Rising sun: A tale of two crises
Policymakers have two ugly episodes uppermost in their minds. The first, and worst, is a return to the 1930s depression. Until the past couple of weeks, a re-run of that horrifically dystopian outcome had seemed inconceivable. Then came the almost...
Policymakers have two ugly episodes uppermost in their minds. The first, and worst, is a return to the 1930s depression. Until the past couple of weeks, a re-run of that horrifically dystopian outcome had seemed inconceivable. Then came the almost complete seizing up of credit markets, the bankruptcy of a few banks and the bail-out in both the US and Europe of a number of other large financial firms.
The good news is that politicians and policymakers seem at last to have grasped how serious this crisis is. A global economy with a financial system that is crippled is not a global economy that is going to grow. Congress has finally passed the Troubled Asset Relief Programme (TARP), which will allow government money to buy up distressed assets from troubled financial firms. With an inter-bank market that has seized up, central banks have been injecting vast amounts of liquidity into the banking system: if banks will not lend to one another, central banks will lend to them instead. Governments have also been injecting capital into troubled banks or getting other, healthier banks to take them over. The UK has offered to inject substantial public funds in its banks and guaranteed their inter-bank funding. To avoid bank runs, some European governments have also been issuing blanket guarantees on deposits. The Federal Reserve Bank (FED), is essentially bypassing the banking system by offering to buy high-quality commercial paper.
By acting both more decisively and with more haste, policymakers will be able to avoid not only the experience of the 1930s but also, so the argument goes, the prolonged agony of the Japanese banking crisis, which simmered, occasionally boiling over, from the early 1990s until 2004 at least. Well, that is possible and certainly desirable. Japan's experience is what everyone wants to avoid. Certainly, the numbers do not make for pretty reading. In 1990, the real, that is, inflation-adjusted, value of Japanese domestic product was JPY444 trillion ($4.3 trillion). By last year that had risen only a quarter in real terms.
The US grew by two-thirds over the same period. But this underestimates Japan's problems because for most of the period since the bubble burst it has been mired in deflation of the ugly, debt-deflation variety, in which the desire to pay off debt drives prices down. Falling prices increase the worth of the output, but clearly are not much reason to trumpet success. In nominal terms, the economy is less than a fifth bigger. But did Japan do so badly? Or should we instead think of Japan as having successfully avoided a wrenching contraction of the sort that the US suffered in the 1930s? The US experience in the 1930s was truly cataclysmic. Per capita GNP fell 38 per cent below trend and per capita durables consumption by more than 55 per cent. Japan avoided that outcome even though its asset bubble was at least as bad as and probably worse than anything experienced by America in the 1920s.
Both the Japanese case and the earlier Latin debt crisis were also easier to solve because regulators practiced forbearance. Bad loans were not marked to market in the same way. Had US banks been forced to provision against their bad emerging debts in the early 1980s, most of the country's big banks would have been insolvent. Emerging debts amounted to about two-and-a-half times their capital.
Those crises were also simpler to solve because only bank debt was involved, most of which was kept on the balance sheets of the banks that had originally lent the money. Contrast that with the present crisis, where these exposures have been carved up and distributed around the world. Even if more and better policy can help avoid a depression, market-based systems, such as those in the US and Europe, whatever their longer-term benefits, will still tend to front-load a lot of the economic pain compared with far more bank-based, un-transparent consensual systems such as Japan's, which look after the system as a whole.
What seems very likely, then, is that the present crisis, which involves de-leveraging by both financial firms and the private sector, will be much more severe in the medium term than was the Japanese banking crisis. It will also lead to growth that is much lower than most now expect and be profoundly deflationary. Inflation is expected to fall very sharply indeed and bond yields to drop more than most people currently expect, thanks to falling short rates and inflationary pressures that are likely to evaporate. It is expected also that corporate profits will fall very sharply and equities to continue to struggle.
• This report was compiled by the marketing department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.
The good news is that politicians and policymakers seem at last to have grasped how serious this crisis is. A global economy with a financial system that is crippled is not a global economy that is going to grow. Congress has finally passed the Troubled Asset Relief Programme (TARP), which will allow government money to buy up distressed assets from troubled financial firms. With an inter-bank market that has seized up, central banks have been injecting vast amounts of liquidity into the banking system: if banks will not lend to one another, central banks will lend to them instead. Governments have also been injecting capital into troubled banks or getting other, healthier banks to take them over. The UK has offered to inject substantial public funds in its banks and guaranteed their inter-bank funding. To avoid bank runs, some European governments have also been issuing blanket guarantees on deposits. The Federal Reserve Bank (FED), is essentially bypassing the banking system by offering to buy high-quality commercial paper.
By acting both more decisively and with more haste, policymakers will be able to avoid not only the experience of the 1930s but also, so the argument goes, the prolonged agony of the Japanese banking crisis, which simmered, occasionally boiling over, from the early 1990s until 2004 at least. Well, that is possible and certainly desirable. Japan's experience is what everyone wants to avoid. Certainly, the numbers do not make for pretty reading. In 1990, the real, that is, inflation-adjusted, value of Japanese domestic product was JPY444 trillion ($4.3 trillion). By last year that had risen only a quarter in real terms.
The US grew by two-thirds over the same period. But this underestimates Japan's problems because for most of the period since the bubble burst it has been mired in deflation of the ugly, debt-deflation variety, in which the desire to pay off debt drives prices down. Falling prices increase the worth of the output, but clearly are not much reason to trumpet success. In nominal terms, the economy is less than a fifth bigger. But did Japan do so badly? Or should we instead think of Japan as having successfully avoided a wrenching contraction of the sort that the US suffered in the 1930s? The US experience in the 1930s was truly cataclysmic. Per capita GNP fell 38 per cent below trend and per capita durables consumption by more than 55 per cent. Japan avoided that outcome even though its asset bubble was at least as bad as and probably worse than anything experienced by America in the 1920s.
Both the Japanese case and the earlier Latin debt crisis were also easier to solve because regulators practiced forbearance. Bad loans were not marked to market in the same way. Had US banks been forced to provision against their bad emerging debts in the early 1980s, most of the country's big banks would have been insolvent. Emerging debts amounted to about two-and-a-half times their capital.
Those crises were also simpler to solve because only bank debt was involved, most of which was kept on the balance sheets of the banks that had originally lent the money. Contrast that with the present crisis, where these exposures have been carved up and distributed around the world. Even if more and better policy can help avoid a depression, market-based systems, such as those in the US and Europe, whatever their longer-term benefits, will still tend to front-load a lot of the economic pain compared with far more bank-based, un-transparent consensual systems such as Japan's, which look after the system as a whole.
What seems very likely, then, is that the present crisis, which involves de-leveraging by both financial firms and the private sector, will be much more severe in the medium term than was the Japanese banking crisis. It will also lead to growth that is much lower than most now expect and be profoundly deflationary. Inflation is expected to fall very sharply indeed and bond yields to drop more than most people currently expect, thanks to falling short rates and inflationary pressures that are likely to evaporate. It is expected also that corporate profits will fall very sharply and equities to continue to struggle.
• This report was compiled by the marketing department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.