LOS ANGELES, July 20 // -- In the current global financial crisis, several "shoes" have already dropped -- there's the subprime mortgage fiasco, the derivatives debacle, the bank failures - and the hope is that the worst is over and business as usual will resume. But at least one financial expert is clear that there's more to come.
In his new book, Eye of the Storm: How Modern Finance, Monetary Policy, and Reaganomics Created the Largest Financial Crisis in History and The New Policy Direction Needed to Rebuild Our Economy, author Stephan Olajide-Huesler, a retired asset manager, investor, and entrepreneur, confirms that several more shoes are poised to fall! "I see the current situation as a deleveraging spiral the Fed is desperately trying to thwart," he claims, "and although hopeful blips may appear on the screen right now, the trajectory is still downward, with significant perils ahead.
"There's no avoiding that shoes will drop; the only question is when, and who'll end up paying for it. But one thing is certain: Today's policy is clearly heading us down a less preferable and ultimately more destructive path. Current policy aims to avoid a reduction in overall debt by injecting liquidity into the economy and avoiding further deflation in the asset markets." Olajide-Huesler continues . . ..
As long as the Fed "succeeds," bank balance sheets will continue to appear sound, one-off gains interpreted as profitability restored, and financial markets will not punish the economy with higher interest rates and a falling dollar. Yet the Fed's liquidity will keep failing to transmit into the real economy because of adjusted risk estimations in the market. Today we can observe this complete failure of liquidity reaching the real economy, even outside the U.S. :
- Monetary measures are almost completely absorbed by asset markets, which . . .
- Inflate and feed banks' balance sheets, but . . .
- Do not affect the real economy! Which is why, further down the road, the economy will not be able to bear a necessary tightening of liquidity flows.
- Unemployment will continue to increase and consumption languish, if not plunge, and housing will struggle to recover as both banks and consumers continue to deleverage and increase savings.
- The taxpayer will continue to eat up the bad assets the banking system spews out.
The enormous transfer of a good portion of the $50 trillion debt burden onto the taxpayer and the Fed balance sheet will eventually affect both the dollar and interest rates, given the size of the sums involved likely rather viciously. Such a transfer neither clears the deck nor strengthens the economy, because it leaves the rotten fundament of our financial system in place. Continuing current policies means we have to expect a drawn-out recession and years of economic weakness.
Real economic developments do not match the liquidity-driven Wall Street rally because it continues to carry more than $50 trillion in debt, more than 3.5 times GDP. This is unsustainable; the economy is simply unable to generate the cash flow necessary to service this debt. During the past 10 years, cash flow generation became more and more reliant on the expansion of debt and asset prices. Shaky ground indeed.
So a contraction in lending and in outstanding debt is unavoidable, either by way of paying it back, swapping it into equity, or by writing it off.
But with a reduction in debt comes the pain of asset deflation, which will affect everyone. It is hard for us to face the reality that so much of the wealth created was an illusion. But face it we must. As taxpayers and likely the parents of children, it is time to take off our asset-owner hats and put on our taxpayer-and-parent hats. As painful as the immediate effect may be, we need to reinstate sustainable relations in our economy. This even the Fed admits but goes about it using the tools that got us into this mess.
Which brings us back to the question: Who will pay for it? So far, the government's intention is to let the taxpayer foot the bill. But it would be fairer and lead to a quicker recovery if asset prices carried the burden. And contrary to what bankers would have us believe, this would not lead to a collapse of the financial industry and would definitely be the less painful alternative in the long run for the economy and the people at large.
Whichever path we choose, the linchpin to the resolution of this crisis is understanding and modifying how the wholesale application of the theories of Modern Finance influence and distort our financial system. What got us here goes much deeper than mere lack of capital or regulation. Just as the large banks strayed from their core business -- relationship banking -- financial markets strayed from their core function: the efficient allocation of risk and capital. Whichever policy is chosen, government needs to urgently address the individual, institutional, and systemic distortions built during the boom.
Olajide-Huesler was born and educated in Switzerland and managed one of the most successful funds in Asia, navigating successfully through the Asian crisis of the 1990s before joining the world's largest and most successful emerging market investment specialists. At one point, he co-managed $20 billion in assets. Over the last 20 years, he's pretty much seen it all in global finance.
For more information about Olajide-Huesler and the book, visit http://eyeofthestormbook.com.
CONTACT: DAN DEL CAMPOS