31.01.2008

Bush rushes to bail out system

Jim Moody highlights some of the problems brewing for the world capitalist economy

Recession beckons. President Bush makes an emergency $150 billion available, the US central bank drastically cuts interest rates and France’s flagship bank falls victim to ‘unauthorised gambling’. All symptoms of the fragility of the world economy.

On January 28, Bush asserted in his speech to the US Congress: “In the long run, Americans can be confident about our economic growth. But in the short run, we can all see that growth is slowing.” This is pretty thin hypothesising about the long term, especially when some pundits are warning that the US could be in danger of a drawn out period of stagflation or a full blown recession.

Bush’s $150 billion economic stimulus plan aims to give tax rebates to 117 million US families. Under the administration’s proposals, single taxpayers would get $600 and married couples $1,200 (plus $300 for each child). Non-taxpayers on low income would get $300. But many commentators are suggesting that this is woefully inadequate as any kind of stimulus. Indeed, how could it or why would it work in practice? We only have to compare it to the £50 billion ($100 billion) that the UK government has made available to one relatively small bank, Northern Rock, to see how measly is Bush’s proposal. In 2006, the world’s largest economy had a gross domestic product (GDP) of $13.21 trillion; Bush’s plan puts a bare 1% more of that into the hands of US consumers, and even then there is no guessing how they might use it. As a novel Keynesian gesture it is paltry, even accepting the dubious propositions upon which such an approach is premised.

Following a crisis meeting the previous week, Ben Bernanke, chairman of the board of governors of the US Federal Reserve, had little choice than to announce a cut in the bank rate by 75 base points (0.75%), from 4.25% to 3.5%. Overwhelmingly accepted as an essential emergency measure to prevent the economy from immediately slipping into recession, this was the first unscheduled Fed cut there had been since 9/11, as well as being the largest single cut since 1982. Immediately after the public holiday for Martin Luther King’s birthday, on January 22 the Fed had been faced with a massive 600-point drop in the Dow Jones index. A further drop of 300 points (2.5%) the next day, despite the Fed’s cut, was followed by a rise of 300 points and modest recovery. But it ain’t over yet. The suspicion is that there are more massive losses in and around the sub-prime disaster still to be disclosed, but about which the Fed is keeping remarkably quiet.

Although some analysts earlier this week were calling for a further 0.25% cut in the US bank rate, the futures market was gambling on 0.5%, which would bring the US bank rate down to 3.0%. And that is exactly what happened on January 30.

As to the Société Générale debacle, France’s economy minister, Christine Lagarde, commented on January 29 that the bank “is in a crisis situation” and should get shot of its chairman, Daniel Bouton. Indeed, Jérôme Kerviel, the SocGen junior employee (on £72,000pa) whose illicit trading lost it €4.9 billion (£3.6 billion) and who was reportedly ‘grilled’ by Bouton last weekend, had exposed big security holes and management and company weakness. Talk now is that the bank is vulnerable to takeover by its French rival, BNP Paribas, or by Barclays, despite prime minister François Fillon offering to defend it against hostile bids.

Economists were forecasting that the European Central Bank, which sets monetary policy for the 12 euro countries, will keep the main bank rate to 4.0% at its fortnightly ECB governing council meeting on February 7. European traders, on the other hand, are speculating on some ‘correction’ (ie, fall) in the ECB rate, even though the bank has denied any idea of an imminent cut. Concerns are centred on fears of inflation and the hubris about the euro zone having been sufficiently ‘decoupled’ from the rest of the world economy. European government bonds fell this week.

At the conclusion of the London summit between Britain, Germany, France, and Italy on January 29, Brown, Merkel, Sarkozy and Prodi issued a bland and empty declaration of confidence. Suggesting that Europe would withstand the blast of cold economic air, though without saying how, they pledged to increase cooperation.

Some commentators have added their voices to Trichet’s, suggesting that the economies of Europe and the Brics (Brazil, Russia, India, and China) are so decoupled from the US that they can escape unscathed. Nothing could be further from the truth. The export of production and financialisation means a cold stateside leads to flu and pneumonia elsewhere.

Meanwhile, the Financial Services Agency reported that 1.4 million householders in Britain would shortly be facing hardship at the end of their fixed-term mortgages, as most would then have payments at higher interest rates than now. Already in December we saw a big turnaround in house prices in England and Wales. Prices fell 0.4%, the first fall reported by the Land Registry for two and a half years. As property prices are integral to the health of the UK economy, this does not augur well.

Any significant cutbacks in the City, for example, are likely to rebound further on property prices in London and affect the wider UK economy fairly rapidly. After all, around one fifth of the UK’s tax take comes from the square mile of the City of London: redundancies there will thus have a huge effect on funds available for public spending. Will the shortfall be made up via increases in income tax? Or is it much more likely that services will be cut, losing more jobs?

Public borrowing surged ahead in December, resulting in the largest deficit since records began 10 years back. Net borrowing reached £7.8 billion, up from £6.4 billion a year ago. “In December 2007, the public sector showed a deficit on the current budget of £5.1 billion, compared with a deficit of £4.0 billion in December 2006 ... Net debt was £536.5 billion at the end of December, compared with £501.8 billion a year earlier. The pre-budget forecast for net debt at the end of March 2008 is £541 billion” (Office for National Statistics).

As the crisis advances, so formerly arcane corners of the world of finance are in the limelight: now is the turn of the monoline insurers. These businesses, crucial to the functioning of the credit markets, guarantee against defaulting purchasers of bonds. Unfortunately, there are some problems: monoline insurers have nowhere near sufficient funds if there are defaults on the $2.4 trillion of bonds that they cover. Ironically, then, they could themselves be defaulting on the cover they offer. No wonder the freemarketeer Bush has rush to come to the rescue with state guarantees.

Of course, while the UK government stopped the potential collapse of UK banking by baling out Northern Rock, there is a limit to what it can do, as with its counterpart in the US, faced with a potentially gigantic systemic failure.