We see global financial crisis tsunami every two years 1998, 2001, 2006, 2008 and again 2011, Why? What’s wrong with the fundamentals? Is our global economy riding on another BUBBLE? What can stabilise it? Let us begin from the very root cause. It all started, with the biggest fiscal stimulus or free money, we have ever seen in the history of modern world, circa $1 trillion US Dollar. You are in USA or EU? Have you taken a large home loan or have you kept your savings in stocks, mutual funds or bonds? If not then your can relax, but all of those who did are living on borrowed times. This is the story of the greatest financial crisis of our times, the one that is on its way.

Bail Out Packages

USA spent hundreds and billions of dollars since 2001 as Bial Out Packages to show they were doing something but problem was they did not properly designed it and not as effective as they should have used it. So, when they start loosing money on wall-street.  They thought, hey we got to get back in the game and get the dice rolling again. Let’s start another bubble; you think dot com bubble was very big. We got a bigger one; we call it the real estate credit. The problem is they never actually cured the crises; they gave alcohol to the drunk. It dose not sober him up. It sets him up for a bigger hangover, so at some point he can’t drink anymore; he reaches the end of his ability and you kill the patient. This is where USA presently is “OVERDOSED”.

George W Bush Jr, statement – “I know many Americans have questions, tonight. How did we reach this point in our economy? What does this mean for your financial future? These are good questions and they deserve clear answers”.

The Beginning 9/11 – 2001

They took down the symbols, the Financial Symbols of America. The twin towers of the World trade. The whole companies went missing. The story of the great financial crisis begins just like many other stories of our era in Unites States. On September 11, 2001, the terrorist knew exactly what they were doing, striking at the ultimate symbol of the global economy. They did it when USA was already slumping into a recession after the dot com bubble had burst.

Alan Greenspan (Chairman of the US Federal Reserve, 1987-2006) said : “Despite the tragic events of September the 11^th. The foundations of our free society remains sound and i am confident, that we will recover and prosper as we have done in the past”.

FIRST CYCLE BUBBLE
Interest Rate Cut to 1%– Steroid for Recessionary economy

In spring 2001, the Federal Reserves started lowering interest rates. During 2001 the interest rate was lowered from 6.5% to 1.75%. In 2003 it was cut all the way to 1% and it remained there for a full year. It continued lowering rates to save companies on the brink and to keep unemployment down.

Immediately after 9/11, the president of the United States George W Bush told the people to be good Americans and go out and shop. But how are they going to do it? You are in a recession. Federal Reserves comes to the rescue providing loans @ 1%. Federal Reserve chairman Alan Greenspan in his memo writes, that he knew that low interest rates might cause a bubble BUT he did not stop.

ITS PARTY TIME traditionally central government removes the punch bowel once the economy starts churning or business cycle starts. The interest rates can’t remain low for too long or people will do things they regret later. This money has to be used on planned and skilled resources. However, it was given to people for consumption and not for investment. Alan Greenspan argued that the Federal Reserves should never remove the Federal cushion but rather keep pouring money in the economy when the recession kicks in. The Federal Reserve would buy all the debts and mortgaged assets clogging the business cycle. Banks and speculators loved it, now they could take greater risk than ever before. If they were successful they could keep the profits and if they were unlucky. Federal Reserve would rescue them. This means every time capitalist fall in trouble Federal Reserve give them candy (Bail out packages).

American citizens went on unprecedented global spending blench. They borrowed and spent Trillions of Dollars to buy consumables. All Federal money worked as alcohol provided almost free.

SECOND CYCLE BUBBLE
Real Estate Credit

In the world, which was suddenly uncertain and the country under attack after 9/11. Nothing felt safer than investing in your own home. In the American dream “OWN HOUSE”.

1^st Bail Out package - $ 440 Billion Dollars

17 June 2002, Then President (U.S.A) George W Bush Jr, – “I do believe in the American dream. Just here right in America if you own your own home u are realising the American dream. He introduced the Govt $ponsored corporations that help create a mortgage system. I introduce to you the leaders today, Fannie Mec and Freddie Mac as well as the Federal home loan banks; they will increase their commitment to the minority market by providing more than $440 billion Federal Dollars. This will use Tax Payers money to help a qualified lower income buyer make a down payment”. Said in his public address

NOW! If you buy a home with almost nothing down. Then you do well if the prices continue to go up. If it goes down, then you can’t do anything but walk away from it and let the banks have it. Low Interest rate caused a housing bubble. Cheap loans encouraged people to buy more and bigger homes, housing prices began to rise by 10% per annum, so many took out a second mortgage on the old house to fund consumption.

Now if Americans want go on a vacation, buy some new clothes and put some addition to their houses. You don’t have the money, how about a home Equity loan? Use your house as a piggy bank. The banks granted loans to almost anyone. Why would you need a decent income to buy a home if you can get rich by just living in it? The market even coined the termed NINA loans. NINA (NO INCOME NO ASSETS, no problem you will get loan anyway).

The legislations were more aggressively pushing lenders to lend the people with modest means, people whose incomes were 80% of the median income or below. Politicians encouraged this for a long time both left and the right political party, have been encouraging home ownership. They created deductions, subsidies and insurances. They created two huge mortgage financing companies FannieMec and FreddieMac. Their job was to use thousands of billions of Federal Reserve money to insure loans for people who couldn’t get them on the open market. They were Government $ponsor Enterprises. They had private owners but they were created by congress and their transactions were guaranteed by the government. Hence in case even if investing giants lost money on defaulting home loan payers, no worries they will be replenished by Federal Dollars. This means Houses bought by American citizens were $ponsored by Federal Reserve Dollars (Tax payer money). Just to keep America a global consumption machine and keep dollar in demand.

Reporters asked Former Chief Economist of Freddie Mac what they got for their money. He replied “I don’t know, that’s a tougher question; they had a pretty good charter. It was a case where the regulatory structure was compromised.

This showed that there was a huge moral hazard courtesy of the Government in the mortgage market. When the government through Fannie Mec and Fraddie Mac started to guarantee mortgages, then the lenders no longer worried of getting their money back because the Government said we guarantee it. Well greed has to be balanced with a certain amount of fear. That’s what down payment and amortisation rule is all about to keep people from getting carried away by the greed of buying a house and making profit by selling it at a higher price. This is the moral hazard once you say you can buy a house with no down payment. All of a sudden there is no risk to the borrower. He doesn’t fear if he over pays because if the house keeps going up he makes money. If it stops going up the bank losses the money in turn Federal Reserves guarantees bank.

US have moral hazard in the Banking system US government guarantees all Bank deposits, what that mean? The depositors don’t care what the banks do with their money once they deposit it because they know the government guarantees it. The banks inturn lends money to the home buyers without any income verification due to strong legislations in place. Such finances were guaranteed by the government the reason is the private sector would not guarantee such crazy loans. So government used tax payer’s money to guarantee such hazard.

The big banks dared to make riskier loans because they had started repackaging these loans and started selling them to others as securities. They sold them to each other, to Fannie Mec and Freddie Mac and they sold them to Norway, to Germany and to China who picked them in large numbers to sustain it own overheated economy depended on US consumers for selling their manufactured goods. Now if the loans turned bad, some one else will end up with the hot potatoes.

Every body wanted to buy these securities because the rating agencies that rated the securities, gave the mortgage packed bonds their highest rating AAA, which promised huge payoff at almost zero risk. The rating agencies just thought the house prices would just keep raising. After all these securities were selling because of these ratings.    

They were great days but it was all based on the market on steroids (Federal Reserve Bail out Packages). Loans were cheap enough to keep driving housing prices up. In 2006 when the interest rates returned to normal level. The spell was broken. People could no longer get new loans to pay off their old ones. Those who were given a mortgage despite of very low income couldn’t afford to stay. The prices started falling making the mortgage packaged securities increasing worth less. The rating agencies removed the high ratings from the securities. Investors who never looked beyond the ratings suddenly didn’t know what they have bought. They didn’t know how risky those loans were.

Even after assurance of consistent growth by US government officials. The dominos started falling investing companies stoped buying mortgage backed securities and refused to lend to them who dependent on them. Investment banks like Baer Sterns and Lehman Brothers suddenly couldn’t get new loans to stay in business. Frannie Mec and Freddie Mac could no longer hide the disaster.

The Financial crisis in 2008 started in a way that is similar to today’s situation. It started with an economic crisis in the US. With a government that acted decisively. After 9/11 and the dot com collapse, the US government decided to set save the economy “BY INFLATING A NEW BUBBLE”

Today the world is trying to get out of the financial crisis. “BY INFLATING A NEW BUBBLE”. The difference is this bubble is much bigger.

2008-2009

A Global BUBBLE was created after dot com and real estate bubble burst. This is called the Bail Out Bubble. Its not only the United States, this is a global bubble they are all into it. Hey, the economy is going down recession is setting in sales don’t look good, exports soft, need more money? How about we call it stimulus packages, from Australia to the United States, from UK to China the respective governments is dumping funny money into the system to keep it going.

In September 2008 the US economy is near collapse. Fannie Mec and Freddie Mac have been taken over by the government. On September 15^th, 2008 giant investment bank Lehman Brothers goes bankrupt after monumental bets on real estate. AIG the largest insurance company in the world, collapses the next day. Fear sets in it seems like any one can fail. Suddenly banks no longer dare make loans to companies or each other. Experts warn that the economy is about to collapse.

President George W Bush address to people : “We are in the midst of a serious financial crisis. The Federal government is responding with decisive action. After my proposal the Federal Government would put upto $700 Billion taxpayer’s dollars on the line to purchase trouble Assets that are clogging the financial system”.

2^nd Bail Out Package - $ 700 Billion Dollars

In a televised speech President Bush scares the market even more. While still claiming they can trust him he has a solution. The US government wants to spend huge amount on Wall Street banks to cover their bad deals. Even banks who don’t want the money will be forced to take it, so that the public won’t know which banks are on the brink of collapse.

On October 3^rd 2008, congress approves the biggest financial Bail Out in history $700 Billion US Dollars. Around the world in Germany, Italy, Canada, South Korea, and Britain other politicians do the same. Billions of dollars were spent on countries refurbishment.

David M Walker the US comptroller general he quit because he was so worried about the US economy that he wanted to have the freedom to warn about what may happen. He said In my view the bail out was necessary in certain regards but in many cases we wasted a lot of money because we didn’t do three things First Have clearly defined objectives about what we are trying to achieve. Secondly have criteria established upfront as to who would get the money and who wouldn’t get the money. And Third Have conditions established upfront as to they could and couldn’t do with the money. As a result of not having those three things money went aimless and wasted.

Second Part 2^nd Bail Out Package – Auto Industry

Nov 19^th 2008, a month later President Bush gives Billions of Dollars to General Motors and Criser the money comes from the Bail Out package. That was really designed to save the financial industry. Congress in the political cover to save the US economy paid auto workers a bail out package of around $100 Billion Dollars. The big guys on Wall Street they can’t take their losses. They are cry babies capitalists.

16^th December 2008, Federal Reserves cut their key interest rates to lowest level on record. It was time again to pour more free money in to the economy. The Federal Reserve reduces interest rates to practically 0 %, to restore investor’s confidence. Other central banks did the same.

This means hey you have no credit no problems just sign on the dotted line. The housing bubble they inflated blew up with all the carnage and all the bankruptcies. Now what is the solution Government just do the same thing they did before, instead of having interest rate at 1% let’s have make it 0%. Let’s buy every thing we can. Let’s print money and buy mortgages. Buy credit cards debts, student loans, buy bonds. They tried encouraged risk taking and convince Americans who are already loaded on debts to go out and buy more stuff, to go on deeper into debt.  If bank don’t want to lend them money lets make the banks lend them money by passing a new legislation.

While the Feds lowers interest rates President elected Barack Obama prepares an enormous stimulus package, meant to get the US economy going.

3^rd Bail Out package - $787 Billion Dollars

President Barack Obama statement – “We are running out of the traditional ammunitions that is used in a recession which is to lower the interest rates. They are getting to be bad as they can go.”

17^th February 2009, President Barack Obama – The American Recovery and Re-investment Act, that i will sign today a plan that meats the principles i laid in January. Is the most sweeping economic recovery package in our history”. Said in his public address

On February 7^th 2009 Obama approves a stimulus package worth $787 Billion Dollars, with the Bush Stimulus package a year before. US politicians have now spent close to 1 Trillion Dollars to stimulate the US economy. The money is spent on redoing roads, Airports, education, unemployment and other benefits. All spent on consumer spending and not to encourage build new industries to stimulate growth and build job. Hence once the stimulus alcohol is over the economy is back to its crisis position. This time with a larger debt on the government and people, the problem is now so big that government stimulus is not going to buy those five or six years of phony growth. Only to the horror of the government to realise that they can’t afford to burden the countries debt position.

Its not just the US that’s increasingly looking like a house of cards. During the crisis many governments went deeply into debts. Estimates say that the average debt in the richest nations will exceed 100 % by the year 2011. These are loans taken at currently lower interest rates. Should the interest rate rise by 1% the US interest payments would rise 100 Billion Dollars per year. That’s more than the annual cost of the Vietnam war. Iceland was until recently one of the richest nations in the world, when the crisis hit Icelandic banks collapsed. The Icelandic stock market crashed leaving the debt with small population. In Greece the deficits have hit to record high the national debt has approached 135% of GDP. The market wants higher interest rates for Greek loans increasing the pressure on its strained economy. Its seems like the Greek government needs a Bail Out to avoid collapse.  Italy, Spain, Portugal and Britian are other EU nations with similar problems. The other EU countries which are going strong are highly depended on world economy, more than half of their prosperity is based on exports. When other countries crash they get hit almost as hard. All this because of lower interest rates and government loan companies making loan easier to get.

AAA to AA+

Till now United States is rated AAA but if it doesn’t start taking steps to put its financial house in order that AAA rating would be lost. If US loose the confidence of their foreign lender then there would be dramatic decline in the Dollar, a dramatic increase in the interest rates, significant fuelling of inflation a very deep recession and possibly a depression. That would be felt around the world. 

Debt position of US on 9^th Aug 2011

In Aug 2011 the total debt of US is $14.591 Trillion. USA is accumulating debt at a rate of $3.96 Billion per day since September 28, 2007. US Gross Debt to GDP ratio is almost 100%. With total debt per family is $668,095 with contrast to saving per family of $ 6,873. Which means every family in US is in debt of about more than 100 times in proportion to its annual savings.

The largest holders of debt are the central banks of China, Japan, the United Kingdom and Brazil.

Stake Holders in US debt – China holding

It is hard to argue with China’s view that the US has been addicted to borrowing and living beyond its means. But the addict wouldn’t have been so hooked without a generous dealer. China has been the main supplier of the cheap debt that the US has found to be such an irresistible drug.

The problem is not just that China is the biggest foreign holder of US Treasuries with more than $1,100bn. Even more concerning is the rate of increase of China’s holdings, from less than $100bn a decade ago to the vast and unprecedented pile it has amassed today.

That increase has made China the most important buyer of US debt over the past decade. It was knocked off its throne only briefly when the Federal Reserve stepped in to buy government bonds with its quantitative easing programme.

China’s largesse did not cause the global financial crisis – it did not cause US regulators to overlook dangers in the subprime mortgage market. But it did act as a facilitator, enabling the US to enjoy the ultra-low interest rates for a prolonged period of time that encouraged all kinds of crazy risk-taking.

China’s bottomless appetite for US debt is a direct result of its own distorted currency regime, whereby it buys much of the foreign exchange streaming into the country in order to hold down the value of the renminbi and, in turn, invests that foreign cash in US government bonds.

One constructive thing to come from the US rating downgrade could be a stronger conviction inside China that faster exchange rate reform is needed. Xia Bin, an academic adviser to the Chinese central bank, said as much on his micro-blog, arguing that Beijing has no choice but to internationalise its currency. The central bank got off to a promising start on 8^th Aug 2011, raising its daily fixing for the renminbi by the most in nearly a year and letting its exchange rate climb to a record high against the dollar. Is the world’s biggest debt dealer finally cleaning up its act?

Printing of Global US Dollar - Gold Standard

After the Second World War, a system similar to a Gold Standard and sometimes described as a "gold exchange standard" was established by the Bretton Woods Agreements. Under this system, many countries fixed their exchange rates relative to the U.S. dollar. The U.S. promised to fix the price of gold at approximately $35 per ounce. Implicitly, then, all currencies pegged to the dollar also had a fixed value in terms of gold. Under the administration of the French President Charles de Gaulle up to 1970, France reduced its dollar reserves, trading them for gold from the U.S. government, thereby reducing U.S. economic influence abroad. This, along with the fiscal strain of federal expenditures for the Vietnam War and persistent balance of payments deficits, led President Richard Nixonto end the direct convertibility of the dollar to gold on August 15th 1971, resulting in the system's breakdown (the "Nixon Shock").

This means USA can print as much US dollar as they want without any base for Gold or irrelevant of its resources.

To understand the crisis associated with printing of currency to pay debts.
Many parallels between 1924 Germany and present-day United States are cause for concern. You can look at the constant depreciation of the dollar since the early 1970's and fail to be alarmed. It seems contemporary America differs from 1924 Germany only in the duration between cause and effect. While the German experience was compressed over a few short years, the effects of the American inflation have been more drawn out.

In my view, this has occurred for two good reasons:

First, American central bankers have learned enough from the German experience to delay and extend the consequences of printing too much fiat money.

Second, Germany was a small state isolated from the rest of the world, a pariah nation of sorts following World War I. As a result, it had a difficult time finding a market for its government bonds. German deficits had to be financed internally -- a difficulty which greatly accelerated the printing of fiat currency.

Up until recently, the United States enjoyed a strong world-wide demand for its government paper. By continuously being the consumption ground of this modern economy. Be it Overheating Chinese goods industry and Aust supplier of raw material to china or India service industry. Thus, the negative affects of government deficits have been subdued. Now, with consistently low interest rates, and a growing fear globally that U.S. deficits may have run out of control, foreign support for the U.S. bond market has faltered. In the absence of international buyers, the Fed could be forced to monetize an ever larger portions of the debt -- the modern equivalent of printing money.

Whether or not the situation will slip out of control is a matter for debate. The trend, however, is alarming. The largest annual contribution to the outstanding public debt during the Nixon years was $30.9 billion; Ford - $87.2 billion; Carter - $81.2 billion; Reagan - $302 billion; Bush(Sr.) - $432 billion; Clinton - $347 billion; GW Bush - $1,017 billion; Obama - $1,885 billion.

Especially  in an economic crisis or a war, the pressure to inflate becomes overwhelming. Any alternative may seem politically disastrous. Whether it be the Roman emperors repeatedly debasing their coinage, the French revolutionary government printing a flood of assignats, John Law flooding France with debased money, or the Continental Congress issuing money until it was literally "not worth a Continental," the story is similar. A government in financial straits finds its easiest recourse is to issue more and more money until the money loses its value. The entire process is accompanied by a barrage of explanations, propaganda and new regulations which hide the true situation from the eyes of most people until they have lost all their

savings. In World War I, Germany -- like other governments -- borrowed heavily to pay its war costs. This led to inflation, but not much more than in the U.S. during the same period. After the war there was a period of stability, but then the inflation resumed. By 1923, the wildest inflation in history was raging. Often prices doubled in a few hours. A wild stampede developed to buy goods and get rid of money. By late 1923 it took 200 billion marks buy a loaf of bread.

Why is Dollar in demand? - $ per Barrel oil

Since the agreements of 1971 and 1973, OPEC oil is exclusively quoted in US dollars. This created a permanent demand for dollars on the international exchange markets. As of 2005, OPEC continues to trade in US Dollars, but some OPEC members (such as Iran and Venezuela) have been pushing for a switch to the euro.

Since the beginning of 2003, Iran has required euro in payment of exports toward Asia and Europe, though prices are still expressed in US dollars. Iran is planning to open an International Oil Bourse(IOB, exchange), on the free trade zone on the island of Kish, for the express purpose of trading oil priced in other currencies, including euros.

US have always used its military forces to control Middle Eastern countries. This has been to keep its monopoly on Oil pricing and keep US dollar in demand in global economy. Even though US is not the producer of Oil still it reaps the benefit of profits for per barrel sale. It needs oil industry to keep the strength of US Dollar as global currency.

What NOW – After US Dollar loses market confidence?

Downgrading of US rating from AAA to AA+ has slipped United States from the position as safe heaven for investment. This will lead to increase in borrowing cost for United States and with such huge amount of debts accumulating with a pace equivalent to GDP of some small countries per day. Higher Interest rates means more debt at higher pace, higher inflation in USA and in turn fall of confidence in US dollar as global currency and crash of modern world largest economy U.S.A.

One way to avoid this unavoidable phenomenon is to change its status from consumer of world economy to producer or manufacturer. Which can be supply of goods or technology, to save the dollars worth in world economy in absence of gold standard?

The clock is ticking and time is not working in favour of them.

"To cure its addiction to debts, the United States has to re-establish the common sense principle that one should live within its means,". – This stage is already over, they need something more?

Compiled by

CA Prashant Singh