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Zeitgeist of the Great Crash of 2008

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Third, the economic credibility of the West has been undermined by the crisis. This is important because for decades much of the United States' influence and soft power reflected the intellectual strength of the Anglo-Saxon brand of market-based capitalism. But now, the model that helped push back socialism and promoted deregulation over regulation -- prompting the remaking of the British Labour Party, economic reforms in eastern Europe, and the opening up of Vietnam in the 1990s -- is under a cloud. The U.S. financial system is seen as having failed.

Furthermore, the United States and countries in the eurozone have resorted to large-scale nationalist economic interventions that undermine free-market doctrines. The U.S. government has taken equity stakes in more than 20 large financial institutions and, according to Treasury Secretary Henry Paulson, may eventually invest in "thousands" of them. In addition, it has temporarily guaranteed the key debt of its entire banking system. France, Germany, and the United Kingdom have intervened even more extensively, each in a slightly different way, with Germany, for example, backing the full amount of all private deposits. The British government's banking interventions, when measured in relation to the country's GDP, are even larger than those of the U.S. government relative to U.S. GDP.

All these interventions will stop the global shift toward economic deregulation. As President Sarkozy put it, "Le laisser-faire, c'est fini." Or, as Chinese Vice Premier Wang Qishan said more diplomatically, "The teachers now have some problems." This coincides with the natural and very long-term movement away from the U.S.-centric world that started after the fall of the Berlin Wall two decades ago.


CHINA'S GAIN

This movement also reflects the rapid rise of other economies, especially China and India. The U.S. share of world GDP had been declining for seven years before the financial crisis hit. And it looks increasingly likely that China's GDP will surpass the United States' at some point during the next 25-30 years. The rising nations' growing economic strength brings increased global influence and competition with it. The result, in the words of Richard Haass, president of the Council on Foreign Relations, is the emergence of a "nonpolar world."

China, for example, will suffer a lesser blow from the global crisis. It is experiencing some economic pain. Its export markets, led by the United States and Europe, are slowing dramatically. China is also suffering from price declines in certain urban real estate markets. Its growth slowed to nine percent during the third quarter of 2008 -- a rate that other nations would envy but was China's slowest in five years. These factors explain why the Chinese leadership is implementing a multiyear economic stimulus plan worth over $500 billion, or approximately 15 percent of GDP. Still, the IMF is projecting that the country's economy will grow by 8.5 percent in 2009.

In financial terms, China is little affected by the crisis in the West. Its entire financial system plays a relatively small role in its economy, and it apparently has no exposure to the toxic assets that have brought the U.S. and European banking systems to their knees. China also runs a budget surplus and a very large current account surplus, and it carries little government debt. Chinese households save an astonishing 40 percent of their incomes. And China's $2 trillion portfolio of foreign exchange reserves grew by $700 billion last year, thanks to the country's current account surplus and foreign direct investment.

This means that although China, too, has been hurt by the crisis, its economic and financial power have been strengthened relative to those of the West. China's global influence will thus increase, and Beijing will be able to undertake political and economic initiatives to increase it further. China and the Association of Southeast Asian Nations are just concluding an agreement that would create the world's largest free-trade area, and Beijing could take additional steps toward Asian interdependence and play a stronger leadership role within the region.

China could also expand its diplomatic presence in the developing world, in order to further its model of capitalism and, in places such as Angola, Kazakhstan, and Sudan, satisfy its thirst for natural resources. In the midst of this crisis, it might also help finance emergency loans, either directly, through bilateral financing arrangements, or indirectly, by creating an additional facility at the IMF that could expand the organization's available credit beyond what current quotas allow. China should also be expected to make strategic investments through its sovereign wealth funds. Given China's appetite for natural resources, this is one likely area of interest; its relatively underdeveloped financial-services infrastructure is another.

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THE FALL OF THE REST

India may also survive the crisis relatively unhurt. There, as in China, the financial system plays a small role in the overall economy. India also remains a fairly closed economy in terms of foreign investment, and so it is less dependent on external capital. Close observers expect India's growth to continue, perhaps at an annual rate of 6.5-7 percent. But India does not have nearly the wealth or the internal cohesion of China. This past fall, the government of Prime Minister Manmohan Singh narrowly avoided losing a parliamentary vote of no confidence and having to dissolve itself over opposition to the nuclear agreement it signed with the United States in 2005. The overall result is that India is inwardly focused and not particularly equipped to advance its geopolitical standing.

Much of the rest of the world, however, has been hit hard by the crisis. The damaged Western banks, which had consistently supplied credit to businesses in the developing world, have abruptly stopped providing it. As foreign capital has been withdrawn, currencies, local banking systems, and stock markets in already poor states have weakened sharply. Eastern European countries that had been running exceptionally large current account deficits and had built up substantial foreign debts are particularly hurting. Hungary, Latvia, and Ukraine are prominent examples, and Hungary and Ukraine have already secured emergency loans from the IMF.

In Russia, the plunge in oil and other commodity prices has caused a near collapse of the ruble and of local share prices. The government of President Dmitry Medvedev has been spending huge amounts, perhaps $200 billion so far, to prop up the currency, Russia's financial system, and several highly leveraged state-controlled enterprises. With $500 billion in foreign exchange reserves, Russia remains in a strong financial condition even after these rescue efforts. Yet these sobering events will make some of its renewed geopolitical ambitions harder to achieve. In theory, this could permit a thaw in U.S.-Russian relations if Obama were to make an overture. Before that happens, however, Moscow might try the "get tough" approach that Soviet Premier Nikita Khrushchev used with U.S. President John F. Kennedy in Vienna in 1961.

The outcome of the crisis will be more serious for Iran and Venezuela, which, like Russia, have suffered from the fall in oil prices but, unlike Russia, have limited foreign exchange reserves. Iran's economy was already rickety, and internal pressures are now likely to grow. Venezuela, which has been spending freely to advance President Hugo Chávez's international agenda, is facing an even more severe problem.


A SCALPEL, NOT A HATCHET

This historic crisis raises the question of whether a new global approach to controlling currencies and banking and financial systems is needed. Many economists and leaders are advocating such a reordering and calling for a Bretton Woods II. But creating a wholly new global financial order would be unworkable. Financial and currency markets are too large and too powerful to be contained; the days of managed exchange rates are over. Global financial regulation would probably cause more problems than it would solve, if only because the reforms needed in the West differ too much from those required elsewhere.

A better approach is to focus on a few key measures. First, the crisis is an opportunity to strengthen and reshape the IMF. The organization has $250 billion in unused lending capacity, but this capital base has not been adjusted since 1997 and may not be large enough to help the many developing nations currently suffering balance-of-payments and liquidity crises. (Hungary, Iceland, Pakistan, Ukraine, and six other countries have negotiated or are currently negotiating emergency-financing packages with the IMF.) This should be remedied. The IMF can also be made more flexible. Historically, it has conditioned its assistance to borrowing countries on their tightening their belts, by, for instance, reducing their budget deficits. Conditionality remains necessary over the long term, but with this crisis still unfolding, the IMF is rightly moving toward temporarily suspending it. Furthermore, high-surplus countries, such as China and the oil-producing states in the Persian Gulf, should be made larger shareholders in the IMF. It would be logical, for example, for these nations to lead any new and separate lending facility established by the IMF.

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chin:

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Second, the G-8 framework is increasingly obsolete. The economic power and wealth of China mandate that it, at a minimum, be included in the group. Because it is more representative, the G-20 framework (19 of the world's largest national economies plus the European Union) should be used more often, and the G-8 less so.

Third, the Basel II guidelines regulating the capitalization of banks should be revised. They proved severely inadequate at protecting banks against the balance-sheet crises that have befallen them. A better approach would be to build capital cushions for banks during prosperous times that could be depleted during crises.

The United States will remain the most powerful nation on earth for a while longer. Its military strength alone ensures this. But the crash of 2008 has inflicted profound damage on its financial system, its economy, and its standing in the world; the crisis is an important geopolitical setback. The international acclaim that greeted Obama's presidential victory may soften its effects, but even this enthusiasm cannot wipe those away. This is partly because the crisis has coincided with historical forces that were already shifting the world's focus away from the United States. Over the medium term, the United States will have to operate from a smaller global platform -- while others, especially China, will have a chance to rise faster.[/quote]
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chin:
FINANCIAL LUNATICS?
The end of the world as we know it
By Michael Lewis and David Einhorn Published: January 4, 2009

http://www.iht.com/articles/2009/01/04/opinion/edlewis.php

Opinion piece from IHT. Michael Lewis is the author of "Liar's Poker" (The book is in the bookshelf in the upstair master bedroom toilet.) David Einhorn is from Greenlight Capital and author of "Fooling some people all the time" (The book is in the bookshelf on top of the TV.)

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Americans enter the New Year in a strange new role: financial lunatics. We've been viewed by the wider world with mistrust and suspicion on other matters, but on the subject of money even our harshest critics had been inclined to believe that we knew what we were doing. They watched our investment bankers and emulated them: For a long time now half the planet's college graduates seemed to want nothing more out of life than a job on Wall Street.

This is one reason the collapse of our financial system has inspired not merely a national but a global crisis of confidence.

Good God, the world seems to be saying, if they don't know what they are doing with money, who does?" Incredibly, intelligent people the world over remain willing to lend us money and even listen to our advice; they appear not to have realized the full extent of our madness. We have at least a brief chance to cure ourselves. But first we need to ask: of what?

To that end consider the strange story of Harry Markopolos.

Markopolos is the former investment officer with Rampart Investment Management in Boston who, for nine years, tried to explain to the Securities and Exchange Commission that Bernard L. Madoff couldn't be anything other than a fraud. Madoff's investment performance, given his stated strategy, was not merely improbable but mathematically impossible. And so, Markopolos reasoned, Bernard Madoff must be doing something other than what he said he was doing.

In his devastatingly persuasive 17-page letter to the SEC, Markopolos saw two possible scenarios. In the "Unlikely" scenario: Madoff, who acted as a broker as well as an investor, was "front-running" his brokerage customers. A customer might submit an order to Madoff Securities to buy shares in IBM at a certain price, for example, and Madoff Securities instantly would buy IBM shares for its own portfolio ahead of the customer order. If IBM's shares rose, Madoff kept them; if they fell, he fobbed them off onto the poor customer.

In the "Highly Likely" scenario, wrote Markopolos, "Madoff Securities is the world's largest Ponzi Scheme." Which, as we now know, it was.

Harry Markopolos sent his report to the SEC on Nov. 7, 2005 - more than three years before Madoff was finally exposed - but he had been trying to explain the fraud to them since 1999. He had no direct financial interest in exposing Madoff - he wasn't an unhappy investor or a disgruntled employee. There was no way to short shares in Madoff Securities, so Markopolos could not have made money directly from Madoff's failure. To judge from his letter, Harry Markopolos anticipated mainly downsides for himself: He declined to put his name on it for fear of what might happen to him and his family if anyone found out he had written it. And yet the SEC's cursory investigation of Madoff pronounced him free of fraud.

What's interesting about the Madoff scandal, in retrospect, is how little interest anyone inside the financial system had in exposing it. It wasn't just Harry Markopolos who smelled a rat. As Markopolos explained in his letter, Goldman Sachs was refusing to do business with Madoff; many others doubted Madoff's profits or assumed he was front-running his customers and steered clear of him. Between the lines, Markopolos hinted that even some of Madoff's investors may have suspected that they were the beneficiaries of a scam. After all, it wasn't all that hard to see that the profits were too good to be true.

Some of Madoff's investors may have reasoned that the worst that could happen to them, if the authorities put a stop to the front-running, was that a good thing would come to an end.

The Madoff scandal echoes a deeper absence inside our financial system, which has been undermined not merely by bad behavior but by the lack of checks and balances to discourage it. "Greed" doesn't cut it as a satisfying explanation for the current financial crisis.

Greed was necessary but insufficient; in any case, we are as likely to eliminate greed from our national character as we are lust and envy.

The fixable problem isn't the greed of the few but the misaligned interests of the many.

A lot has been said and written, for instance, about the corrupting effects on Wall Street of gigantic bonuses. What happened inside the major Wall Street firms, though, was more deeply unsettling than greedy people lusting for big checks: leaders of public corporations, especially financial corporations, are as good as required to lead for the short term.

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