First International

Debt and the price of money

- Monday 13 August 2012 -

SHIPPING is immersed in debt, as banks supported the rush to order new ships at ever-increasing prices, even when the Chinese boom had gone into decline.

Shipping is today grossly over supplied with ships of a young age, while the market for their services has declined and will remain so until the global economic issues are resolved, which will take many years.

The principal reason for the financial crisis is that all the markets over the past decade were fueled more by the supply of debt money than the supply of the products that are traded on them. It has been the huge additional creation of paper trades, options and derivatives that created a false boom.

Thus the daily volume of trading in foreign exchange is now a 10-fold multiple of the monetary value of world trade. Not satisfied with merely trading in issued debt from corporations and governments, the investment banks created credit default swaps to hedge against the underlying risks of the debt instruments.

This is the equivalent of betting on a horse to win while others bet on it to lose and the betting continues throughout the race. This form of spread betting is now endemic in the capital trading markets and at times becomes the tail that wags the dog, as we saw in the so-called sub-prime house mortgage markets in the US.

This increase in money supply and its attendant debt levels fueled inflation that continues today and which is trumpeted by some as the way out of today’s financial crisis. Inflation is, however, economically one-sided. Costs go up and the purchasing power of money goes down.

Since the mid-1990s, the US Federal Reserve and other Central Banks have led a massive increase in debt though issuing more government bonds and providing cheap loans to the banks, while encouraging companies to borrow more and yet chastising the consumer for the growth in credit card debt.

Meanwhile, the saver, the cornerstone of capitalist society, is being penalised by low interest rates and higher prices on everything from cars to cornflakes. The ever-growing retirement community faces the worst scenario of all.

Yet the US and European governments solution to today’s crises is more debt.

Having followed the machinations of the Greek crisis, it is foolish to think that lending Greece more money will solve its problems. It needs its weak currency back to stimulate its tourist industry and its limited exports.

Greece needs to find its own way to increasing their tax collections and reducing the costs of its government. Austerity measures imposed by other governments that have fundamentally different economic structures simply will not work.

Couple this with writing off 50% of the debts Greece owes to the private sector banks and restructuring the country’s balance sheet on a long-term basis. Meanwhile, the EU and the ECB are not taking any write-offs on their loans to Greece, but they must do so and lend any more without proper security.

These debt write-offs would greatly help the Greek economy, but cause losses for the banks — which they, in turn, would pass on to their shareholders. After all, the banks made the loans for commercial gain and should not be rescued when the borrower cannot pay.

Greece still remains bankrupt, but as long as it stays in the euro, it will never be able to repay its debts.

The Greek losses and the likelihood of more to come from Italy, Spain and Portugal will require most of the European banks to raise further capital to remain in business. As we have seen with the losses at JP Morgan Chase and the collapse of MF Global, the problems will not be confined to Europe.

Meanwhile, in the US, the present administration has taken things one stage further, increasing the government’s debt by $1trn and then finding ways to spend it and inflate its way out of trouble.

The US Glass Steagall Act should never have been repealed in 1999, as it fundamentally changed the definition and behaviour of banks around the world, with the notable exception of China that still separates banking from securities trading and brokerage.

As a result, most of the large commercial banks now run huge capital casinos, trading billions of dollars of paper every day, much of which is not primary but derivative in nature.

Stringent new rules restricting banks from trading securities and derivatives would greatly stabilise the markets and move the trading activities away to non-bank entities that cannot take deposits, must publicise their activities and be subject to close examination, thereby causing the banks to refocus on their customers.

Financial discipline is important at all levels of society and just as careless spending by governments must be stopped by elected politicians, so the activities of banks need to be harnessed to ensure the security of savings and the provision of loans on a more tightly secured basis.

Debt should be more expensive and more difficult to obtain, not cheaper and more freely available.

If we continue to borrow at all levels, from governments to the high street, then the value of money will steadily diminish and prices will continue to rise. Savings will depreciate in value and standards of living will decline.

Shipping’s current problems stem from the abundance of debt in the last decade and the easy-to-get public equity. The equity has nearly all been lost, but the debt survives — and many shipping companies still face insolvency. More equity is being issued primarily to pay the interest on the debt, but in some cases just to pay dividends.

Shipping cannot ignore the current global financial problems, as they directly affect the demand for shipping services and, with the new risk capital coming from private equity firms and investment banks who are not long-term investors, the shipping recovery looks a long way off.

The price of money should equal the value of money, but not be driven by the volume of money supplied by debt.

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