Governments are Scared. Really Scared.

The post below this one gives the background to why Governments are borrowing zillions to spend. They’re trying to stop economies declining too much, or too fast because the assumptions made about default rates on loans now underpin a huge amount what we call capital in banks, and potential liabilities for insurers. Governments are trying to slow down defaults on these shaky loans which, through the mechanism described, have become the capital base (and therefore lending base) of the banks.

In short, the basis of capitalism itself, capital, has been undermined by what has been set up in esoteric financial structures.

If individuals and companies default on paying loans at the rate currently predicted, Governments may not be able to fill the hole of all the AAA rated stuff becoming junk fast enough. Regulators will have to shut the banks down or nationalise them – or restructure the banking system entirely (good/bad bank). But because the banks are now so interconnected (see it like STDs passing around an unprotected sex orgy) this would simply have to be a world wide agreed solution – no country could go it alone.

Thats why govts are panicking and printing money and exchanging liquid government gilts/Treasury Bills for the banks worthless stuff. (As an aside, in the US the Federal reserve is refusing to say even to Congress what they, the Fed, have taken from whom in exchange for how much – what we do know is that operation, unvoted on by lawmakers, and with no public disclosure, has cost $8Trillion, more than four times TARP plus the current Obama stimulus package combined – freedom of information court cases pending (Bloomberg LP v. Board of Governors of the Federal Reserve System, 08-CV-9595, U.S. District Court, Southern District of New York (Manhattan). (If you are not a conspiracy theorist check out the history of the Fed on youtube).

We really do not want RBS nationalised because all these crap loans and synthetic instruments liabilities would then have to be guaranteed by us the taxpayer….the liabilities are potentially astronomical – no-one knows or can know what these liabilities are.

Which is why the banks now wont lend except to sure-fire real world good quality borrowers….they’ll need the money themselves… But if they don’t lend, companies will inevitably default on existing loans. Companies commonly borrow money on a “rolling” basis. Its like having a mortgage which you renew each year – you pay it back and a “new” loan for the same amount is made to you on newly renegotiated terms. You need the mortgage each year to live in your house.

But as these rolling agreements come up for renegotiating the banks are not relending. And there’s nowhere else to borrow. So the company simply can’t pay the loan back, and its bust. Even if they can re-borrow, it’s on high interest rates which makes them less profitable, and more likely to default. And try getting insurance on the loan! More expensive loans, and frightened lenders. There is no stopping this. This is why even the politicians are saying that the govt spending won’t fix the recession, but it will be a lot worse if they don’t. Its true. But the costs of preventing the worst will be paid for decades, and even then , we simply don’t know how bad it will be.

What we do know is that the “money” which was “created” to pay bonuses now isn’t there, that the capital the banks and regulators thought they had to lend on isn’t there, that lending shrinks by a double digit multiple of a banks capital base, and that the rate at which borrowers are likely to default is going through the roof, which further downgrades the “assets” when the credit rating agencies examine the books. Companies are losing a lot of money and are looking likely to default on the loans they have (triggering a synthetic market multiplier), and unemployment is soaring leading to further mortgage defaults.

That’s why with consumers and companies stopping spending, Obama/Brown et al have to focus on Govt spending to keep companies profitable (so they wont default and banks can lend to them), and keep people in jobs (so they wont default on their mortgages).

But Govt is losing the battle.

Its why ON TOP of Obamas stimulus package, he’s going to need even more money to fill the AAA rated holes which are already appearing at a frightening rate in banks as credit downgrades hit their capital base of wobbly loans. Everyones hanging on to their cash, not surprisingly, and Govt is all that’s left to fill the gap of spending, but the consensus is its too late and it just can’t be enough.

How will this end?

Well, this is the dramatic beginning to the end of the Anglo Saxon economic hegemony in the world. Even if the worst of a depression is avoided, the interest on debts the UK/US will be paying to China, other States (oil producers mainly), and a wealthy elite of bondholders, will be with us for a long, long time. We already spend more money paying interest in the UK than we do on Defence spending. This constitutes a massive drag on our capacity to recover from recession (lots of interest to pay every year), like Japan. We are moving closer to a position of third world countries who cannot generate enough revenue to ever pay off their debts and the interest wipes out a good deal of the profits they make from their work. If this seems exaggerated, this is from an LSE professor in the FT last week.

“I have spent a good part of my career as a professional economist working on developing countries and emerging markets - in South America, in Central and Eastern Europe and the former Soviet Union and in Asia…. as the recession deepens, and as discretionary fiscal measures in the US produce 12% to 14% of GDP general government financial deficits, [this produces] figures associated historically not even with most emerging markets, but just with the basket cases among them, and with banana republics.”

The UK, of course, is right up there.

That’s where we’re at with borrowing to pay for ameliorating the effects of this banking bonanza hangover.

We’re not going to be third world, but you get the drift.

So a chunk of what we took for granted will go in terms of easy consuming lifestyle of goods, services and energy, as we live under the yoke of either increased taxes (to pay for govt interest payments) or devalued currency (through printing money to pay for govt interest payments). That’s the only way to pay our increased public debt interest (well, we could borrow more….).

It’ll take 2-3 more years to work through, and then there will be no upswing like a V, it’ll be like an L. Once the soufflé is flat it’ll just stay like that because of the amount of interest payments on debt and the strict rules on new lending that will be imposed.

So we’ll just live within our cash means. Less financing deals, less equity release, less credit card ease, less money to borrow to buy houses. So less easy money. Just what you’ve got in cash and savings. You want something, you’ll have to save for it. And it’ll be less easy to create surplus to save.

Not the end of the world. And life will always be fine for those at the Ritz. And not everyones in the same boat.

There’s a book called “The Second Great Depression” which predicted the downfall rather well. The writer was American and was asked what it would be like after it all fell down in the States. After a thought he said it would be like living in England; you mainly work for what you need, not what you want, and have cost free pleasures like walking. Sobering to get a perspective on our country.

Research shows that feelings of wealth are subjective (we compare to others) and as long as we’re fed, sheltered and safe, it ain’t money that makes us happy. Maybe something else can come through when all the clamour dies down.

In the meantime I recommend massaging and being massaged by partners and friends, home baking, making music together, lovely walks, sharing meals with friends and loved ones, a good book, and old fashioned fun and laughter.

Your neurochemistry can’t help but induce happiness if you smile. :-)