Capitol Hill Blue Forums Political Issues Finance, the economy & Economics How will the financial crisis develop?

The markets are going crazy. On Monday, the Dow-Jones in New York rose more than 200 points to its highest level in 13 months. Gold is more expensive than at any other time in history; the dollar continues to weaken and is almost at the level it was when the great financial crisis began last year. Dealers for banks and hedge funds are buying stocks and commodities as if they think a boom is imminent. They’re buying gold as if they feel they have to protect themselves from inflation and they’re selling dollars as though they expect interest rates in America to stay at zero forever.

None of this has anything to do with reality. American unemployment is rising faster than had been feared, meaning the next recovery will be far weaker than normal. Factories stand empty and payrolls are falling – both strong indicators for coming inflation. And of course it’s also clear that the dollar can’t keep sinking forever and that interest rates in the United States will have to rise again.

[SNIP]

The banking crisis has by no means been resolved. In Germany, the Bavarian State Bank has reported new losses amounting to billions of euros; in the United States, officials closed five banks on Friday to keep them from total collapse, an action hardly noticed by the public.

The logic of a financial transactions tax is simple. It would impose a modest fee on trades of stocks, futures, credit default swaps and other financial instruments. For example, the UK puts a 0.25% tax on the sale or purchase of shares of stock. This has very little impact on people who buy stock with the intent of holding it for a long period of time.

[SNIP]

Since the financial sector is the source of the country's current economic and budget problems it also makes sense to have this sector bear the brunt of any new taxes that may be needed. The economic collapse caused by Wall Street's irrational exuberance has led to a huge increase in the country debt burden. It seems only fair that Wall Street bear the brunt of the clean-up costs. A financial transactions tax is the way to make sure that this happens.

Today is Thanksgiving. After looking over the movement in the international exchange rates over the past three days, and going to some of the lesser known money sites, I have the feeling that we are in a pivotal period.

On September 28, 2009, the Office of the Comptroller of the Currency report on banks derivatives trading activities showed that the estimated value of all derivatives held by US commercial banks was rising, increasing nearly 1% over the last quarter and 12% year to year, to $203.5 trillion (total includes interest rate, FX, credit and other derivatives).

Bank holdings of credit default swap (CDS) contracts remain greatly elevated. Although down from their peak in the fourth quarter of 2008, banks hold more than five times the amount in such derivatives than at the end of 2004, when the US economy was taking off.
Banks exposure to derivatives, while falling slightly, remains alarmingly high. Bank of America’s total derivatives-related credit exposure relative to its capital was 137%; Citibank 209% and Goldman Sachs 921%.

Trading credit derivatives is once again highly profitable. After seeing huge losses on these instruments toward the end of 2008 and into first quarter of 2009, banks generated $1.9 billion in cash and derivative revenue in the second quarter of 2009. That is problematic because regulatory reform is still stuck in Congressional committees and subject to industry pressure not to spoil the party. As banks find it difficult to find credit worthy borrowers, they are using their fund to trade derivatives to drive profits. This asset new bubble built by Fed funny money, unlike the previous ones, does not even bother to create an illusion of prosperity, nor full employment.

Once again derivatives are being used not to hedge risk but to generate unsustainable trading profit. Soon it will be deja vue all over again. But first the world economy needs to recover from the current crisis which may not take hold until 2014. If history is any guide, around 2020 will be the time for the next global market collapse.

November 24, 2009