Where to Is the Financial Crisis Drifting?

Published on Current Concerns, by Professor Dr Eberhard Hamer, No. 15 /August 2010.

Theoretical alternatives of solution – Both market and administration economy offer alternative solutions:

• Market-based solutions:

  • When banks are highly indebted or hold unreliable or rotten papers they have to devaluate, according to the laws of the market, charge off, and, if necessary, file for bankruptcy. In these cases the losses remain with the banks’ owners, and in addition also with its creditors.
  • This is exactly why the international high street banks were not allowed to be handled and liquidated according to market procedure: The owners behind them (high finance) did not want to bear the losses, and on the other hand they had such great political power via the governments they controlled, that they were able to enforce a solution to the expense of others. 
  • However, the reorganization of the international speculation banks is not ­finished. We still have to dispose of about half of their toxic waste products – some of them have been parked in bad banks –, so that according to the laws of the market they would still have considerable need of writing off – that means losses – in the next decade.
  • When states are highly indebted and cannot obtain more credits, they have to declare themselves bankrupt according to the laws of the market. The state will then cease to amortize its debts, either going on a long-term repayment freeze or force creditors to write off large parts of their credits, so that the state will be solvent again with only the remaining debts and the lowered interest on them. That is why state bankruptcy always means a loss to the state’s creditors. This was exactly the reason why Greece was not allowed to declare state bankruptcy. Its creditors were again those same international speculation banks (namely Goldman-Sachs), which had already been able to shift their losses onto the taxpayers’ shoulders during the first private banking crisis. Now in the Greek debt crisis they politically arranged things in a way that it was not them, the creditor banks, who had to bear the losses. Instead the European governments are purportedly saving Greece, feigning “European solidarity” – but in reality they are again saving the banks and take over their losses. Merkel struggled desperately, but she gave in to the pressure of the Brussels politbureau and after a phone call from the American president. The Federal President was forced to sign the packet of debts without scrutiny in a matter of hours, and resigned afterwards, possibly because of shame.

• Solutions based on administrative ­eco­nomy:

If the private sector is not to bleed, then the public sector must bleed, the battle against the crisis must be based on administrative economy. In the case of the first banking crisis, state intervention was at least able to prevent a short term crash, so the notion that state guarantees could at least spread market-based adjustments over a longer time, and thus win time, proved right. In the course of about two years, around half of the rotten financial products have been destroyed by private and public devaluations, and this way, the correcting power of the market has worked slowly, but it worked.
It is a matter of argument whether it was responsible and, in the long run financially worthwhile, to save international banks like for example the HRE (Hypo Real Estate Bank) at the public’s expense in order to minimize their owners’ – US high finance – losses and to gain time for restructuring. The final answer to this will depend on the further progression of the second phase of the crisis.

But once states have covered the losses of the private banks or have run heavily into debts, there is no avoiding their own restructuring. If they do not want to do this in a market-based way (state bankruptcy), they must find a solution based on administrative economy. Theoretically, there are again two methods of doing this:

–    Axing national debt by means of balancing the budget. This can be done by increasing state revenue (dues and taxes) or by a policy of austerity.

  • Theoretically there aren’t many additional means of increasing state revenues, because most states are already burdening their citizens to the limit of their tolerance. But there are many components of public expenditure, where it would theoretically be possible to save money. For instance, you could cut down state responsibilities, e.g. disband tens of thousands of state staff together with their offices, you could even bring about advantages by withdrawing subsidies (e.g. mining subsidies). States have also reduced public salaries. This is also a possible option to put state finances back on their feet. In Greece, even half of all public servants would have to be dismissed, because they have been recruited by the present government, they have no purpose, no position, and no use. Above all, you could cut social benefits. Why do we have to pamper each and every immigrant with social benefits at once, contrary to other democracies? And why do we pay benefits for life, and even to successive generations? If we think back to the time after World War II, then we worked our way up by economizing. So the theoretical possibility exists today, as well. But whether this is socially and politically possible, remains doubtful.
  • Yet the choice of a recovery by economizing is not without certain consequences. If for example Greece wanted to weather its outrageously high national debt solely by economizing, the country would at once fall into the deepest economic crisis of its history, and moreover pass its depression on to its partners in foreign trade. And above all, this depression would last more than a decade because of the amount of debts – an idea which is difficult to conceive. If even several states had to get out of debt by economizing, this would mean an escalating long-term recession or even depression, e.g. in Europe. This again would mean that large groups of the population would become impoverished and therefore the need to survive would probably result in a civil war. No democratic government can sustain this. A democratic government that economizes, gets the chop. It has always been this way, and therefore democratic governments no longer seriously try this method. The Greek minister of finance has already signalized that he is going to break his vows of economizing and will make no further efforts in this direction.

–    So the last remaining fiscal possibility of correcting the relation between escalating money supply and smaller amount of goods is an adjustment by way of devaluation, i.e. inflation or currency reform, to reorganize the state.

  • Inflation has the great advantage of aiding key groups, first of all the state with growing tax yields and the devaluation of old debts. It also helps businesses, as far as they are able to carry through price increases. Earners of income and pensioners only realize belatedly that they are the losers. Yet the main difficulty of inflation lies in the fact that it will not help the countries in the short term which have been excessively encumbered with debts by now, but only in the medium term. You do need inflation in the double-digit range to significantly relieve say the US or the Mediterranean States from their current liabilities. 3, 4, or 5 percent are not sufficient. But this interferes with currency microstructure and partly dissolves it. What’s more, on an international scale inflation means the redirection of commodity flow and of currencies. If the inflation gets higher, it also often is no longer controllable, and develops into a runaway inflation, that will always lead to currency reform. Therefore inflation does not constitute permanent reorganization, as it would have to do in order to definitely solve the problem of indebtedness.
  • Only a currency reform would serve to permanently reduce the states’ debts in a short time. In most cases after wars or financial mismanagement there were attempts to write off a government’s debt by currency reforms. There is a hundredfold history of currency reforms, so it is an ordinary proceeding.
  • A currency reform would have the theoretical advantage to be immediately effective, to be taxable with winners and losers, and to prevent a recession or depression, because after the devaluation, things immediately go on.
  • Above all, a currency reform is the last theoretical option for writing off an excessive government debt, when all other options either fail or – are not feasible for political reasons.

Practical options for solution: … (full long text).

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