How to stop the financial panic? (Part 1)


Governments around the world are shocked and appalled at their failure to stop the deepening financial crisis. Nothing they tried has helped calm the crisis. Profitable companies are prohibited from borrowing. Trust is gone. Since October 7, the US stock market has broken records of poor performance not equaled since 1932 on fears of a serious slowdown in economic activity. Says Stephen Jen, monetarist at Morgan Stanley (MS) in London: “The choices for the real economy are between a recession and a depression. »

Can anything be done to stop this panic? In fact, yes. It won’t be quick or easy. But the prerequisite for a new approach is to unlearn the doctrines that were developed in the aftermath of the Great Depression, the last time financial conditions were worse than this. The world has changed in the seven decades since, and what worked to ease the financial crisis then may not work today – anyone who tries to borrow money can see that.

So far, financial decision makers in the United States and their counterparts abroad have mostly employed the helicopter technique – i.e., dropping billions across the financial landscape with the secret hope of reinvigorating lending and consumption. Generations of economists around the world learned this approach at the feet of the late Nobel laureate in economics Milton Friedman, who coined the helicopter metaphor. Federal Reserve Chairman Ben Bernanke, while somewhat different from Friedman, shares his general approach and actually earned the nickname “Ben Helicopter” after quoting Friedman’s invention in a 2002 speech.

So following that logic, the Federal Reserve is aggressively lending money to all comers. Another example of helicopter money is the synchronized interest rate cuts by central banks on October 8 that resulted in US federal funds interest rates rounding to 1.5%. Central banks figure that by flooding the banking system with billions, they can get the banks to redistribute the money to the rest of the economy. But while lowering interest rates and providing liquidity is essential, it’s still not enough, says Paul JJ Welfens, president of the European Institute for International Economic Relations in Wuppertal, Germany. Welfens adds: “It’s very dangerous if you don’t have a strategy. The situation is getting worse because no one is doing what is necessary to restore confidence. »
An alternative approach favored by many specialists is to place the money strategically where it will do the most good, even if that means having winners and losers and allowing a few credit channels to limit damage. for the moment.

One possible tactic would be direct investments by governments in selected banks on a large scale. The theory behind this approach is that the banks are so badly hurt that simply lending them more money won’t solve anything. To rebuild their balance sheets so that they can start lending freely again, the banks need fresh capital, and the government is the only party that is able to provide it under these extreme conditions. Sweden employed this strategy to resolve a banking crisis in the early 1990s. And on October 8, Britain took a giant step in the same direction, announcing an offer to buy up to $88 billion in shares. preferences to Britain’s largest banks. The government also said it will guarantee up to $437 billion of bank debt. “This is the start of a process of settling a big problem where banks will not lend money to each other for long periods of time,” Chancellor of the Exchequer Alistair Darling told Sky News. End of the first part

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