Is the world standing on the verge of a new phase in the long running saga of the global financial crisis? Could the next chapter of the financial crisis look similar to the one from 2007-2008? Remember how the dead calm of the summer holiday season was disrupted on August 9, 2007, by events in Paris?
While world attention is focused on the current US Congressional debt-ceiling impasse, there are many contributory factors for the financial turmoil that lies ahead, as indeed there were at the start of The Great Unwind (2007-?) involving BNP Paribas and The Great Reset (2008-?) involving Lehman Brothers.
Events are getting too close to call and this could be an extremely volatile summer for the global financial markets. Fasten your seatbelts, there may be sudden turbulence ahead
Challenge 1: Eurozone Contagion
The European pseudo-solution to the problem in Greece may have been fine if Greece were the only member amongst the PIIGS that needed assistance. Not just Greece, Portugal and Ireland, but also Italy and Spain — the too big to fail 3rd and 4th largest economies in the Eurozone — will likely need some level of EU assistance in the near future. A jump in Italy and Spain’s borrowing costs is fuelling fears the Eurozone debt crisis is spreading. There is increasing evidence of contagion in their domestic financial markets and the Tier-1 capital ratios of their banks are coming under increasing pressure. Investors are become increasingly sceptical that last week’s second bailout for Greece will keep the Eurozone crises from spreading to Italy and Spain. In fact, the rise in Italy’s borrowing costs may put in doubt its participation in the next tranche of the Greek bailout in September, according to Eurozone officials.
Challenge 2: European Banks’ Vulnerability
When examined carefully, Europe’s latest plan to prop up Greece looks suspiciously like a Paris-Berlin plan to bolster European banks. The exposure of French and German banks to the PIGS — Portugal, Italy, Greece and Spain — is phenomenal. In fact, the sovereign debt crisis in Europe is masking a fundamental interbank lending crisis and as the value of peripheral governments’ debt declines the banks’ reserve ratios are showing signs of degradation. These crises could easily metamorphose into full blown systemic risk. The impact of trans-European banking crises would be to dry up the lending which fuels the engines of the European economy.
Challenge 3: France’s Woes
There are new warnings being sounded that France — the 2nd largest economy in the Eurozone — could be stripped of its top-notch credit rating without “more efforts” to tackle its debts. The IMF told President Sarkozy’s government that further spending cuts were needed for the country to hit its budget targets in the face of weak economic growth. Given the importance of France as a member of the G7 and one of the pre-eminent members of the EU, the lowering of its credit rating could wreak havoc in financial markets and plunge the European single currency into renewed crisis.
Challenge 4: Derivatives
Remember the 0.6 quadrillion dollar problem* ATCA flagged a few years ago in regard to counterparty risk? Guess what, it is still there! The $600 trillion global Over-The-Counter (OTC) derivatives market is still broadly unregulated although a number of new rules for privately traded swaps — the biggest part of that $600,000 billion dollars — have been proposed by the two US derivatives regulators: 1. Commodity Futures Trading Commission (CFTC); and 2. Securities and Exchange Commission (SEC). Over the course of the three G-20 summits held since the start of the global financial crisis, world leaders have agreed to tighten financial regulation slightly, but only for banks, while leaving other market players — including shadow banking players — free of restrictions and scrutiny. As was true before the crisis, no one is monitoring the almost limitless “virtual” market for derivatives worth $0.6 quadrillion in Over-The-Counter trade, where money moves freely without official rules or contact with the real economy. This is the big elephant in the room and should most asset classes — including equities and commodities — tank, there would be massive counterparty risks brewing in this space that could spawn multiple trans-national crises of the Lehman Brothers and AIG type.
Challenge 5: US Congress Impasse
The US Congress is trying hard to make a solvent government look like Greece. The Senate and the House of Representatives are unable to reach agreement over extending the United States’ $14.3 trillion debt ceiling by the August 2nd deadline. Each day without a deficit reduction deal means an increasing risk of default or downgrade is likely. Even if the credit rating of the US were to go from AAA to AA+, this would not necessarily mean that the US debt was no longer worth holding. In fact, in comparison to the vast majority of sovereign debt issued by governments across the world, the US debt would still remain amongst the safest and most liquid of alternatives. For example, China, India, Russia and Brazil are not AAA. This does not stop them from being major players. However, the way the US politicians have portrayed the crisis, the financial markets may react badly because of the excessive drama that they have injected into the issue of raising the debt ceiling. Quite why a routine challenge has been turned into a crisis is difficult to comprehend because it is unlikely to make any political party look good.
Challenge 6: Crisis of Leadership
In the end, America and Europe might pass or fail in the latest challenges because of their leadership or the lack of it. The leaders seem to be ill-equipped or myopic for the tasks at hand. This is the real tragedy: inadequate leadership leading arcane institutions coupled with financial and government architecture that is incapable of responding in a timely manner to a kaleidoscope of new crises.
The multiplicity of challenges outlined is erupting at a time of slowing global growth. Should this new phase of the global financial crisis occur next, a number of countries with slowing growth may slide back towards recession. On this occasion, the governments have already used up their monetary and fiscal tools. They are not going to be able to deploy them a second time. What turn will the coming phase of the global financial crisis take next? As Mark Twain once remarked, “History does not repeat itself, but it does rhyme!” Are we about to travel back in time to August 2007, September 2008 or some random year from the 1930s?
. Unintended Consequences of Printing Money in Trillions? – 8th November 2010;
. Derivatives Quadrillion Play: How Far Away Are We From A Second Financial Crisis? – 23rd March 2010;
. Quadrillion Playing Submerged Elephant in the Room! – 25th April 2009;
. G20 Summit must focus on Derivatives, Off-Balance-Sheet Vehicles; 8 Bubbles Quadrillion Play Grows 22% to $206k per person-on-planet – 19th March 2009;
. Bank Stress Tests, Liquidity Trap, Black Hole, Top Global Risks, Yen’s Safe Haven, Japan’s Exports, Live Poll, Obama – 26th February 2009;
. The Four Scenarios: Debt Deflation, Hyperinflation, Quadrillion Play and Muddle Through – 15th November 2008;
. The Eight Bubbles: What are the Numbers suggesting? – 8th November 2008; and
. The Invisible One Quadrillion Dollar Equation – Asymmetric Leverage and Systemic Risk – 28th September 2008.
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