Where will the money come from? Who will bail out the governments?
Wall Street plunged again last night, dispelling any notion that this crisis might not be in the same league as the global financial crisis.
In this, the sovereign debt crisis – GFC Mark II if you like – things really are different.
During GFC I, the debt sat in the hands of companies and individuals. It was the governments which bailed them out. Now we have GFC II, the question is: who will bail out the governments?
We are talking about governments in Europe and the US. Australia has plenty of foreign debt but comparatively little government debt.
The answer is: governments will eventually either have to default – throw their hands in the air and say they cannot pay – or they will have to hit up those who do have the money.
Who has the money? The rich people and the big companies. They will be loathe to pay. They will fight it tooth and nail. Nobody likes paying tax, especially the rich. But there may be little choice.
Let’s contemplate for a moment the alternatives.
The alternatives are: one, the situation isn’t that bad anyway, the world will muddle through. Two, the situation is this bad but instead of raising money via taxes, struggling governments can cut their spending instead.
Dealing with the first proposition is unfortunately quite simple. With every day that passes, the slather of global economic data increasingly points to, at best, slowing economic growth and, at worst … let’s not go there.
With the exception of gold and US treasury bonds – the best bets in times of great global fear – financial markets have been mercilessly hammered by sellers for three weeks and, worse, authorities are virtually powerless to stop them.
Already, rates have been sliced to almost zero by central banks on both sides of the Atlantic. All manner of corporate rescues and stimulus programs have been performed in the past two years, only to leave an even bigger load of debt.
And on Monday night the US Federal Reserve came out with its latest response to the collapse, the Harvey Norman option – a two-year interest-free period!
Incredibly, the Fed said it would keep its base rate near zero for another two years. Wasn’t it low rates which caused the problem in the first place, drowning Wall Street and the US mortgage markets with cheap money and blowing up a rollicking big bubble?
It’s a sign of towering desperation, that officialdom is powerless to do anything but inflate the debt and the currency to nothing and overawe one bubble with another.
Moreover, after examining the Fed entrails, or so it said, Goldman Sachs subsequently came out and said the Fed was likely to sally forth with QE3, which is another exercise in simply printing money euphemistically labelled quantitative easing.
They have printing $US2.5 trillion, buying their own debt, radically expanding the supply of money and keeping share prices buoyant on Wall Street.
It hasn’t worked, so they will simply do it again – even though inflation is ticking up on either side of the Atlantic and words like “Weimar” and “Republic” are being bandied about on mainstream talk shows.
Meanwhile, over the sea, the European Central Bank (ECB) took the exceptional step this week of buying Italian and Spanish bonds, aggressively, worried as they are of a domino effect of Eurozone defaults.
So, things are bad. Incidentally, worse for Europe as unlike the US, the Europeans can’t simply turn on the printing press, create more money, buy their own debts and drive down the size of their debts.
To the question of responses then.
Governments are running out of money at a time when economic growth is slowing and so, therefore, is the revenue from their tax receipts.
Thankfully, the Australian government doesn’t have much debt but Europe and the US do, and our prosperity is, to a great degree, bound to theirs. We have a lot riding on the outcome of policy in America and Europe, as does China, who in turn we have even more riding on these days.
Besides the government rescue and stimulus programs during the GFC which bailed out banks and others considered ‘‘too big to fail’’, corporations around the world went cap-in-hand to their equity markets big-time.
In Australia, floats had completely dried up but new equity raised, but secondary market capital raisings totalled a record $106 billion in 2009 alone as most of corporate Australia rushed to recapitalise.
The institutions, large funds managers, bailed out the corporations. Ironically the biggest of these are owned or controlled by the banks and the banks had been underpinned by government guarantees over their funding and deposits.
The upshot of government love and support was on display yesterday as the Commonwealth Bank – which had been allowed to snaffle BankWest on the run and without proper scrutiny during the GFC – handed down a spectacular $6.8 billion profit.
Interest margins fattened too even though management put on usual talk of how tough it was out there. Same deal every reporting season, profits smash records, CEO laments tough environment.
Unlike in GFCI Australian companies are mostly in fine shape, cashed up with low debt levels and ready, for the most part, to withstand sluggish economic conditions should things get tighter.
This is largely the case in the US too, where there is $US2.5 trillion swishing around on corporate balance sheets. The government, on the other hand, would be broke but for another well-reported rise in its debt ceiling last month from $US14.3 trillion.
The furious debate between Republicans and Democrats, which held America ransom until an eleventh-hour reprieve and paved the way for the country’s first credit-rating downgrade, provides the key to the provenance of the next round of bail-outs.
Republicans argued that cuts to government spending were the sole answer to restoring the budget while Democrats wanted to raise taxes. Spending cuts versus revenue rises, those are the two options.
Just as the corporate world recapitalised via placements and rights issues during GFCI, the government world now needs to recapitalise.
Governments can hardly have a rights issue, in the traditional sense like a company, but they do have the choice to either raise taxes or cut spending.
This option will become even more perplexing for administrations in Europe and the US as time marches on. The riots in the UK, have been blamed in some quarters on the Tory government’s austerity programs.
Although the riots are more about straight looting and vandalism, the cause of the mob has arguably been dignified by cuts to social programs. The disgruntled classes can point to government bailing out its mates at the top end of town.
Right or wrong, the mob now has its raison d’etre. The rich are still rich but the poor are poorer.
Washington would be looking at this with some discomfort. If the choice comes down to higher taxes on the rich and the corporations, there will be a battle.
Corporate lobbying and the Republican control of Congress makes it easier to envision violence on the streets than the introduction of higher taxes.
In the debt ceiling fight, the Tea Party was prepared to wreck America’s economic credentials by threatening default in order to force the Obama government to capitulate and agree to spending cuts over tax hikes.
The right wing is violently opposed to lifting taxes. Even last night as markets were again in disarray, here were their laissez-faire proponents calling for tax cuts as the panacea to all ills.
Fairytale stuff. Tax cuts are good for an economy, sure. But not one on the brink of disaster. Like the QE programs it will do nothing but put off the inevitable reckoning with creditors.
Like the family budget in severe trouble the US needs to restore the balance sheet and increase productivity, not go on a family holiday and try to spend its way out of trouble.
The spectre of real violence on the streets if social programs are cut, and recession and the unemployment crisis deepens, is real.
Unemployment on the official numbers still hovers above nine per cent. The likelihood of double dip recession is increasing.
The flipside of raising taxes is damage to demand. That’s also the flipside to spending cuts. Either will expedite the slide back into recession. But at least one will raise money while spending is restrained.
Europe faces the UK-government dilemma too. It’s not a matter of if but when Greece defaults. The industrious countries will not carry the fiscally lazy ones for ever. Germany and France would let the Eurozone laggards go if the choice came down to social unrest in their own countries.
And they may have to make those choices soon. When governments need to be bailed out, where will the money come from? Where is the money?
It’s not a palatable proposition for either the rich or the corporations but governments on either side of the Atlantic are likely to hit them up soon. Call it the government rights issue if you like.
Everyone should have their tax cuts later, when budgets is back in order and stability and growth are restored.
With the riots in the UK, economics and the global financial crisis have now well and truly criss-crossed with social policy.
We are finally at the intersection of Main Street and Wall Street.