Capitalism died last week, and was then re-born. At least that is one interpretation of what will surely go down in history as one of the most important and eventful weeks ever seen in the world of economics.
Markets certainly seem to think their troubles are behind them. Last week the Dow Jones saw its biggest falls recorded in one day since 9/11, not once, but twice. But the sell off was everywhere – from the deserts of Wall Street, to the gardens of Japan. From Milan to Yucatán.
But then the master of ceremonies, Hank Paulson, made a new mix, and on Friday, and at the time of writing, Monday morning, they celebrated, buying like they had never bought before – and they danced to the beat of a new rhythm stick.
The FTSE 100, for example, enjoyed its single biggest daily rise ever recorded on Friday. It seems capitalism is dead, long live a new type of capitalism, one based on sensible regulation, one based on a benevolent state interfering like a wise uncle, and one based on moderation, as excess and greed are banished.
Okay, that may sound a little over the top, but the above is no more than a reflection of some of the comments flying around the blogosphere over the weekend.
But has Hank really saved the economy? Over the weekend one commentator said George Dubya was the President of the US in name only, the real president was the former Goldman Sachs chairman, turned interventionist, Henry Paulson.
Maybe we need to consider the up and down sides of Paulson’s action, and ask is the worst really over, or is this just another manic dance? And what about the US taxpayers, and the implications for the UK? Maybe, the ultimate consequence of this new paradigm of government interventions is that taxpayers everywhere will say of Hank, he “hit me with his rhythm stick.”
Back in 1992, Francis Fukuyama authored a book entitled The End of History. He didn’t mean literally the end of history, more the end of ideological evolution, that the collapse of the Soviet Union meant the end of ideological conflict and a once and for all triumph of Western liberal democracy.
Some argued the war against terror showed that history was far from over, that the West’s triumph was not guaranteed, but others said that Al-Qaeda represented no more than the final throes of an old order.
But then a new threat emerged, and this time we saw uncanny parallels with the predictions of Marx – that capitalism would destroy itself. Is that what we saw last week, the beginning of the end of capitalism? That may seem like an extreme take on things, but then again, if the likes of George Soros are right, and we have been seeing the unraveling of market fundamentalism, and the crash of a debt bubble 25 years in its making, then the dangers in this era of nuclear weapons become all too clear.
It is easy to criticize Hank, and say he has rewarded banks for failure. Indeed, for the banks on Friday, it must have felt as if all their Christmases had come at once. The US government is to take on all that toxic financial waste – it is to let the bankers’ problem become the US taxpayers’ problem. The US citizen is to bail out those who earned seven-figure salaries.
But if he the government had done nothing, the consequences could have been dire indeed.
Yet this is the odd thing. If the economic situation was bad enough to warrant such extraordinary action from the Fed, then the stock markets should have been much, much lower at the outset. Friday’s buying should have been from a significantly lower start point.
$700bn is a lot of money; in fact, it may be easier to describe it as a $0.7 trillion bail out. By talking in terms of trillions, even if it is percentages of trillions, we perhaps get a better feel of the magnitude of the money involved.
UK GDP is $2.7 trillion. So see the scale of the US bail out in terms of around a quarter of the GDP of the world’s fifth largest economy.
But the monies involved do not stop there. As Capital Economics pointed out: “This bailout will blow the Federal budget completely out of the water. The slowing economy meant that the budget deficit was already on track to widen to around $530bn, or 3.5 per cent of GDP, in 2009. Add in the $200bn for Fannie Mae and Freddie Mac and the $700bn for the new asset-buying fund and the deficit can be expected to balloon to at least $1400bn, or 9 per cent of GDP. It could climb even higher if Congress tags on its own proposals to bail out mortgage borrowers. A deficit of that size would easily eclipse the Reagan deficits of the early 1980s, which never exceeded 6 per cent of GDP, and would rival the deficits run by Japan at the height of the battle against deflation.”
You don’t spend that kind of money without consequences, and one of the big fears floating around at the moment is what will happen to the dollar. On a strict affordability basis, the pound is overvalued against the dollar, but if some of the fears doing the rounds at the moment are proved correct, the dollar could be about to tank.
Then there are the US taxpayers. If they get burdened with the cost of bailing out US banks, then the long-term cost of that will be less spending by the world’s most important consumers. How can the rest of the global economy cope if the citizens from the world’s biggest importer turn into scrimpers and savers?
But this is the big hope.
The hope is that the fundamental problem lying behind the credit crunch has been lack of confidence. Confidence is such an ephemeral thing. No bank can withstand a complete loss of confidence. The most solvent bank could be forced into bankruptcy if people lose confidence in it. If the credit crunch is at heart down to lack of confidence, then the US government rescue should do the trick.
Bear this in mond, in return for taking on debt, the US government is extracting its pound of flesh. The US taxpayer may come out of all this a winner – maybe the US government will eventually make a tidy profit. If this crisis is just a confidence thing, it seems that the action orchestrated by Paulson was spot on, and he really has created a new rhythm for joyous dancing.
But if this is a crisis born of asset prices that were too high; if US households just can not afford their debt – and if US house prices continue to fall – then the US taxpayer may not say: “Das ist gut, c’est fantastique,” instead they may say: “c’est terrible.”
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