Saturday, 4 April 2009

Has systemic risk been eased by de-risking marginal economies?

Assuming that the International Monetary Fund (IMF) is fully funded in line with the G20's communique and expressed commitments, the risk of individual or even multiple failures at the nation state level, especially in the emerging markets of Eastern Europe will have receded substantially.

Removing the likelihood of sovereign defaults will undoubtedly help to ease the nervousness that global capital markets were feeling as they began to choke on a massive supply of gilts, bunds and Treasuries without also having to worry about more exotic paper from countries which many players couldn't even find on the map.

Also a major precedent was set by allowing the IMF to engage in its own form of Quantitative Easing by allowing it to "conjure up" SDR's, its own international currency, to the tune of $250 billion. This is a novel undertaking and opens the door, in a manner that is no longer just a theoretical possibility, to the notion that there are no constraints as to how much "liquidity" could be provided by the wise men at the IMF. It also could give rise to a new variant on the private gain/public pain asymmetry where effectively the international bank will be providing a planetary-funded safety net under the global financial system.

So should we all now feel safer as corporate welfare becomes transformed into a new supercharged form of welfare for all risk capital that is deemed by the IMF as too big to fail and worthy of support through periods of what, they may well come to believe, are merely temporary liquidity crises?

My contention is that in de-risking marginal economies and marginal industries/sectors we have not decreased the likelihood of systemic risk but may in fact have massively enhanced it. But that may not become apparent for a few more years.

For the time being we may have bought time for the repair to global balance sheets by sowing the seeds for an eventual resurgence of real estate backed asset values. To that extent it may be that the legacy assets will, in the not too distant future be looking far less troubled than they do at present.

Longer term it is hard not to see that the price we will be paying for this will be commodity based inflation of perhaps an extreme kind. The world's non-renewable and finite resources will not be magically extended or become more abundant because of the decision to increase the purchasing power of marginal states and entities that really should now be undergoing root and branch restructuring exercises.

In the quaint old days before the conversion to Quantitative Easing there was - despite all of the ineptitude of bankers and regulators - at least some attempt to monitor the value of assets and liabilities on a constant monetary basis. But how can one preserve any semblance of financial prudence when nearly all notional capital risk of entities deemed to be of strategic importance by national governments, and now by international rescue agencies as well, have an implicit liquidity guarantee which is under-written by an ever expanding global money supply?

We appear to be emerging from the current financial crisis with an heroic new leap of faith in which we are truly casting our fate to the wind. The leap of faith is based upon a belief that citizens of Planet Earth can continue to finance ever larger deficits by the creation of ever more notional debt.

In an act of innocent mass hypnosis, and I genuinely believe that the prime movers at the G20 meetings in London this week were not cynically and malevolently concocting what they knew to be a phony solution, it has been declared by edict that the global financial economy is too big to fail.

It will not be the first time, or perhaps the last time, that the future of humanity rests more on optimism and hope than on logic and realism.

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