Learning from the past
Written by A Forex View From Afar on Tuesday, September 23, 2008The Treasury proposal of a huge infusion of capital into the financial system and bank’s balance sheets had already been used by other countries, although the outcome was not always so bright. The plan proposed by Mr. Paulson is similar to the one used in Sweden the 1990’s, as we reported this week, in helping banks deal with the bad debt. However, the Swedish had a different approach to this solution; in exchange for the capital infusion Sweden asked for equity. However, Mr. Paulson’s plan only asks for the bad assets and nothing more in return.
The problem is how exactly these toxic papers will be valued. If they are overpriced, the taxpayers will suffer a huge loss, since the Treasury will pay for valueless paper, with little chance of forward redemption. If they are underpriced, or the Treasury pays the same price as their current real value, it won’t solve anything since banks can achieve a similar outcome just by writing-down the bad debt. From here, this appears that the U.S. proposal is loss-loss situation to the taxpayer, and maybe therefore to the Usd.
Even with the “Swedish solution” applied to the U.S. problem, the real economy may still have a hard time ahead. The Swedish economy recovered some 4 years later, in a period when unemployment rose from 2.1% to an incredible 19.9%. In Norway, a neighboring country that faced the same problem, unemployment also rose at a strong pace in the following years, but not as much as in Sweden.
Japan also had to deal with a huge asset bubble in the early 1990’s. The Japanese authorities had chosen a similar solution, injecting huge amounts of capital into the economy. The strategy was called “quantitative easing” and had no real effect over the economy. Actually, the only effect (counter-effect more likely) is that the Japanese economy has never fully recovered from the asset bubble, not even to this day. The Nikkei topped out around 40,000, dropped to around 7,000, and today trades at 12,000. Cash infusions do not always work, and in some cases just prolong the crippling effects of what would otherwise have been a painful but warranted natural reduction of those unable to perform in a changing financial arena.
The mountain of U.S. debt needs servicing, and this may be the cost of reckless borrowing. The U.S. economic outlook may not as bad as that of Sweden or Japan, just yet, but things are delicately balanced between imparting a reasoned argument to mortgage the future and the huge financial liability to the U.S. taxpayer of this creating another debt mountain that will never get repaid. The U.S. struggles with current debt payments as it is, managing to make the minimum payment when servicing its overseas commitment of repaying existing debt. A rise in unemployment and a drop in output are still expected over the next quarters, and that is not the environment that will make the dollar bulls feel warm and fuzzy, nor overseas wealth funds swoon at that thought of U.S. based assets dominating their books.
The U.S. is the economy that pulls the levers on the global scale, but we have asked our-self time and again recently whether 'The Global Player' may not become just another one of the 'Group of Global Players' in quick time. The BRIC (Brazil, Russia, India and China) group is watching the outcome closely. The BRIC’s are seen to be more than capable of forming an economic bloc, similar to the European Union, and have been studied to such a degree that the BRIC’s by 2050 could have a wealth and global dominance that eclipses the current Global Players.
The King of Currency has some suitors, and the World’s currency may now have to see some backing from the U.S. economic infrastructure being re-built on firmer foundations than the last re-balance, if the Usd is not to come under some valuation pressure.
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