The Financial Jigsaw – Issue No. 23

My unpublished (100,000 word) book “The Financial Jigsaw”, is being serialised here weekly in 100 Issues by Peter J Underwood, author 

Last week we looked at how democracy has failed in its truest sense due in the main to the creation of fiat currencies which have caused governments to be beholden to the banksters; here is the link to last week:  Issue 22

 This week we will examine the effect of the global financial crisis in 2008-9 on government policy and what our financial masters say they have learned from the experience.  In the following ten years it seems that little has in fact been learned as central banks have colluded to issue the largest amount of new currency in the history of the world.  We have yet to discover the ultimate result of such experiments but as time passes, it does appear that we are returning to a crisis period yet again.  

CHAPTER 5

GOVERNMENT FINANCES 

“Government is not reason, it is not eloquence – it is a force! Like fire, it is a dangerous servant and a fearful master; never for a moment should it be left to irresponsible action.”

George Washington

Measuring a country’s economic health

We have already covered some aspects of debt and credit in previous Issues showing when governments exceed the limits of reasonable debt levels bad things can happen.  Gross Domestic Product (GDP) is the accepted method of measuring a country’s economic health; the total borrowing of the government (the national debt) is expressed as a percentage of GDP.

Unpleasant things can happen when government debt exceeds 100% of GDP (source: This Time is Different – Reinhart & Rogoff-2009). Four studies published in just the past three years document this conclusion.

These studies are highly relevant since OECD figures indicate that gross government debt exceeds 100% in the USA, UK, Europe, and Japan as well as in many other OECD member countries. Three of these studies were conducted by foreign scholars and published outside the United States:

• Swedish economists Andreas Bergh and Magnus Henrekson find a “significant negative correlation between size of government and economic growth in as much that an increase in government size by ten percentage points is associated with a 0.5% to 1% lower annual growth rate.” (Journal of Economic Surveys, April, 2011)
• In an empirical investigation for the euro area, Cristina Checherita and Philipp Rother find that government debt to GDP ratio above the turning point of 90-100% has a “deleterious” impact on long-term growth. Additionally, the impact of debt on growth is ‘non-linear’. This means that as the government debt rises to higher levels, the adverse growth consequences accelerate. (European Central Bank, Working Paper 1237, August 2010)
• In The Real Effects of Debt, Stephen G. Cecchetti, M.S. Mohanty and Fabrizio Zampolli determine “beyond a certain level, debt is bad for growth. For government debt, the number is about 85% of GDP.” (Bank for International Settlements (BIS) in Basel, Switzerland, September, 2011)
• In Debt Overhangs: Past and Present – Post 1800 Episodes Characterized by Public Debt to GDP Levels Exceeding 90% for At Least Five Years, Carmen M. Reinhart, Vincent R. Reinhart and Kenneth S. Rogoff confirm that public debt overhang episodes are associated with growth over one percent lower than during other periods, and such episodes lasted an average of twenty three years. They write: “the long duration also implies that cumulative shortfall in output from debt overhang is potentially massive”. (National Bureau of Economic Research, Working Paper 18015, August 2012).  Reinhart and Rogoff had made a detailed study of public debt in their book: “This Time is Different – 2009”.  Furthermore when private debt rises above 160% to 175% of GDP, growth is also stunted. This argument is important since private debt in U.S.A. was 260% of GDP in the fourth quarter of 2012.

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A consequence of the Global Financial Crisis 2008

Public and private debt is merely one aspect of the distortions apparent in all economies throughout the world today. There are many other features associated with government fiscal management when combined with the nefarious activities of global financial institutions.

I promised not to dwell on the causes of the global financial crisis of 2008 but it might be helpful to gain some understanding of how one key individual sees potential solutions unfolding in order to prevent another meltdown.

Henry Merritt “Hank” Paulson, Jr. (born March 28, 1946) is an American banker who served as the 74th United States Secretary of the Treasury.  He had served as the Chairman and Chief Executive Officer of Goldman Sachs, and is now chairman of the Paulson Institute, which he founded in 2011 to promote sustainable economic growth and a cleaner environment around the world, with an initial focus on the United States and China.

Hank’s book: “On the Brink” describes his experiences as Treasury Secretary when he managed a team of experts handling the financial meltdown during 2007-08. He writes of the lessons he learned and noted some observations critical of the current financial system, especially of that used in the USA.

Since he left Treasury he had been approached by people eager to hear about his experiences and two questions often appeared: “What was it like to live through the crisis?” and “What lessons did he learn that could help us avoid a similar calamity in future?”  He hopes that the first one is answered by reading his book and goes on to list some lessons, although complex, he narrowed them down to just four crucial ones:

1. “The structural economic imbalances among the major economies of the world that led to massive cross-border capital flows are an important source of the justly criticised excesses in our financial system. These imbalances lay at the root of the crisis which causes the US government to borrow large amounts of money from oil-exporting countries and Asian nations which it can never repay except by printing money and thus inflating away the debt burden”.
2. “Our regulatory system remains a hopelessly outmoded patchwork quilt built for another day and age. The system has not kept pace with financial innovations [see Chapter 8 about Financial Engineering] and needs to be fixed so that we have capacity and the authority to respond to constantly evolving global capital markets”.
3. “The financial system contained far too much leverage [excessive borrowings], as evidenced by inadequate cushions of both capital and liquidity [money].  Much of the leverage was embedded in largely opaque and highly complex financial products [derivatives].  It is generally understood that both commercial and investment banks in USA, UK, and Europe as well as the rest of the world did not have enough capital [they ran out of money!].  Less well understood is the important role that liquidity [cash – again!] needs to play in bolstering the safety and stability of the banks.  The credit crisis [global financial meltdown] exposed widespread reliance on poor liquidity practices, notably a dependence on short-term funding; which means institutions using these methods need to have plenty of cash on hand for bad times and many did not”.
4. “The largest financial institutions are so big and complex that they pose a dangerously large risk”.  In 2015 the top ten financial institutions in the USA held close to 60% of total financial assets, up from 10% in 1990, and continually growing bigger.  The concept of ‘To Big To Fail’ (TBTF) has moved from academic literature to reality and must be addressed.

Hank goes on to list a number of steps to be taken by the US government to reduce global imbalances that have been decried for years by many prominent economists, some even Nobel Prize winners, who should know better.

Perhaps they actually do know better but, like many politicians and media pundits, they are captured in the merry-go-round of financial opportunity and reward?  I think it important to quote Hank Paulson in his book, “On the Brink,” [at page 441]: “Our government needs to tackle its number one economic challenge, which is reducing its fiscal deficit.  Our ability to meet this challenge will to a large extent determine our future economic success.  We are now on a path where deficits will rise to a point at which we may simply be unable to raise the necessary revenues even if significant tax increases are imposed on the middle class.”

To be continued next Saturday

Author: Austrian Peter

Peter J. Underwood is a retired international accountant and qualified humanistic counsellor living in Bruton, UK, with his wife, Yvonne. He pursued a career as an entrepreneur and business consultant, having founded several successful businesses in the UK and South Africa His latest Substack blog describes the African concept of Ubuntu - a system of localised community support using a gift economy model. View all posts by Austrian Peter