Whats Next?

Finance is so weird. The massive imbalances are obvious to everyone and yet there is huge debate about how they will resolve.

I will try to give my 2 cents worth.

The root cause of the problem are the huge foreign reserves built up by over productive undervalued currencies, and for arguments sake I will lump China and Japan together in this even though their bubbles have occurred many years apart. Both China and Japan have beaten American manurfactures successively on the head. What has kept the American economy going is the steadily lowering of interest rates which I think somehow replaces labor with capital although I don’t understand this. Anyway what is easily understood is that GDP and employment have been kept up in America by using other peoples money (Japan and China) to consume and build. This was enabled by lowering interest rates and facilitated by the creditor nations through their willingness to lend at those rates.

Now it looks like this process is coming to an end and I think that we should not look to the past twenty years as a guide to what will happen now because there are too many differences. Globalization is now pretty mature. Accordingly and to make my argument as simple as possible the world should be considered as a single economic unit and now I’m heading in the direction of Reinhart and Roghoff sp? although I have not read their book. But consider this. The savers of the world the Chinese and Japanese have nice looking credits on their investment statements. BUT the statements ultimately represent loans made to their governments. In the case of Japan much of the loans made by the people to the government were spent by the government in Japan to prop up the economy for the past decade or so. In the case of China the loans made to the government have been used by the Peoples Bank of China to buy US treasuries in order to maintain their currency peg.

So globally what we have is a situation where vast amounts of private savings have been entrusted with domestic or foreign sovereign debt programmes and probably all somehow leveraged 10x. Well! you might say what is so unusual about that! And I would say nothing except that the debts are so large and are sustainable only at low low interest rates. I would ask what happens if there is a crises of confidence in sovereign debt?

Remember how subprime was going to be so easy to contain? Lets hope that the emerging sovereign debt crises in member countries of the EU IS contained! The possibility of a global sovereign debt crises is to horrible too imagine. We won’t be merely worried about capital gains or losses on our bonds. Return of funds in a stable currency may be of a greater concern. Crikey now I’ve got myself all worried again.

Feel free to correct criticise or enlarge.