China and the developing world for "saving too much." Liu harshly condemns Greenspan, explains how Greenspan engineered the mess during his tenure as Fed chairman, and concludes that now there are only two options left:
The Fed has a choice of accepting an economic depression to cut off stagflation, or ushering hyperinflation by flooding the market with unproductive liquidity.
The first web page of the article is rather dry, as Liu reviews the fundamentals of how the U.S. Federal Reserve functions. Along in the second web page, things get more interesting. First, Liu demolishes the idea that the current bi-partisan "stimulus" package in the U.S. will do any good, and heaps scorn on the Bush tax cuts of 2001 and 2004 as ill-conceived and implemented without preparation of proper incentives for new investment. And Liu is not shy about pointing directly at the underlying problem:
... for the last two decades, even in boom time, the US middle class has not been receiving its fair share of income while increasingly bearing a larger share of public expenditure. The long-term trend of income disparity is not being addressed by the bipartisan short-term stimulus package.
Liu then surveys the explosive growth of credit swaps (CDS) (now at $45 trillion, three times the size of U.S. GDP) and collateralized loan obligations (CLO), and details why and how the loan insurers like MBIA and Ambac Financial were brought to their knees, and explains how the crises is now heading toward territory outside the banking system and will soon cause the collapse of companies other than banks.
For the insurers to maintain the necessary triple-A rating, their capital reserve would have to be repeatedly increased along with the premium they charge. There will soon come a time when insurance premium will be so high as to deter bond investors. Already, the annual cost of insuring $10 million of debt against Bear Stern defaulting has risen from $40,000 in January 2007 to $234,000 by January of 2008. To buy credit default insurance on $10 million of debt issued by Countrywide, the big subprime mortgage lender, an investor must as of January 11, 2008 pay $3 million up front and $500,000 annually. A month ago, the same protection could be bought at $776,000 annually with no upfront payment.
Credit-default swaps tied to MBIA's bonds soared 10 percentage points to 26% upfront and 5% a year, according to CMA Datavision in New York. The price implies that traders are pricing in a 71% chance that MBIA will default in the next five years, according to a JPMorgan Chase & Co valuation model. Contracts on Ambac Financial, the second-biggest insurer, rose 12 percentage points to 27% upfront and 5% a year. Ambac's implied chance of default is 73%.
As big as the residential subprime mortgage market is, the corporate bond market is vastly larger. There are a lot of shaky outstanding corporate loans made during the liquidity boom that probably could not be refinanced even in a normal credit market, let alone a distressed crisis. A large number of these walking-dead companies held up by easy credit of previous years are expected to default soon to cause the CLO valuations to plummet and CDS to fail.
At he begins to wrap up, Liu is not interested in taking prisoners.
The last decade has been the most profligate global credit expansion in history, made possible by a new financial architecture that moved much of the activities out of regulated institutions and into financial instruments traded in unregulated markets by hedge funds that emphasized leverage over safety. By now there are undeniable signs that the subprime mortgage crisis is not an isolated problem, but the early signal of a systemic credit crisis that will engulf the entire financial world.
Both former Fed chairman Greenspan and his successor Ben Bernanke have tried to explain the latest US debt bubble as having been created by global over-saving, particularly in Asia, rather than by Fed policy of easy credit in recent years.
Yet the so-called global savings glut is merely a nebulous euphemism for overseas workers in exporting economies being forced to save to cope with stagnant low wages and meager worker benefits that fuel high profits for US transnational corporations. This forced saving comes from the workers' rational response to insecurity rising from the lack of an adequate social safety net. Anyone making around $1,000 a year and faced with meager pension and inadequate health insurance would be suicidal to save less than half of his/her income. And that's for urban workers in China. Chinese rural workers make about $300 in annual income. For China to be an economic superpower, Chinese wages would have to increase by a hundredfold in current dollars. . .
Not only do Chinese and other emerging market workers lose by being denied living wages and the financial means to consume even the very products they themselves produce for export, they also lose by receiving low returns on the hard-earned money they lend to US consumers at effectively negative interest rates when measured against the price inflation of commodities that their economies must import to fuel the export sector. And that's for the trade surplus economies in the developing world, such as China. For the trade deficit economies, which are the majority in the emerging economies, neoliberal global trade makes old-fashion 19th-century imperialism look benign.
The role central banking plays in support of this systematic fleecing of the helpless poor everywhere around the world to support the indigent rich in both advanced and emerging economies has been to flood the financial market with easy money, euphemistically referred to as maintaining liquidity, and to continually enlarge the money supply by financial deregulation to lubricate and sustain a persistently expanding debt bubble.
Concurringly, deregulated financial markets have provided a free-for-all arena for sophisticated financial institutions to profit obscenely from financial manipulation. The average small investor is effectively excluded from reaping the profits generated in this esoteric arena set up by big financial institutions.
Greenspan blames "the Third World, especially China" for the so-called global savings glut, with an obscene attitude of the free-spending rich who borrowed from the helpless poor scolding the poor for being too conservative with money.
Yet Bank for International Settlements (BIS) data show exchange-traded derivatives growing 27% to a record $681 trillion in third quarter 2007, the biggest increase in three years. Compared this astronomical expansion of virtual money with China's foreign exchange reserve of $1.4 trillion, it gives a new meaning to the term "blaming the tail for wagging the dog".
Liu's conclusion is stunning in its brutal truth:
While the equity markets are hanging on for dear life with the Fed's help through stealth inflation, the bond markets have collapsed worldwide, with dollar bond issuance falling to a stand still, euro bonds by 66% and emerging market bonds by 75% in Q3 2007. Lenders are simply afraid to lend and borrowers are afraid to take on more liabilities in an imminent economic slowdown. The Fed has a choice of accepting an economic depression to cut off stagflation, or ushering hyperinflation by flooding the market with unproductive liquidity. Insolvency cannot be solved by injecting liquidity without the penalty of hyperinflation.