Solutions to the Global Financial Crisis

No one seems to be talking about solutions to the Global Financial Crisis, other than printing more money, authorizing more spending to the people who caused the problem, and "maybe" slipping into deficits here in Canada.

At present, some people are looking at this, and going "Why are the rich getting bailed out?" as now the financial markets have stabilized but when one see's the allocation of the U.S. bailout, its to major banks, one of whom has recently taken over another with the obvious question: does this money provide money for such takeovers and merger and acquisition deals to go on and on ... ?

Back to Canada, we are likely to slide into deficits and big ones at that, as revenues dry up. This is not the way to get into a deficit when one is facing twin ills of deflation (recession/depression) and inflation in the price levels by money based injections.

In my UofT days, I called this monetary inflation, "non-natural" inflation, as this price level rate of change was merely from the absence of the Bank of Canada controlling the rate of growth of physical money.

Similarly, I called natural inflation, the phenomenon where people have to adjust to changes in relative and absolute prices, domestically.

The sum of the two, was evidenced in the rate of change in prices, with natural inflation very difficult to measure but implicit in the "inflation" rate we see in "numbers" and feel in our diminishing wages.

As such a theorist, internationally, we have had some reduction in natural inflation via "globalization" and strong work on creating an interdependent world amongst those that formerly were perceived as threats strategically to the Western world. The principal effect of this action was to reduce absolutely prices on some consumer goods, via the transfer of high paid labour to low paid labour, and low externality production, to production with high levels of externalities (pollution, plus).

Financial investments by the major banks and major corporations made this possible, encouraged by their respective governments.

Africa? No threat. No action.

Now a huge gob of non-natural inflation, to reflate failed financial markets, threatens to seriously overtake, and destabilize Canadian families into tightening their spending (and others' worldwide), as there is no relief in sight on the real wage front.

The effects of this are obvious.

Stagnant economies.

Extreme pressure on China to stop its mercantilism policy on its exchange rate instead of just considering further actions.

Higher unemployment from excess production capacity in Canada while likely China builds more capacity.

Where does it end?

A Conservative government supporting globalization, if elected in the U.S. will doom us, like Herbert Hoover.

In Canada, we recently elected a minority Conservative government that prefers to govern as if it had a majority. It hopes to avoid to slipping into a deficit by revenue shortfalls, by cutting government spending, with a threat made to the professional unions that wage increases or palatable settlements are off the table.

In a recession/depression, Keynes would encourage government spending and monetary control. Keynes? Lord John Maynard Keynes, was the genius behind reflating the Western world in the dirty 30's (1930 - 1939).

In our world now, we have the exact opposite policies, with a major mercantilist power disrupting free market economies.

I hate saying this, but it will get worse for many people over this financial crisis that underlies a real economic problem that will not got away simply with money flashed everywhere.

China watches over internet cafe customers in web crackdown

China watches over internet cafe customers in web crackdown

from the Times Online

Consider that our own ISP's will be turned into copyright cops with C-61, our new copyright legislation, how different is this from what Communist China does to its citizens?

Not much in my humble opinion.

IMAGINE PEACE

IMAGINE PEACE

The Sick Patient: the Global Economy

Today, watching some of the coverage of CNBC of the global financial crisis, we had the address of the Fed Reserve Chairman, who said all the money he injected will somehow be reabsorbed but it is not his primary concern i.e. inflation. The message hit the markets like a ton of bricks because the abandonment of the inflation as the primary concern and instead a focus of "reflation" implies a deflation going, on top of the crisis in confidence in the credit markets.

That crisis has been going on since February when the commercial paper market hit a dead end, with new issues not being accepting by banks on credit concerns of the underlying company's and the lack of the ability to float/resell the paper to institutional investors. In February, the Fed in concert with other central banks injected $600 billion dollars in high powered money into the world economy, a stimilus package that in Canada we see in a 3.5% inflation rate so far, with likely more to come i.e. higher rates.

Today the Fed announced an open ended intent to purchase Commercial paper, but in a scary thought, on what terms? Is this a take over of the purpose of a bank in a transaction with a bank's customer? The banks that are solvent, must be scratching their heads on this one, because this must have been a profit centre for their clients. Now they deal with the Fed? Why bother with a bank?

The US nationalized in effect their mortgage industry, wiping out enormous investor wealth.

This is not all going well with markets reacting by reducing the financial assets of investors by another 5% in the US.

Investors only? How about pension plans? And individual RRSP's?

With reactive actions around the globe to increase amounts guaranteed for cash investments in banks, the rush to cash is on.

I look at the above, and realize that this world, is a monetarists managed world. Its not neo-Keynesian, and for those who are not familiar with those terms, John Maynard Keynes was the preeminent thinker to turn around the Great Depression in the 20th century. His tax and spend theories of course were not popular with the elites as they ended up paying a great share of taxes, that governments then spent to reflate, to cause economic growth and jobs to recover.

A neo-Keynesian approach is well overdue for discussion and the Central bankers of the world have to keep their focus back on the price level or we will have serious price inflation, and economic stagnation if not depression like conditions.

The nationalizations and destructions of the financial institutions in the most dynamic economy as President Bush calls his America, is not the solution to the mess. It is causative of more destruction in confidence and in wealth.

I cannot believe there are no more investment bankers left in the United States. Who would have thought that possible a year ago?

The bottom line here is of course the militarism that the US chose to pursue as the answer to a foreign threat that went overboard. While some estimate this as an annual Trillion dollars expenditure, it would seem by cutting taxes, no one is willing to actually pay for that. With an $11 Trillion dollar economy, the US had better refocus on what it can truly pay for and is willing to pay for. A flight to US Treasury securities, might just end with all governments globally backing their own banks cash, as they have started to do.

This is an epic mess.

With respect to Canada, the US has a very bad virus, and when it has to chose between home and abroad, it has always chosen home. We face a very tough time coming. Our Central Bank Governor has also "pushed on a string" by injecting money at a problem that is not solvable my mere money. The lessons of the 70's have been totally lost, and the fix of 80's is going to be painful to relive.

UPDATE 1:
The Central Bank of Australia has cut interest rates by one full percent. The Yahoo article noting this says what I have noted above: "they" are looking for monetary solutions, to pour more money at the problems, and this is very wrong headed in my beliefs.

And Harper is sliding in the polls for his passive approach to the economy. Some pundits who deal with the polls are seeing a Liberal government as Dion has not been resting on his laurels or lack thereof. Resting on what one has done, i.e. contribute to the problem, is not a solution to political success. Cutting taxes in good times especially for those that do not need more money, is not saving the fiscal measures, for when they are needed.

Schiller, Canada's Real Estate Market, and the Worldwide Financial Crisis

Its bemusing to me, to think that anyone thinks that Canada's globalized corporations, including banks, insurance companies and brokerages are shielded from the current financial crisis worldwide.

Its also bemusing to me, that my fellow Canadians are not going to be suffering shortly from this financial crisis, that some call "a crisis in confidence," that some call "a crisis in financial derivatives," that some call "the sub-prime" crisis of the US.

Remarkably, we do not have the "sub-prime" crisis because Canadian's don't get lines' of credit on their homes and spend more than they save (we do).

Remarkably, we do not have the "sub-prime" crisis because we cannot buy a house with 100% financing (we can still until October 28, 2008).

Could our financial institutions play in the derivatives markets (yes)?

And what exactly are the plunges in the TSX telling investors about the sanctity of their financial assets?

Our Bank of Canada Governor, formerly an employee of Goldman Sachs, has overseen the Money Supply, giving us now 3.5% inflation and rising.

How did that happen?

He injected funds like all Central bankers earlier this year, to boost the flagling US economy: in total $600 Billion in "High Powered" money was injected. Inflation a surprise? No. A guarantee.

Robert Schiller, the Arthur C. Okun Professor of Economics at Yale, who studies the housing market extensively, realizes full well that "asset" inflation has absorbed most of the rise in Money supply the Central bankers have over supplied for many years prior with low, low interest rates to "push on a string" the economies of the world, causing many unwise financial decisions, including the period in Canada where you could finance a house purchase 100% through the CMHC or GE Capital.

Well GE Capital has signalled its leaving our market. And the Department of Finance July 9th put an end to CMHC loan's at 100%:

On July 9, the Department of Finance announced adjustments to the rules for government guaranteed mortgages aimed at protecting the strengthening the Canadian housing market. CMHC supports the new parameters and the government’s ongoing efforts to maintain a strong Canadian housing market.

Consistent with the government’s direction, CMHC will no longer be accepting mortgage insurance applications for 40-year amortizations or 100 per cent loan-to-value mortgages on or after October 15, 2008. Those mortgages with a 40-year amortization and the 100 per cent loan-to-value mortgages already insured by CMHC are not affected. CMHC mortgage insurance coverage on these mortgages is good for the entire life of the mortgage.

So Schiller made some comments on the Canadian real estate market and he see's not much difference between the US market (down in excess of 15%) and ours.

For our economy, its coming from the adjustment from asset based inflation we enjoyed, feeling more wealthy, to asset based deflation and price inflation.

For the non-economist, think about money as water (money) being poured into a glass pitcher, and there being two glasses for that water to go into. In Canada, the pitcher has been used to pour into the asset glass. Now its being poured into general prices, and moreover, the asset glass is shrinking, overflowing now with more sellers than buyers in the real estate market at current prices. Where is that overflow of water (money) to go? Prices.

Are the spigots being turned down i.e. interest rates being raised? No.

So what is the expected result? A weakening currency, signifying a troubled country again, with economic problems and a country lacking the leadership to correct these maladies.

How low will the dollar go, as we get more inflation also from a falling currency as most of our consumer goods are imported?

Again, looking at the asset based deflation (securities are included in this category in this post) and price inflation, and the low interest rates still operative at the Bank of Canada, we can expect a below 90 cent dollar, price inflation likely in the 5-8% range shortly, and a deterioration of the employment market.

Nice.

And since we feel poorer as our homes are not salable at what we think they are worth, we tend to look at the debt we have borrowed against it as an albatross over our necks, increasing financial stress, tightening the spending we have discretion over, and well, surprise we get a full blown recession, if not depression (contraction in the economy v. just a decrement in the rate of growth, still above "0%."

That is called "stagflation" and a phenomenon of 1974 through 1980 until the Monetary Control Act was brought in and Paul Volker had to take severe measures (very high interest rates) against high inflation and a sputtering economy.

Is Canada immune? I don't think so. I think our financial institutions while being conservative in their natures as "Canadian" some must have gone for super normal profits, and have gotten caught with their fly's open.

The question for most home owners is: is this 1990 again? I tend to think it is not, that the asset class in real estate will not shrink as much as the financial asset class. Certainly, Robert Schiller see's otherwise and there are certainly differences between the "Homesteader" laws that allow a person to walk away from their home in some US States, and leave the keys and loss in value with the bank, v. Canada where you are stuck with that debt to the bank (but for Alberta and Saskatchewan I believe). That weak law, that lets someone walk away without penalty, leaving the risk of the depreciation of the value of the home with the financial institution is the US "sub-prime" crisis in a nutshell.

That said, with the feeling of being poorer, some may seek to downsize their homes, and normally we see the weakening of the higher end homes in these types of markets. This is being seen in Canada.

Moreover, affordability in a broad way, will contract demand for homes. Less demand mean builder inventories rise, and construction jobs dry up, and the lack of confidence spreads.

Meantime, the resource based economy out west, is still crying for skilled and non-skilled labour as they have an endless demand for the resources they produce (and locally pollute) from the world at large. Will the "mess" in central Canada, and the required fiscal and monetary policies to cure them, impinge on the growth in the West, or will that very growth mask the regional problems that this country is and will face in very serious ways over the foreseeable future?

For more on Schiller and Real Estate , see here. Schiller homepage at Yale.

Ed. Note: Oddly or not, while I was at the University of Toronto, I worked on the fix to stagflation and inflation as my central focus. Reading Schiller is almost like reading me, while he lacks what tools I developed from the work of his chair's name sake, Arthur C. Okun. In situations such as "stagflation," a Value Added Subsidy is required, the opposite of a Value Added Tax in my opinion. Since our Stephen Harper has stoked the economy with the opposite cut in the VAT, he leaves little ammunition left for stimulating the economy out of the "stag" part of stagflation.

globeandmail.com: Harper's claim of 200 new food inspectors not true: inspection agency union

globeandmail.com: Harper's claim of 200 new food inspectors not true: inspection agency union