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Tuesday, 28 October 2008


I hope readers notice the fashion forward timeliness of topics chosen here. Today's is illustrated by Heironymus Bosch.
We have a morality in financial accounting that is double-entry book-keeping whereby we expect both sides of balance sheets to add up the same, that is when counting up income and expenditure where the balancing item is profit or loss. For assets and loan accounts, which are not part of income and expenditure, there is no obvious balancing until we insert equity value. Below-the-line or off-balance sheet items of economies (which by convention we only measure for size in terms of income and expenditure) are confusing to the unenlightened, even the generality of accountants and, dare I say it, to many economists, never mind our importuning bankers.
When television, radio, newspaper and web media discussions conflate in the same breathlessness recession and falling asset values, what is happening to both INCOME (GDP = national output = earnings + net profits) and to WEALTH (Net Assets = equity and property, plus lending & borrowing) one has to issue a warning that ‘Income’ and ‘Assets’ are not linked in ways that are intuitively obvious (except for the fact that less net wealth means less collateral for borrowing or lending and more reliance on income for security, and a fall in income means less ability to maintain consumer spending while also keeping up mortgage and interest payments, about which Governments can intervene by lowering bank base rates, increase transfers from rich to poor and lower tax rates relative to wage and consumer price inflation - if that can be called intuitive?)
If these matters of income and assets are casually inter-mingled, this is confusing to the General Public who may imagine that all the reported stock market falls and asset writedowns translate directly into, for example, a 3% fall in GDP (Jeffrey Sachs, FT, October 28) or into 1% fall (Martin Wolf, FT, October 29) this quarter and next, or that world GDP in the current quarter is falling globally by about 1% but will be just about 1% positive in 2009 (JP Morgan Chase).
Martin reports Nouriel Roubini’s gleeful sarcasm how every few weeks or days banks feel obliged to shave chunks off their previously over-bullish forecasts. Roubini’s moralistic tone like that of the general public and media vilification of irresponsible lending by banks is stunning to most bankers. They believed in their own prudence and simply do not know why it is that they did not know whatever it is they should have known better?
The Bank of England reports today that the world’s banks and other financial institutions have lost (written down for now so far) $2.8 trillions (nearly 5% in ratio to world GDP and actually part of GDP only when fully translated into profit/loss ) while neglecting to remind us of the bigger picture of all stock market capitalisations and property falls of somewhere in the region of a 66% ratio to world GDP. The fact is that we do not have a logical economic calculus, a closed double-entry system of a standard accounting model, within which to place all the much bigger (sometimes astronomical) financial numbers that are outside of world GDP (globally about $60 trillions net of inflation), numbers such as world real estate, financial assets and debt values ($200, $100 and $100 trillions), derivatives outstanding ($550 trillions nominal), annual financial cash market turnovers $1,500 trillions single-counted), or global velocity of money (interbank transactions $7,500 trillions single-counted).
Jeffrey Sachs, who advises the UN Secretary-General, took as a working assumption that if wealth has fallen by $15 trillions in the US (whose size is one quarter of the world’s economy), then this may mean a fall in spending of 10% ratio to this loss, which is how he gets to a 3% fall in world GDP, which all governments must do something to mitigate or compensate for. Jeffrey should look at the global economic model of the UN DP International Poverty Centre. His numbers (like mine) are finger-in-air, back-of-fag-packet models and our typical economists’ shorthand on all this must leave public and politicians rabbit-in-headlights confused. Bankers, we know, are already floating powerless like stunned fish weakly tail-flopping having lost all oxygen out of their familiar dark pools. Thank goodness Keynesian responses are somehow hard-wired into Governments’ tacit reflexes and not all economic history 101 forgotten. Stephen Roach (FT October 28), Chairman of Morgan Stanley Asia, recommends that The Federal Reserve be given explicit responsibility for financial stability? But, the Fed, like all central banks (including globally BIS and IMF) have always had that. Indeed, the Fed has it in full measure with the Comptroller of the National Currency, the FDIC and other tactical supports. Stephen writes very sensibly, but his argument is evidence for the fact that he like most top bankers neglected to study central banks’ financial stability reports, which claim goes to the heart of our present crisis; whatever warnings central banks issued year after year have been ignored by the very people that the usually very prescient and quite timely information was designed for!
The fact is banks’ write-downs wiped out the world’s banks capital reserves (though not equally). The fact is too that this much is normal in a severe recession, but this time the recession has some way to go yet and banks’ worldwide capital reserves will need replenishing again before recovery is upon us. It will be about 6 years before asset values recover their 2006 prices (my contribution to gloomy forecasting). World GDP will meanwhile stumble and then re-grow modestly.
The traditional job of central banks is to do all they can to ensure the financial system muddles through until then without causing longer term damage to itself or others. The traditional job of governments is to ensure the damage to the most vulnerable in society is compensated and that everyone is spring-cushioned sufficiently to bounce back.
Let’s agree that much.

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