Stupidity and the Global Financial Crisis Part Two

Albert Einstein defined stupidity as doing the same thing over and over again and expecting different results. Industrial civilisation is providing a scenario that provides us with the opportunity to test the stupidity of the world’s leaders.

In 2008, two major problems combined that resulted in the Global Financial Crisis (GFC) Part One. The first of these was the oil price spike, the second the unravelling of the subprime mortgage debacle, which came close to collapsing the global financial system.

In late 2010, it appears that similar pressures are building to those that triggered the GFC Part One, so let us conduct a thought experiment, to test the possible outcomes of the GFC Part Two and the stupidity or otherwise of our political leadership.

Commencing in late 2004, global oil production reached a production plateau. Demand continued to grow however, with strong growth particularly from China and India resulting in a predictable outcome, namely that the price of oil spiked, reaching a record in July of 2008 of US$147 a barrel.

Concurrent with rising oil prices was the unravelling of the sub prime mortgage debacle; with borrowers that should never have been loaned money predictably enough finding that they could not meet their repayments. The flow on effect on our Ponzi banking system was that international trade and finance came very close to freezing up, arguably with only the actions of the world’s reserve banks preventing economic collapse.

In short, a combination of too much debt and the spiking cost of the lifeblood of the global economy resulted in the deepest economic downturn since the Great Depression. The medicine of choice by governments around the world was stimulus financed by you guessed it, more debt.

The logic of this response was based on the assumption, or hope, that such stimulus would enable future growth which would in turn pay off the debt. Of course if this response fails, all that it has achieved is to kick the can, or snowball, a bit further down the road. 

Today a similar set of circumstances to those that triggered the GFC are building. The price of oil is hovering around the US$90 a barrel mark (at historically high levels). With strong demand growth from developing nations and a rebound in consumption in nations such as the US, when combined with anaemic growth in supply, it is likely that oil prices will head higher in the short to medium term.

It should be noted that every post war oil price spike has resulted in recession and there is no reason to expect that the next spike will be an exception. 

Simultaneously we have a serious debt problem, both privately (such as Australian and Canadian home owners) and publicly (the national governments of Greece, Ireland, Portugal, Spain, the UK and US to name a few, as well as many cities and states).

With falling tax revenues and ballooning deficits, the solvency of many governments around the world is and will be tested.

The scene is being set for part two of the GFC.

Who knows when these circumstances will reach crisis point, but for the purposes of our thought experiment September 2011 will do nicely, a neat three years on from round one of the GFC.

What exactly triggers the crisis is both unpredictable and unimportant for our purposes. Let’s pretend that the oil price has spiked to record highs and the default of a sovereign nation has caused widespread bank failures and the near freezing of credit around the world.

The world’s leaders will respond to such a crisis, so let’s consider two global responses, the first of which I have called "lullabies and boondoggles", the second "bitter sweet medicine". 

Lullabies and Boondoggles

In the "lullabies and boondoggles" scenario, as the crisis unfolds, leaders around the world meet to determine how to solve the "financial crisis." The response is a not very imaginative repeat of the circa 2008 solution, either borrowing or effectively printing more money through quantitative easing, to act both as a stimulus for future economic growth and maintain the flow of credit that keeps the economy functioning.

Massive government stimulus and cheap credit for the "too big to fail" banks results in the economy stabilising - at least on the surface. There is even a modest recovery in the stock market and commodities. The obedient and unquestioning mainstream media builds a meme of economic recovery.

Unfortunately true recovery and growth cannot be fuelled solely by debt. True growth would depend on the production of real goods of real worth that contribute to real GDP. Increased resource costs are putting the brakes on the production of real goods, so the debt-fuelled recovery is confined to speculation on the stock exchange, some investment in goods produced in countries with low labour costs, and the production of various synthetic financial instruments of limited value in the real world.

Consequently Main Street seems to have missed out on the recovery with un- and under-employment remaining troublingly high, foreclosures on the increase and house prices falling. Whilst consumer goods such as iPODs continue to get cheaper, the necessities of life, such as food, water, power and fuel, are becoming increasingly expensive as resource costs rise and labour costs drop.

To make matters worse, the so-called recovery is punctuated by another series of crises in the years ahead. The timeframe between each crisis reduces whilst the impact increases. Fiscal stimulus appears to have less and less effect, at least for those at the bottom of the food chain or on the peripheries of the global economic system.

For those at the top, even though their numbers are getting smaller, their wealth and power increases. The anger of the masses, sick of more taxes, reduced services and the increasingly unbelievable rhetoric of the political leadership builds and spills over leading to civil unrest, revolutions and in some cases civil war.

Bitter Sweet Medicine

In the "bitter sweet medicine" scenario, the world’s leaders agree that solving a problem largely caused by too much debt won’t be solved by more debt. They also acknowledge that the world’s resources are finite, no matter what contemporary economic thought suggests, and the requirement for limitless growth that underpins our current financial system is incompatible with a finite planet.

The world’s leaders decide to radically restructure the global financial system. Banks assets are "marked to market" resulting in the failure of most of the "To big to fail" banks, fiat currencies are phased out and replaced with currencies backed by precious metals and energy and the banking system moves towards 100% reserve requirements.

The results are tumultuous. Initially unemployment sky rockets, asset prices plummet and international trade suffers a dramatic drop. Despite this, the world’s leaders remain firm.

Over time, as the enormous debts in the financial system are expunged and the financial system resumes its role as a mechanism for allowing the production of goods and services, as opposed to a producer of wealth in its own right, the economy stabilises. Admittedly it’s a much smaller economy and people generally are much poorer than pre-crisis.

However most people have come to realise that most of the wealth that was destroyed was virtual wealth only due to the fraudulent nature of fractional reserve banking and fiat currencies. People have to work much harder to survive, but their basic needs are being met, largely because communities have become the centre piece of economic organisation. In many ways, people are more fulfilled.

While international trade still exists, most of the things that people "need" are produced close to home. Cottage industries develop, producing everything from clothes, to furniture and soaps. House prices have become affordable, although it takes much longer to save a deposit than before with the majority of banks now being low risk "savings and loans" institutions.

Government welfare has been pared back significantly, but with the resurrection of the household economy and lower expectations, most people don’t need as much support from their Government. And with the much smaller levels of energy (and other resource) consumption, climate change, resource depletion and peak oil cease to be of much concern.

No easy way

Neither of the two scenarios outlined above provide our leaders with a particularly palatable choice. I guess that is the nature of predicaments - there is no easy way out. Perhaps if different decisions had been made back in the 1970s we would not be in this situation now. Unfortunately you can only play the cards you have bean dealt and industrial civilisation’s current (self inflicted) hand is a losing one, at least in terms of maintaining the status quo.

The world’s leaders are left with two choices. The first is to maintain the current unsustainable and increasingly unstable economic system for as long as it can, hoping that there will be some technological or other break through that will allow growth to continue in perpetuity. Alternatively they can dismantle the current economic system, dissipating much of the power and wealth inherent in that system as well as their position within it, but with the potential for building a sustainable economy.

So how stupid are the decisions of our leaders likely to be? Judged on their track record to date, my hopes are not high. The actions of politicians and central bankers around the world since 2008 to the present day have all focused on attempting to prop up zombie corporations and zombie countries. In this, they have largely been successful, at least in the short term.

We seem to love the upside of capitalism; growth, prosperity and jobs. The downside, such as recessions, corporate bankruptcies and market reversals, that punish risky investments and poor decisions but at the same time prevent major economic catastrophe, government seems to abhor.

Perhaps if the too big to fail corporations had been allowed to fail in 2008 and if countries had been allowed to default on their debt, we would no doubt be in the middle of a nasty depression. This depression would however have provided an opportunity to reset the global economy. We now face a much worse prospect, that of global economic collapse.

It appears only a matter of time until the GFC Part Two is upon us. If this is the case, the stupidest thing that the world’s leaders could do is to attempt to prolong the current economic system. The likely result of that approach is many more crises leading, at some point, to economic collapse.

Counter intuitively, the smartest thing for the world’s leaders to do is to do nothing, bar restructuring the financial system to one requiring 100% reserve requirements for banks and currencies backed by something more tangible than "trust me." Unfortunately for those who are relying upon the current system to deliver wealth and prosperity, industrial civilisation is well past the point where there are any easy options left to transition to a "sustainable" economy.

Perhaps it is time that "we" built an alternative system whilst "they" do their best to destroy the current one.