By:Arturo YARISH

November, 2010

Courtesy of the author

This essay was inspired in multiple articles presented in the Business section of The New York Times since the financial and credit crisis began in the USA, one of them being an article by Vikas Bajaj titled “Central Banks Intervene to Calm Volatile Markets”, published on 11 August 2007.

The pages of the Financial and Popular press are currently full of articles that attempt to explain the mounting volatility rocking the world’s financial markets. In the past few days leaders of International Finance have begun to say publicly that the crisis is being brought under control but, while continuing to predict future tranquility, as recently as 21 August, approximately ten days into the spreading crisis, The New York Times again reported that    “Wall Street remains worried…”. As the effects of the Credit Crisis spread growing uncertainty, the wild swings in reporting the crisis trace the “wild swings” in the markets. On the same day that The New York Times noted the continuing worries on Wall Street it also presented stories under the following opposing headlines that appeared less than an hour apart. First the paper announced “Wall Street Set to Open Higher” then forty five minutes later a second article projected that “Wall Street Heads Toward Lower Open”. While the Times’ reporters may be credited with attempting up-to-minute coverage of fast changing conditions such conflicting headlines should be taken as measure of the accumulating problems below the surface.

As the Crisis deepens and both Ben S. Bernanke, USAmerican Federal Reserve Bank, Chairman and the Treasury Secretary, Henry Paulson head to testify before USA Senate Banking Committee, the effects of the Liquidity Crisis widen from financial markets to the stock markets , and into the job market. As major markets anticipate further declines, financial corporations have already begun to announce job cuts. While officials offer repeated assurances that they are in control, the swift expansion of the crisis contradicts them.

An accurate understanding and assessment of the causes and consequences of the forming crisis is essential to all of us at every level of society. The leaders of financial institutions: bankers, investors, speculators and economists of the national and international, institutional networks speak confidently in public as if they are able to control the multiplying problems or at least manage them. While the leaders reassuringly explain their corrective measures, the mainstream press tries to put the best gloss on a very dangerous situation. Yet, as the contradictory news reports show, the expanding crisis grows beyond control of financial experts and the comprehension the mainstream reporters.

I write for the working people with the intent of providing a background, a clearer perspective of the depth and breadth of the ensuing problems and the consequences of the current measures being taken by central bankers. I write for the working family readers trying to understand the terminology, often fearing the personal cost and wondering how the attempted corrections will affect them on the job, in their family finances and their future. I write with a sense of urgency to reach out to the one thousand nine hundred employees at Capital One who will loose their jobs and to the many other workers who will soon be on the streets. I ask how they will be able to pay their mortgages, credit card bills, car payments, and their children’s college tuition expenses. Will their pension funds disappear as happened to the Enron employees; will we slip into a depression? We must all ask ourselves what can people do help themselves and their children?

In following paragraphs I will attempt to outline: what is happening and why; what is a “Liquidity Crisis” or a Credit Crunch and why has it formed; what can the leaders of financial institutions do about it; what are they willing to do and how will their decisions affect working people in the USA, throughout the Americas and the rest of the World?  This credit crisis as already demonstrated its world-wide reach and its potential global consequences.

A very panicky moment has formed. Actually the present financial crisis has been forming for a long time but few people could notice the accumulating problems and fewer cared to look too closely at the causes. While too few cared to patiently examine the long-term consequences of the decisions of high-level economic decision makers over the last thirty years in  the USA , social and economic inequities  multiplied: domestic and international debt grew  to unprecedented levels, interest rates were held at artificially low levels, working families’ incomes stagnated, tax policies had the effect of transferring one trillion dollars a year from the lower 90 % of the income earners to the upper 1% (one percent ) of the richest people in the USA, (The Trillion Dollar Income Shift Parts 1,2, & 3  www.zmag.org/ZmagSite/Apr2007/rasmus0407.html), the national savings rate feel to zero and stealth  inflation steadily increased. The Neoliberal economic programs based upon debt expansion, a soft-dollar policy, the de-industrialization of the domestic economy, union busting, job-exportation, wage reductions and the upward transfer of wealth and income has resulted in a typical over production crisis now leading into the world-wide financial melt down. The fundamental errors of Cowboy Capitalism are now tearing in to Casino Capitalism, and again the financial pyramid shakes while capitalists shudder.

Over the past several days many of the world’s central banks have been pushing huge quantities of Usamericandollars (Usad’s) and Euros into circulation through a number of standard quick-fix methods in order to stem the crisis. We should be aware that the capacity of the central banks to continue to inject funds at present levels is limited and the long-term consequences are “stagflation”* at best.

National central banks only have four or five financial control valves to turn. Generally they can print or destroy notes (national currency), make deposits in member banks, provide loans to member banks and raise or lower the inter-bank lending rates. Two of the most talked about inter-bank interest or lending rates in the USA are the Fed Funds rate, which is the rate at which banks lend surplus funds to each other or the Discount Rate, which is the rate the Federal Reserve Bank (The Fed) sets to lend money to members of the Federal Reserve System. There are other financial transactions The Fed and other central banks can make. They can, for example, buy or sell financial obligations of their respective governments such as bonds and notes that will also affect the amount of money in circulation. If they buy these financial obligations they increase the money supply and when they sell them they reduce it. Since 11 August central banks all over the world have been trying control the spreading crisis by rapidly increasing the amount of money in circulation (four hundred billion Usamerican dollars or Usad’s as of 15 August) but the crisis grows.

The primary task of central banks is to manage the national money supply which in the USA is composed of three primary monetary group measures usually called M1, M2, and M3. M1 is composed of cash and demand deposits including your checking account deposits and mine ; M2 is composed near money or short term investments such as Money Market accounts and mutual fund accounts, and M3 is made up of M2 plus very large institutional inter-bank deposits. http://invest-faq.com/articles/regul-fed-m123.html. The overall money supply is more fully measured by the velocity of money in circulation that is how fast money changes hands, and the reserve requirement, the amount that the Fed requires that member banks hold in reserve to meet normal withdrawals.  The reserve requirement also contributes to overall movement of money or the velocity of money in the system by moderating its circulation base on the proportion which is held in reserve. It is important to note that the growth in the overall money supply as been increasing steadily. http://en.wikipedia.org/wiki/Money_supply

Basically the Central Banks give loans to their member banks, mostly commercial banks, as a way smoothing the customary glitches that occur during regular system-wide, inter-bank operations such as check Clearing-house procedures. In the USA, The Federal Reserve Bank, is regularly lending or depositing Usad’s in commercial, national banks like Citibank or Chase so that these commercial banks will have an adequate money supply to provide low cost loans to Wall Street brokers such as Bear Sterns or Merrill Lynch, that will use the funds to lend to their customers so that money will continue circulating in the stock, commodity and other financial markets.

Most traders are so highly leveraged, meaning they bought their stocks and other more sophisticated financial instruments with borrowed money. As this financial instruments  bought with borrowed money decline in market value , the owners will eventually be forced, at a certain point, to sell large quantities of financial paper (bonds , stocks etc.) thus pushing the market prices down further and more rapidly. The central banks are “injecting” or “infusing” huge amounts of cash into the entire International banking system so that the players can keep playing because, if the Commercial Banks will not or cannot continue to make loans to the players in the various markets, the liquidity crisis will deepen meaning that the circulation of available funds will either slow down or stop. If the Banks feel the risk of making loans is too high and they stop lending at the present rate, the game quickly grinds to a halt and may dive into a Crash as happened in 1907 and 1929.

I am over simplifying to give the briefest but most compact yet comprehensive, summary background to the causes of the advancing crisis; the solutions designed by bankers and its potential consequences. At this point the central banks are flooding the markets with funds e.g. currency, so that the interconnected financial systems will not collapse.

Federal Reserve Bank Chair, Ben S. Bernanke, is a complete monetarist. His analysis of the “Crash of 29″ informs his decisions to “infuse”, pump money, into the system at a higher and faster rate than normal to assure the Big Banks and the Big Brokerage houses that cash will continue to flow in sufficient quantities to support more or less normal business operations of the lending / borrowing process. Without going into greater details, the “infusion” of funds is an obvious, massive emergency measure executed to hold down interest rates but it is only a stop-gap, confidence-building, measure which cannot be sustained and which will contribute to a future inflation that will soon add more problems.

The Fed is in a tight bind between the National Banking establishment that would like to expand the money supply to get through the present crisis and those in the international financial community who feel they are holding too many usad’s and want to reduce the quantities they hold; in other words the international holders of dollars are ready to sell more dollars. In another sense the present situation is becoming more volatile because the huge international supply of usad’s in the world cannot be controlled in the same manner as a national central bank would have controlled domestic money supplies in the past. The international supply usad’s is too large and the promise to redeem them, in some way, is impossible. The sages of the financial world know that the dollar can only circulate as empty promises to pay, but to pay what and to pay when. The value of the enormous quantities of usad’s floating around the world’s financial markets are totally dependent upon two totally faith based factors: the holders of usad’s will maintain there “full faith and confidence” in the USAmerican Federal Government to continue to pay a relatively acceptable interest rate. The

Theology of Capitalism now comforts its reality. The Fed cannot raise interest rates because it will aggravate the fast spreading deterioration in the housing mirage market. It cannot lower interest rates very much because it will accelerate the growing international move out of usad’s. The Fed and other central banks are adding operating liquidity, cash, to the system in huge, unprecedented quantities to keep the system going for all capitalists. The bailout phase, that people wonder about, because we, the ordinary working know that some financial institutions are “too big to fail”, will come when political pressure increases to lower the Fed Funds rate , the  USAmerican inter-bank lending rate or more obviously when the Discount rate is lowered. The Fed Chair, Bernanke has resisted the growing pressure to lower the Discount Rate and the Fed Funds rate because he knows the international consequences: USA-Dollar dumping. The Europeans and Asians are maneuvering to protect themselves.

President Bush was basically correct when he recently made the statement that the liquidity is there but what he did not say and probably does not fully understand, is that potential investors perceive the present risk to be much too great to enter the market . Therefore, by not lending the money a real liquidity crisis, a credit crunch, is congealing and can potentially gather strength very quickly as three related financial decisions are made by lending institutions and individuals: money is not lent in sufficient quantities by banks or brokers; institutions and groups such as hedge funds begin selling in self defense to preserve what they can and international holders of usad’s reduce their dollar exposure. A fourth possible banking decision, to “call-in” that is demand payment on existing loans, will cause more selling and push market prices down further and faster. One can almost hear the sucking sound of the vortex.

Bernanke is now afraid to bailout the rich investors in the hedge funds because saving them by lowering the Fed’s Discount Rate and soon the Fed Funds rate will accelerate the flight from the usad’s. Thus, if he succumbs to the increasing political pressure to save the very rich investors in high risk areas, he could create an uncontrollable inflation that will choke the overall domestic economy and send more forceful shock waves through the international markets that will increase usadollar flight and then force him to raise interest rates later to protect the usadollar, a maneuver which will then choke the domestic economy anyway.

What the Fed is now doing is taking the risk of increasing a short-term inflation with the hope that the move will calm the National and international markets. Then later The Fed will try to control the inflationary tendency they are now generating by putting extra currency in to circulation, thus intensifying elongating the pernicious cycle. Concomitant with the stop-gap measure of “infusing” funds to the system, the financial leaders are now trying to “talk the crisis down” that is they are trying  to convince people at all levels that the crisis is under control because they, the high priests of Capitalist theology , know they have no new valves to turn and most of those valves are stuck between two of the causes of the dollar crisis: the present soft-money or low-value dollar policy, and the massive international usad’ float. (On Calming the public see the NYT 13 Aug, “Small Investors See as Safer in the Stock Slide”)

Keep a sharp lookout. While I do not practice pure trend analysis, I note we are on the outside edge of the long “Kondratieff Curve” www.economyprofessor.com/economictheories/Kondratieff-cycle.php which has been extended and aggravated by the Neoliberals who really believe that they can endlessly tweak the processes through each successive crisis but this time the crisis has been fully internationalized and the international equivalents of the National institutions are not in place. Duck and start organizing.

While the central bankers are presently concentrating on managing the general liquidity crisis, the first phase of the bailouts was set in motion by the reduction of the discount rate. The administrative phase of future bailout programs will soon appear after the USA Senate Banking committee hearings, as programs to save homeowners not as programs to help the hyper-rich to escape the consequences of their profligate gambling at the table of Casino Capital. Eventually working families everywhere will be forced to pay through increasing inflation, cost reducing lay-offs and a growing tax burden to pay for bailing out the big players.

There are dark clouds on the horizon.

I invite comments and energetic criticisms which may help me refine the rough overview of the crisis that I quickly prepared.

* Stagflation: no economic growth accompanied by high rates of inflation.