Inflation, stagflation and money supply

A banker’s view of the crisis we’re about to experience

Echoing Mr Padoa-Schioppa, Charles R. Morris in Trillion Dollar Meltdown explains that apart from the sub-prime fiasco, other financial dominos are about to fall in the current avalanche, before order is restored to the financial sector.

Mr Morris, a banker and former lawyer has authored ten books. In this book, he succinctly relates just how bad the sub-prime catastrophe is, and why it will take a sustained effort to get us out of this swamp.

Morris weaves a convincing story linking the 1960s economic liberalism of John Maynard Keynes, the crippling stagflation of the 1970s, the laissez faire free-for-all of the 1980s and 1990s and the world of very cheap money and financial creativity gone insane that epitomised the last seven years.

The sub-prime crisis is only the first of many dominos that will fall this year. Disasters looming large in 2008 include: corporate debt, commercial mortgages and credit cards, he promises.

Morris explains that “not so long ago, the sum of all financial assets - stocks, bonds, loans, mortgages and the like - which are all claims on real things, were equal to global GDP. Now they equal four times global GDP. And derivatives, which are really claims on claims, have a notional value of 10 times global GDP”.

This is not sustainable.

The soaring ratio of credit to real output is a measure of leverage. His analogy is that of an inverted pyramid. The more claims that are piled on top of real output, the more wobbly the pyramid becomes. And when, not if, it becomes too wobbly, it will fall fast. He estimates that the value of all the coming write downs and defaults across the financial sector - including residential mortgages, commercial mortgages, corporate bonds, high yield (or more correctly termed “junk”) bonds, leveraged loans and credit cards - will total no less than $1 trillion.

Morris appraises recent economic history and describes how fashions change. What was once in vogue among governments and the business community, eventually gives way to another economic doctrine. The historic move from Keynesian economics to Monetarism will (Morris hopes) swing back to Keynes sooner rather than later.

He recalls how America’s infatuation with the Japanese economic model started in the days of Camelot, President John F. Kennedy’s time in the White House, and continued until the dying days of the Carter presidency. Both the government and the business communities were infatuated.

This envy reached a crescendo just about the time that Japan’s economy was tanking. A slowdown that would last more than 15 years. The decline in Japan as well as similar economic malaise in France and Germany convinced many in America that Keynesian activism was dead in the water, and that when it came to economic woes, many Americans believed that the government was far from being the solution. It was the problem.

And so like rats leaving a sinking ship, the scurry away from Keynesian economics began.

Even before the inauguration of Ronald Reagan as the 40th President of the United States, the arrival of Milton Friedman’s brand of economics was recorded in the United States Congress. An unknown Republican from Wisconsin named William A. Steiger, pushed through a cut in the capital gains tax in April 1978, a mere eight months shy of his death.