ÁMBITO FINANCIERO – In January 2006, on the occasion of the use of international reserves to pay the IMF, I published an article warning that it was a very bad idea to get rid of more than $9 billion that could be useful when the bubble broke out that was gestating at the time. Today I feel that I am living a déjà vu; since at international level, the same conditions are taking place that took to the crisis of 2007-8. Therefore, my perseverance in warning the current Government that it must take measures to deal with this contingency, which the majority considers being a shock, as it was then. In 2006, narcotized politicians, analysts and investors with the excesses of financing that generates growth and artificial profits without roof, they proclaimed, modifying the phrase of Francis Fukuyama: “The end of the crises”. That was the title of the following article that I published explaining, not only that that did not make sense, but why I considered that a new crisis was incubating giving the arguments that I comment next.
Since 2001, due to fears of a crisis following the terrorist act against the Twin Towers, the Federal Reserve sharply lowered the benchmark interest rate. For that to happen, it bought US Treasury Bonds issuing dollars and increasing credit. The problem is that people demand loans to spend or invest, not to keep the dollars in their pockets; so this tends to generate a loss of currency value.
At that time in the US, the core CPI was followed as inflation indicator, which was the total consumption basket minus energy and food that are considered more volatile. The downside is that this involved taking a biased compass. China and other Asian countries had begun to implement market rules of play in their economies; which caused a strong growth of their economies. When a poor person has more spending capacity, he just applies a greater proportion of his new income to food and energy, so the demand for these and, consequently, their price, rise sharply. Now, in the US, before the increase in the values of both components of their basket, they had to restrict consumption in the rest and, therefore, their prices tended to rise very little. Those were just the ones that relieved the Core CPI, underestimating inflation.
If the Federal Reserve and the analysts of the world had looked at the total CPI or the prices of the assets, they would have noticed that a bubble was being inflated. Although its president Alan Greenspan realized the “irrational exuberance of prices”, it tended to increase the interest rate very slowly; so it ran behind the market depressed by economic growth, which forced him to continue issuing liquidity and inflating the bubble until it burst.
Today the exact same thing happens. The Federal Reserve has been holding low-interest rates since 2009 and has been inflating a new bubble. This time it is not noticeable in consumer prices because the crisis of 2007-8 generated a global reaction towards greater savings and lower debt; since that was the assumed origin of said setback. Therefore, the excess liquidity has not been going to spending, but to investment and over scarce debt assets; so it is observed that today the prices of financial assets, even removed the impact of inflation, are far above when the previous crisis exploded. In fact, even in the US real estate market that was the one that was awarded the debacle, in some indicators shows values, without inflation, above those of 2007, when everyone knows that “Whoever burns with milk sees a cow and cries.”
It should be noted that the crisis of 2007-8, was not “the fault of mortgages”, but that the majority of surplus liquidity was directed because it generated a possibility of extraordinary gains by alleviating the conditions to take credits from people and give them the guarantee of two semi-state entities such as Freddy Mac and Fannie Mae. Only the bubble that inflated the most burst faster; but there were bubbles in the whole world. This happens because when the Federal Reserve decides to exceed the provision of liquidity, this attitude is generalized to all central banks; since there is a mistaken idea that a low exchange rate is bad for the country’s economy. That is if the Federal Reserve issues excessively and depreciates its currency, the other central banks of the world try to prevent it from going down in their markets by buying dollars by issuing their own currencies and encouraging their own bubbles.
If someone asked if the bubble would necessarily burst, perhaps not if the Federal Reserve could raise the rate a little more quickly to try to deflate it. Nor do we know when it will explode if the Fed does not do its homework, but the chances of an international crisis will begin to increase from mid-year and it will not take more than 2 years to occur. Where will the first bubble explode? Nobody knows, but it will automatically start a chain burst.
This government inherited a state and a Central Bank almost bankrupt. Due to the gradualism is chosen as a strategy, they have achieved a very slow and limited progress in terms of improving their solvency.Therefore, there is no possibility that they can withstand the credit cut that would imply a global crisis. Therefore, today that there is excess liquidity the Government should aim to generate a financial safety net with contingent credits (to be used if there is an international debacle) that could be provided by international organizations, central banks of developed countries and commercial banks, covering the financing needs of at least one year. You will have to pay for these loans, but it is necessary to remember the saying “A banker lends you the umbrella only when there is sun”. If a crisis breaks out, we will be one of the first countries to which credit will disappear. Then, it will be late and the costs for Argentinians will be enormous.
Written by Aldo Abram
Executive Director, Libertad y Progreso.
Originally publish in Spanish Ámbito Financiero