G&S: Del 21 A crisis of trust in the monetary system - what impact would it have on the world economy?

A crisis of trust in the monetary system - what impact would it have on the world economy?
The situation in the world economy has in the past year been marked by a number of extreme events and equally extreme responses from the governments. We have seen downfall movements in the stock market followed by recoils. We have witnessed a stock market with a rare unprecedented volatility. The word "financial crisis" has come into everyone's awareness. Export markets around the world have shown dramatic decline. Real estate prices have fallen sharply in many countries. Interest rates have been cut to extremely low levels. In many places, unemployment has risen to alarming levels and the number of business bankruptcies have increased dramatically.

Countermeasures have also been at least as extreme. Unfunded government stimulus packages have had small or ¹⁾no impact on the unemployment rates. Poorly managed companies have been granted government guarantees and bail-outs since they have been considered to big to fail. National banks in several countries have been saved in government stimulus packages with the effect of large national budget deficits made possible by using the printing press. Countries have implemented scrapping programs ²⁾like the "cash for clunckers" program implying that fully functional cars are scrapped with governemnt reward money, so the owner taking on a credit can purchase a new vehicle (often a SUV). This despite the fact that credit has been part of the fundamental causes of the crisis to start with. Consumption stimulated by government money without any savings to back up the consumption has been one of the root causes of the crisis.

As follower of the Austrian school of economics, I believe the remark of Milton Friedman and Anna Schwartz in their book "Monetary History of the United States 1867-1960": - "Inflation is always and everywhere a monetary phenomen".

Some argue that the crisis were created by government intervention. Incentives, legal and tax breaks have been given to banks that ³⁾started up business in economically weak areas. Banks have been rewarded for giving credit with lower collateral (subprime). In Sweden, the state controlled bank (SBAB) were in the forefront to push up lending, lowering rates and constantly setting new records in lowering the demand for collateral. This has been a race that the private banks had to follow. We can leave the causes of the crises aside for a while. What is interesting however, is how it will progress.

What will be the next phase of the crisis?

Derivatives, a ticking time bomb?
According to the Bank for International Settlements (www.bis.org) there were USD 687 725 billion outstanding OTC derivates in June 2008 ⁴⁾. BIS is an organization often referred to as The Central Bank of central banks

683 725 billion of dollars (or 683 trillion dollars) , say that sum a couple times. It is as unreal as monopoly money or counting the number of grains of sand on the beach. This is also equivalent to twelve times world GDP.

 ⁵⁾In June 2009 IMF called for the eurozone governments to take urgent steps to clean up the banking system. The purpose was to restore confidence in the banking system and disclose of all possible losses. IMF also warns of hiding banking problems awaiting elections.

⁶⁾Warren Buffet calls the derivatives "weapons of financial mass destruction".

Hyperinflation, where and why?
Throughout history we have seen inflation and hyperinflation repeatadly. In Germany in the 20's, in Hungary during the 50's, in Yugoslavia and Argentina during the 90's and in Zimbabwe during the 2000's. More examples exist and they all share the common fact that they have been preceded by printing an incredible amount of money before the money finally became worthless. The above mentioned currencies however had a relatively peripheral role in the world economy at the time they were printed into worthlessness. 

No currency of large importance to the world economy has so far been inflated to worthlessness. The world currency system is also much more intertwined today than ever before. Currencies like Sterling Pound and U.S. dollar have long been considered as a safe haven for reserves. This has been a fact for both companies and central banks all over the world. A hyperinflation and a collapse scenario, might therefore cause chain reactions involving companies, countries and their respective assets and currencies.

The dollar party
Today the dollar could be compared to a party that nobody wants to leave. Those holding large dollar assets probably know about the continuous dilution of their assets. At the same time, if they would start dumping their assets to the market, they would risk the value of their remaining assets since selling dollar assets could easily start an economic avalanche.

The steady growth in precious metals prices
We have seen a steady rise in precious metals prices. According to some, precious metals function as a safe haven investment in troubling times. Precious metals represent a real value in contrast to paper money. Precious Metals can not be printed or created as electrotic credit by a central bank computer. Some investors also believe that gold is real money and that the rise of precious metal prices is a clear indicator of paper money inflation.

The next phase of the financial crises
The trillion dollar question is what the next phase of the financial crises will be? Will the world economy recover, and if so, what will it recover to? Will it recover to more unfunded consumption? Will all the green shots that many politicians are talking about become reality? Will we see a strengthening in currencies or a slow decline in inflated dollars and pounds, in a race towards to zero? Or will there be a crash like in the movie Rollover from 1981? What do you think will happen?

A clip from the movie Rollover: http://www.youtube.com/watch?v=9PSKWCtzPuI

¹⁾Estimate for stimulus package impact for unemployment (page 4):

http://otrans.3cdn.net/45593e8ecbd339d074_l3m6bt1te.pdf

The outcome,

http://www.zerohedge.com/sites/default/files/images/trajectoryerror.gif

²⁾Cash for Clunkers: Trucks are the most popular buys:

http://mjperry.blogspot.com/2009/08/trucks-are-most-popular-clunker-buy-and.html

³⁾Community Reinvestment Act (of 1994):

http://en.wikipedia.org/wiki/Community_Reinvestment_Act

⁴⁾Derivatives source: http://www.bis.org/publ/otc_hy0905.pdf

⁵⁾http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5479590/IMF-tells-Europe-to-come-clean-on-bank-losses.html

⁶⁾http://news.bbc.co.uk/2/hi/business/2817995.stm