Fed Chairman Bernanke testified last week that “the situation in Europe poses significant risks to the U.S. financial system and economy”. This indicates the extent to which financial globalism has become a controlling factor in U.S. economic and financial prospects and policy.
While globalism wasn’t supposed to have that level of influence, there was a memorable warning in the great North Atlantic Free Trade Agreement (NAFTA) debate of 1992. As it was conceived of at the time, globalism meant trade rather than finance, and became a presidential campaign issue. It was at that time that Ross Perot famously associated globalism with a “giant sucking sound” of jobs being lost to low-wage countries.
Today, the issue is financial globalism, not trade, and per Bernanke’s above statement, all efforts are being made to contain or “ring-fence” Euro sovereign and bank meltdown from also taking down the rest of the world’s financial asset valuations and the solvency of the institutions holding those assets.
This is not easy when Euro banks are highly leveraged, perhaps 30 times and funded by short-term financial claims such as deposits or Repo loans that can and do run without notice. This forces the sale of the banks’ troublesome assets, not just for liquidity to retire deposit but also to downsize the book of assets by the above leverage multiple for each dollar of declining net worth.
That all fits the description of a financial crisis (as previously explained in Dominos) but what makes it even more of a government crisis is when the bank’s questionable assets are government debt. The forced selling with few buyers and declining prices only makes it more transparent that the government is near insolvent and can’t backstop the bank’s insolvency as well.
This unstable equilibrium is destabilized one step further when other arm-twisted governments are coerced into providing bailout aid, because the costs of the spreading financial meltdown to them exceed their bailout costs. So the implication of financial globalism is indeed the giant sucking sound of sapping resources across the globe into a financial black hole which used to be called Greece, Ireland and Portugal but is now also called Spain.
This is done with a large multiple of the original bank asset write-downs as all banks are run, and in turn forces business firms to be cash-hoarding machines instead of expanding producers. The combined corporate stock market meltdown and bank asset sale meltdowns create financial multipliers of lost market value perhaps 10 to 20 times the bank’s actual defaulting assets. Such was the experience of 2008.
If the central banks are called in and they are indeed poised to spring into action, it would require a substantially larger asset purchasing infusion than the insolvency losses in the first place. This is because the multiplier of financial shrinkage due to a dollar loss of bank capital is far greater than the melt-up multiplier of a dollar of central bank liquidity. Banks are short of capital and don’t in turn expand with a money supply multiplier of textbook lore when central banks expand, which explains why central bank QEs are in the trillions when the bank losses causing the interventions are in the billions.
So here we are with governments and central banks poised to react with the old game plan of QEs to inject purchasing power into asset markets, but what we need is a new game plan with a reduced vulnerability to global financial interconnections unless fiscal sanity re-emerges. Hence, ring fencing or financial containment means the end of financial globalism as was developed over the last decade.
As the world moves away from financial globalism, expect one of the first and obvious disconnects to be Greece divorcing itself from the Euro currency — or, more rationally, for Germany to come to grips with the idea that they set themselves up to be the easy mark in the Euro game of wealth redistribution.
In response to prospective Euro breakup, both borrowers and lenders are re-aligning themselves to be borrowing and lending in the same country as cross border finance means one might end up holding assets in a declining country currency and owing in an appreciating currency. So private parties are de facto withdrawing from financial globalism even before governments constraints set in.
If and when Greece exits the Euro, financial markets will likely fade for a few hours until it collectively realizes it is better for Greece, Europe and global financial markets, and the flight to the U.S. Treasury and German Bund will recede.
Financial globalism has become a transmission mechanism to spread financial losses across the globe. Hence, the pendulum of financial globalism is now swinging the other direction. Ironically, it will reinforce the reserve currency status of the U. S. dollar despite the U.S. fiscal problems.
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