The fatal assumption made by many economists, who have now persuaded politicians to believe it too, is that we all act rationally when faced with the same set of circumstances. Rational for whom? Take the myriad bail out programmes being touted by governments and central banks all over the world. They all come with promises to “increase liquidity in credit markets”, “facilitate banks to amend existing mortgages and grant new ones” with the end goal of increased non –governmental spending which “will pull the economy out of recession”. That’s all on top of earlier “loans” just to prevent banks, insurance companies and the “Fannies” of the world from going bust, which would have resulted in “complete financial meltdown”.
It may still happen of course. The “Great Experiment” continues apace with the passing of HR1 into law in the US. HR1? The mnemonic for the $787,000,000,000 Obama “Make Work Pay” plan. “Make Work Pay”? That’s really going to confuse a lot of people who already thought it did! For all the money being pumped around it is still very hard for businesses to borrow and potential homeowners to get mortgages. The banks are being encouraged by their new owners – aka the Government – to lend, often to the same people who couldn’t afford the repayments the last time around, which is what started the mess in the first place. In the US banks are obliged (forced) to restructure payments to “affordable levels” which will become “unaffordable” again as the economy slows and unemployment continues to rise.
So with ultra low rates and the banks allegedly awash with liquidity the economists posit that rational human beings should soon start borrowing and spending again. Well firstly the banks are still reluctant to lend – one look at their balance sheets will tell you why – and Joe Public is beginning to feel the pinch and has reigned in expenditure from levels that were not and are not sustainable. A perfectly rational response it would seem unless you are an economist. The paradox of thrift then kicks in and the economy slows even further as a result of the lack of spending and the propensity to borrow takes another downward leg. “It’s not rational”, they cry, but it happens all the same!
Now there are some fortunate souls with huge mortgages taken out in the “good times” who are feeling much happier with life especially those with base rate linked accounts. Some building societies were offering base minus 1% so payments are now effectively zero. But even they are feeling less secure as the value of their houses has come back with a bang and they find themselves with negative equity.
Eventually, by throwing enough money at the problem, it will go away but then inflation is likely to become a serious issue and can the central banks be trusted to use the brake early enough?
Meanwhile the focus of attention is moving to Europe. The problem for the ECB is what to do with Eastern Europe most of which doesn’t come directly under its remit. However European banks that do have been lending huge sums to their eastern neighbours who are unable to service those loans as their economies have gone off a cliff too. And then there are the PIGS; Portugal, Ireland, Greece and Spain who are showing signs of suffering from Iceland syndrome; the cure for which is as painful as the disease.
Another part of the rational jigsaw is that protectionism won’t help solve anything at all but on a daily basis it is becoming obvious that this is just what governments around the world are engaging in. Brazil and Argentina have started a spate of trade tariffs and blamed it on the Chinese. The revised US bail out package was supposed to remove the “buy America” clause but it didn’t and this hasn’t escaped the attention of the French. La Sarkozy has suggested that if the Americans are going to protect their industry and agriculture then “perhaps we should try to do same”; as if that was something new for the French!
In most commercial transactions the law of supply and demand works as economists expect but in the financial sector it is all about fear and greed and always has been. After all this is not the first financial bubble to unwind and it wont be the last, despite threats of ever more regulation to prevent it happening again, but it is shaping up to be the most unpleasant, unless of course your mind thinks otherwise. Psychiatry should become a growth business don’t you reckon?