It is all over bar the shouting

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By Cees Bruggemans

How to identify the ultimate tipping point?

When the water broke on the greatest of all global financial crises, on our Women’s Day last year August, both the ECB and the Fed intervened, injecting something like $100bn each on the day.

This past week, following Lehman’s bankruptcy, Merrill’s self-sale and AIG’s nationalization, the rudderless world lost it completely, requiring $600bn of central bank intervention to be propped up and staying functional.

More important, the piecemeal approach to solving the complex global financial crisis was coming to an end.

Once the realization took hold that 1000 banks globally might already be in the vortex to destruction, you know you have reached the end of your rope.

Even $600bn of intervention in one week is then still only a small ineffective gesture.

Either the global financial system is going to implode, with trust totally dissolved and bank funding generally grinding to a halt.

Or the ultimate weapon is to be mobilized.

The ultimate weapon, as in war, is the state. Not just any state, like tiny Monaco, but a serious bruiser. Such as the United States.

National income $13 trillion annually. National wealth nearly $50 trillion. National debt $4.5 trillion.

As you will notice, one no longer bothers with billions. Suddenly there is a thousand-fold jump into trillions.

Depending on whom you want to believe and which accounting approach you want to use, the Iraqi war has so far cost as little as $600bn and as much as $2 trillion, with annual outlays still over $100bn.

Fixing the current global financial emergency across all asset classes, institutional types and regions would also cost some $2 trillion (with $500bn already paid down), just over half of it in the US.

So we are merely talking here the equivalent of another Iraqi war to settle the books. And that is before adding back what the eventual sale of currently distressed assets will still generate (and possibly even turning a profit for taxpayers).

Really, that’s manageable, don’t you think?

There are some loose ends.

Currently outstanding US public debt is $4.5tn or 33% of GDP. Add the now nationalised Freddie and Fannie housing mortgage stuff ($5.5tn) and you are up $10tn. Add another $1tn for the remaining crisis cleanup and you get a round $11tn or 90% of GDP.

That may change the risk-rating of the US. But then perhaps it won’t immediately, if such decisive action clears the air and the world economy can get back to work, with confident optimism noticeable back to the fore. Exuberantly even.

Apparently, the global vortex opening up last week was the last straw. It usefully generated the political will to finally come up with a comprehensive approach to the global financial problem, which was until very recently shaping very badly.

Simply buy all bad toxic assets off (American) banks (not hedge funds) wanting to offload, with an appropriate haircut, of course.

Private shareholders in offloading institutions shouldn’t go scot-free, senior management and directors should be ‘replaced’, and the world should get back to risk-taking, making, lending and borrowing money.

The US government would end up with an inventory of anywhere up to $1tn in toxic assets, and once sanity and reasonable valuations have returned to global markets, it could start the long process of auctioning off such assets, trying to recoup as much value in order to minimize the bill for US taxpayers, potentially even turning a profit.

An additional twist was Democrat insistence that US homeowners would also get a fair shake, with some of their excessive debt forgiven (presumably at the expense of the banks).

This plan has been talked about already for many months, but it would seem this weekend things finally got serious in Washington, with Bush officials (Paulson), independent experts (Bernanke) and Congressional leaders sitting down and staring into the global abyss and collectively pulling the needed rabbit from the hat.

Congress was about to go into recess later this week, in preparation for the November elections, but looks like delaying its departure by a week.

So if the world isn’t to be toast shortly, the deal needs to be done this week. Deal? Congressional approval for the US Treasury to go and spend a trillion Dollars on toxic assets and make the best of a sad situation.

So is it all over?

Not quite. Only by this Friday, with Congress about to go into recess, will we know for sure whether authority has been granted.

But judging by the handstands being done by global markets since Thursday last week, this is a done deal.

It is all over bar the shouting.

We can breathe again, live again, without fear of a global financial meltdown causing all of us to relive the 1930s depression, or worse.

Keep your fingers crossed, however, that US politics doesn’t intervene at the 11th hour and prevents this ultimate of lifeboats being launched in time.

What does it mean for South Africa?

Global borrowing spreads and costs should collapse once again to more normal levels, though not to pre-crisis levels, which are now recognized as having been extraordinary low.

Risk appetite is reviving, and with nothing as risky as commodities, emerging markets and oversold current account deficits we are apparently an attractive buy.

No wonder the Rand is reviving back towards 7.50:$.

Unless oil and agricultural commodity prices come roaring back, it would mean the main latent inflation risk (precipitous Rand decline) has been unnerved.

And thus the final hurdle would have been cleared for a clean collapse in our inflation rate back towards the target zone next year, without any big risk of something unknown ambushing it (unless it were to be our own politics, a traditional hazard we all know about).

With the Rand firming, oil and agricultural prices down, the economy weakening, latent US financial risk undone, and our inflation on skids, presumably nominal interest rates can be expected to follow lower as well.

As to timing, it may take a few weeks to get confirmation of oil remaining low, the Congress giving its blessing, the Rand firming again towards 7.50:$ (beyond which the SARB starts to accumulate Dollars aggressively), and our inflation actually to be seen tottering and starting its majestic slide.

The fixed-income market is already there, with long bond yields sliding. BER inflation expectation surveys will take a little longer to collect.

But at some point, like a truly proud parent, a beaming SARB can be expected to announce to the world the blessed tiding of a job well done and mission accomplished.

And the rate cutting will be upon us.

Only in measured moves, of course, given our undersaving, export underperformance and import overindulgence, and the consequent 7%-9% of GDP habit of dependency on the rest of the world we have made our own and need to kick.

And this better be achieved the sooner the better, presumably by growing our consumption more slowly and boosting our exports and savings more impressively.

All of this wouldn’t come a moment too soon to prevent the economy from sliding even deeper into the gathering lethargy already observable now in too many sectors.

Source: Cees Bruggemans, FNB, September 22, 2008.


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