With the European crisis continuing to dominate the news, many people now realize that today's global economy faces an unusually uncertain outlook. Indeed, Europe's turmoil is but one of the multiple global re-alignments in play today. What may be less well-recognized is the extent to which specific sectors are already changing in a consequential and permanent manner.
This is particularly true for global finance where volatility has increased, liquidity is evaporating, and the role of government is pronounced but inconsistent. This is a sector where the functioning of markets is changing, along with the outlook for institutions. The implications are relevant for both economic growth and jobs.
The recent volatility in financial markets -- be it the dizzying swings in equities around the world or the fragmentation of European sovereign bonds -- far exceeds what is warranted by the ongoing global re-alignments. We are also seeing the impact of a consequential shift in underlying liquidity conditions -- or the oil that lubricates the flow of the credit and the related ability of savers and borrowers to find each other and interact efficiently.
Facing a range of internal and external pressures, banks seem to be limiting the amount of capital that they devote to market making. Combine this with the natural inclination of many market participants to retreat to the sidelines when volatility and uncertainty increase, and what you get is a disruptive combination of higher transaction costs, reduced trading volumes, and abrupt moves in valuations.
We are also witnessing a loss of trust in instruments that many market participants -- from corporations to individual investors and institutional ones -- use to manage their balance sheet risks. The reduced ability to hedge current and future exposures is even forcing some to transition from using markets to manage their "net" exposures to simply reducing gross footings.
Meanwhile western banks, whether they like it or not (and most do not), are now embarked on a journey -- away from what some have called "casino banking" to what others label as the "utility model." Whether in America or in Europe, banks are under enormous pressure from both the private and public sectors to become less complex, less levered, less risky and more boring.
By withholding new credit, private creditors are forcing certain banks to de-lever -- a process that is amplified by the sharp decline in bank stocks and the accompanying erosion in capital cushions. At the same time, the banks' traditional global dominance is under growing competitive pressures from rivals headquartered in healthy emerging economies.
The result of all this is a further, across-the-board shrinkage in the balance sheet of the western banking system. This is led by Europe where some institutions (e.g., in Greece) are also experiencing meaningful deposit outflows.
After the 2008-09 debacle of the global financial crisis, governments also want their banks to be better capitalized and more disciplined. And while implementation has been both far from consistent and less than fully effective, the intention is clear: Much tighter guard rails and better enforcement to preclude any repeat of the wild west experience of over-leverage, bad lending practices, and inappropriate compensation approaches.
The influence of central banks and governments are also being felt in other ways that impact the functioning and efficiency of markets. Some of the implications are visible and largely knowable while others, by their very nature, are unprecedented and therefore less predictable.
For three years now, central banks have been pursuing a range of "unconventional policies," particularly in America and Europe. The goal has been to reduce the probability of prolonged recessions and severe financial dislocations.
In doing so, central banks have gone well beyond their prudential supervisory and regulatory roles. They have become important direct participants in markets -- essentially using their printing presses to buy selective securities, and doing so not on the basis of the usual commercial criteria that anchor the normal functioning of markets.
Market predictability is also being impacted by the erosion in the standing of sovereign risk in the western world. The cause is the twin problem of way too little economic growth and way too much debt. The effect is a less stable global financial system now that there are fewer genuine "AAA" anchoring its core.
All this will translate into a very different financial landscape. The change will be most pronounced for banks.
Look for western banks to be less complex, less global, somewhat less inter-connected and, therefore, less systemic. With some banks teetering on the edge, certain European governments (e.g., Greece) will have no choice but to nationalize part of their financial system.
Also, with the western banking system shrinking in scope and scale, look for new credit pipes to be built around those that are now clogged. With the aim of supporting growth and jobs, particularly in longer-term investments such as infrastructure, some of these pipes will be directed or enabled by governments.
Have no doubt, the financial landscape is rapidly evolving. Some of the changes are deliberately designed and implemented. Others are being imposed by the quickly changing reality on the ground.
The ultimate destination is a smaller and safer financial services sector. When we get there, a better balance will be struck between private gains and the common good. Banks will be in a better position to serve the real economy without exposing it to catastrophic risk and harmful abuses.
The next few months will shed light on the extent to which governments and, to a lesser extent, business leaders are able to properly orchestrate the process. The more they fall short, the less growth and fewer jobs there will be.
This post was originally published at Reuters. The views expressed are the author's own.
Peter Kellner: The State of the Economy is Leaving the Tories Unscathed
Bernard-Henri Lévy: In the Face of Financial Crisis, Redo Ancient History
Gavin Shulman: The Dow of Life
Heather Hurlburt: GOP Foreign Policy Debate: Dime-Store Neo-cons
There is NO standard sovereign risk anywhere in the world. Nations that are the sole issuer of their own fiat currency that have external debt denominated in that currency have 0/ZERO/NO/NIL risk. These nations (like the US/UK/Japan etc.) have currency sovereignty and by definition cannot default.
Bretton Woods collapsed 40 years ago and the days of convertible currencies and the gold standard are relics of the past.
The laughable, to those who know better, credit agency ratings mean nothing when it comes to sovereign debt. Private investors are constantly climbing over each other to park idle cash with NO risk and receive a coupon rate of interest. It is welfare for the uber wealthy institutions of the world.
Don't believe me? Then explain Japanese or even US debt - you will see that those who eagerly buy up sovereign debt could care less what S&P has to say about anything.
The only western countries with external debt risk are member nations of the EMU. They do not have a monopoly on their own currency. They operate in a foreign currency, the Euro and therefore pose a default risk.
There's also the aspect of this, that war can be waged by bankrupting your competing country, and won, without firing a shot. Well, eventually shots WILL be fired, about the time the affected countries figure out just how bad they got hosed, but it's an aspect of all this to be carefully considered.
You always get it right, never panic, always have both a historic and logical perspective and communicate very clearly.
So my question is: How do we get you to become Secretary of the Treasury ... or at least President?
Very best of good fortune and good health in the coming New Year.
More and more, profits are increased artificially and money is invented out of thin air. Essentially, the vast majority of ordinary people are now cut out of finance even though nearly EVERYTHING has become financialized. Capital no longer flows to new industry, retail, on-the-ground enterprise. Capital is becoming more and more abstract and detached from daily life.
Hence the lack of trust. I mean, it was hard-earned, that lack of trust.
I'm encourage to hear this author sees things getting better, as I've read him often before and he seems to be on it. But wow. I don't see that. It feels like everything is grinding to a halt here.
TOTAL CDS MELTDOWN ON EUROPEAN SOVEREIGN DEBT IS COMING
http://www.zerohedge.com/news/evolution-warns-total-carnage-and-meltdown-european-bank-sales-cds-european-sovereign-debt-soar
THE LATEST GLOBAL SCAM: RE-HYPOTHECATION
http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/
BTW, LOVE your mini bio.
Because they, like the rest of us, don’t know what.
We’ve driven ourselves into a dead end, and our drive for infinite consumption sees the wall of finite resources ahead.
http://www.yourmedievalfuture.com/
Instead of creating $600B and forking it over to Wall Street, the Fed would
give every man, woman and child $2,000.
They would then decide whether to spend it (support economy) or deposit it (recapitalize banks).
Banks are businesses - they should compete for our capital by offering decent interest rates.
Getting free money from the Fed is an abomination.
We have to change our model of economic growth being 70% driven by consumer spending. Instead, model moving forward, should be to get Americans to save instead of spend. This is antithesis of "Ownership Society" which was allegedly building wealth based on borrowed assest, in a never ending cycle of persistatnt borrowing and interest payments.
First step may be, US govt. debt should be owned by Americans instead of foreigners. This way, we'll pay interest to ourselves instead of foreigners.
With such an approach, many retirees may not be so dependent on SS and the uncertainties of the stock market for their 401-K and retirement plans.
Average SS payment of $1,000 / month with mortgage paid, is livable, specially now that Medicare part-D covers drugs. For further help, one should rely on one's children; who have cost boomers about $100,000 / child to raise and educate them to age 20 yrs. That financial contribution, together with love, caring and responsibility, is better than making the same children pay higer SS taxes and channelling the money through a giant Washington-based bureaucracy.
Another option is a 5% tax on all public entertainment above $10:00 to pay for the govt's unfunded pension obligations of 3.5 Trillion; which includes Social Security Trust Fund 2.6 Trillion; which has been depleted by federal govt. borrowings.
- public financing of ALL elections
- reinstauration of Glass-Steagall.
By barking at the moon all day and finger point areas of improvement we will get nowhere.
Let´s do something effective NOW!
We have to stop obsessing about gay issues and other marginal issues
and focus on what matters most at the moment.
You cannot create prosperity through austerity. You have to spend more to kick start and reignite the economy to stimulate demand in a demand-starved economy. Only after the economy has recovered should you then focus on debt reduction.
Yes, Germans and Swiss seem to have a hold on Reality !
American Federal Reserve is just another Printing Company for Banks.
State Banks and Credit Unions seem better managed and more truthful ?