“How should one define a catastrophic scenario in a situation such as this?”

Frankly has been so kind as to translate my most recent post. The original French version is here.

“How should one define a catastrophic scenario in a situation such as this?”

There is no panic yet in the American financial markets, but disquiet is spreading. The Dow Jones industrial index fell by 3.3% over the last four trading sessions, half of the decline occurring yesterday.

During the fateful weekend of September 13th and 14th of 2008 the upper echelons of American finance conducted a review of all that could turn sour if they let Lehman Brothers go under.Everything was thought of, except the money market, the short-term capital market, which today has a trading volume of $338 billion. What a pity, as that is what collapsed, causing a blood-letting which it took nearly $1 trillion (a thousand billion dollars) to bring under control.

This is what explains why all eyes are now fixed at this moment on the money market and why everyone who expects to be needing fresh capital in the next three months is scraping the bottom of the barrel for a little ready cash. The first casualty, of course, will be recruitment of staff, as if recent news about the employment market allowed much scope for this! The second casualty: business investment.

Prices of bonds reaching maturity in August have begun to go down over the past few days, but not as much as might have been expected, which is taken by some people to be a further sign that the debate on raising the US debt ceiling is merely a storm in a teacup. But this relatively mild effect at this point is only due to the fact that the dollar is a reserve currency, there being not too many known substitutes for American debt in the financial markets – and in sufficient quantity – to serve as collateral, i.e. security for deposit as a guarantee. A downgrading of the credit rating for US debt will cause a rise in interest rates and a simultaneous depreciation in the value of these debt instruments, which will force those holding them as security to make a ‘margin call’, which means demanding additional guarantees to make up for loss of value. And this will also apply to the infamous Mortgage-Backed Securities, securities backed by mortgages, which in the United States are nowadays almost all issued by Fannie Mae and Freddie Mac, which are Government-Sponsored Entities, which would have to be wound up, moreover, if found to be in default for more than sixty days, which, according to some commentators, is an outcome that the Republicans are secretly hoping for.

A downgrading of the US credit rating will put the base rate up by only 60 basis points, i.e. 0.6%, which represents an increase of $100 billion in the annual cost of servicing the debt, it was stated last night, but this figure is based upon the supposition that the rating agencies will content themselves with lowering the US credit rating from AAA to AA, even though, in view of the slow rate of progress of efforts aimed at reaching a compromise on raising the ceiling of American public debt – the Republicans opposing all increases in taxation and the Democrats giving no ground at all on proposals aimed at dismantling social-security provision – this should now be regarded as an exaggeratedly optimistic hypothesis. In so far as there are internal regulations here and there limiting the holding of debt instruments to those carrying a AAA rating, which would oblige holders of American bonds to find substitutes for them, this is a gamble, to the extent to which the rating of most of the private American debt instruments is linked to federal bonds, the guarantee offered by the state protecting them up to a point. There were, accordingly, reports in the press yesterday that certain foreign bonds, i.e. several Israeli ones and an Egyptian one, would also be subjected to an immediate downgrading because they are 100% guaranteed by the United States.

And these are only the ramifications which have been thought of at this point. In this connection it should be borne in mind how it dawned on people in the autumn of 2008 that it had come to be the case that in the world of finance everything is intertwined with everything else and vice versa. Clearly, the game has only just begun. I shall leave the last word to a businessman who was interviewed in the Wall Street Journal for its Wednesday edition: “We are preparing for a catastrophic scenario. But how should one define a catastrophic scenario in a situation such as this?”

One thought on ““How should one define a catastrophic scenario in a situation such as this?”

  1. Catastrophic scenario, it looks as if we might be heading towards one….this one will be worse than the one before and the next one will be worse than this one, because the politicians do not come with a solution, hopefully the West (G7!) will find the right answers to help us all out…see below?

    The main thing governments seem to be able to come up with is cuts!

    That means more unemployment. First of all I agree that a basic budget discipline is required of all of us, that is only good housekeeping, however to now punish all the people that are not at the steering wheel of the current (and the one of 2009) crisis is sick…the movers and shakers are to blame!

    The main possibilty to solve the problem lies somewhere else, correct the lack of revenue/income., create real jobs!

    The subject has been raised about the value of the currencies, yes, the Yuan is far too cheap, the Chinese do not seem to see the necessity to drastically change that…they are holding a hell of a lot of dollar bonds….

    Then may be we should devalue the Euro, the dollar, the pound and the yen, the Chinese would not like that either….. leaves only the answer given my be below:

    I wrote this as a remark on the stupid infighting in the USA about raising the deficit.
    “Some of the contributors, seem to aim at the houses instead of blaming the president of the day in the building op of earlier deficits…and indeed look at the current situation …, do we see any of President Obama’s ideas in this solution…no….he had to give in to because of the blackmailing … from the side of conservatives in politics. In the current situation his ideas would have been far better for the country.

    Have the Democrats been street fighting for their cause in the past, like the right wingers have done this time?..no, there was reasonable for and against and, generally speaking, an intelligent political climate things have changed for the worse in a terrible way since the rise of the tea party.

    We all in the West suffer at the hands of the tea party and the neo-con based populist, anti Islamist, and anti Europe movements in Europe “fact free policies” in combination with laisser faire economics are still at the top of the charge, it is really time for a new tune.

    Regrettably we seem to be going insane because of this crisis, look at Europe, that, with a far better running economy, is still being pushed over the brink by financial manipulators like Standard and Poor, Moody’s and the like, after all these companies are paid by investors, who, WANT TO MAKE MONEY, at any cost (for the people) and that all because also there populist run the anti progressive show.

    Of course the big problem in economics is not the deficit in the budget, which is only a consequence of other far more important factors, the non ability for lots of people to make a decent living. I wrote down earlier on the discussion about the difference in opinion between economists:

    “Is not there a conflict of interest between business economy (outsourcing…cheapest location for labor)/financial economy (profit for the shareholder) and the national (social) economy.
    The latter demanding proper wages, based on our level of cost, allowing us to buy goods…that are currently made by our companies on foreign shores?… Hence, the impossibility of significantly creating jobs out of QE?

    Was the problem of a high tech and liberalized future probably overseen when Reaganomics started to grab hold of the economic thinking?

    In that period China was still an isolated country, Russia was badly governed, Brazil was more or less a banana republic….this all changed since the end of the Reagan era, big milestones 1989 (Eastern European and Russian “revolutions” 1995 opening up of China and since of course India has to be added as well and so has Brazil.

    Reallocating exported jobs (good example of money made by workers outside the country working for American companies…I-Pod, I-Mac) would actually need stronger government, more jobs to create more jobs, because effective change must be “promoted”

    i.e.
    1)Import tariffs of 50-100% on the production (FOB) price of imported too cheaply produced goods (difference in wage level of up from 3:1) produced for home based as well as for competing foreign companies . (countries’ traditional produce should be exempt) and ban the lobbying on behalf of outsourcing businesses. (In an ideal world all lobbying should of course be banned.)

    2)Only in case the low wage countries increase the salary’s for industrial workers substantially (25%) per year (Fordism), in order to create more home consumption…this tariff should be reviewed.

    3) Investment in solar energy and, for instance, desalination plants to recreate fresh water. Solar energy would strongly help to improve our trade balance. (no import of oil) and would create a lot of profit making jobs. (In Europe/North Africa Desertec could be a gigantic work and revenue creating project)

    4) Re-introduce reasonable taxation for the very high earners. (quit often these profits result from profits, made on outsourcing/ boundaryless thinking, or financial manipulation of other men’s earnings)

    5) Create new industries cradle to cradle for instance. And invest more in our existing advanced technology base, space techniques for instance.

    It will take ages for us to be competitive with China again and, after all, they owe their current economic power to our – all be it quite often forced upon us,- willingness to share knowledge…and they have come far enough now to stand on their own feet!

    After all they work in a way that capitalism (our capitalist greed) supports communism, in fact they handle their economy in a proper Marxist based way, the game with the tampered dice is always in sight, Marx is still very popular in China, he has helped them a lot…his analyses were always right, but until the current Chinese way of supporting their people, his ideas have always been interpreted incorrectly.

    The government there strongly promotes (with the support of the IMF and our..multi nationals’.. low cost/high profit attitude) low inflation (maximum 10%)
    At a salary difference of 1:10 that means that if our incomes stand still, it would still take at least 25 years for them to come along side this country…Can we wait that long?

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