Wednesday, October 15, 2008

BUBBLES DON'T ALWAYS BURST

By

SUSHANT SAREEN

The international financial bubble has got punctured but the spectre of global financial meltdown that haunted the entire world economy has faded to a great extent after the bailout packages totalling nearly $3 trillion announced by the US and European governments. The institutional and governmental response to the crisis may prevent any global 'Great Depression' or widespread economic dislocation and distress, but this does not mean that the financial markets and consequently, the real sector are going to bounce back anytime soon, certainly not for a couple of years. If anything, the global financial crisis is likely to cause a lot more pain than has been inflicted so far.

Until now only some iconic financial companies have either folded up or have been taken over by more stable companies, and a few thousand people have lost their jobs. A lot more of the same is going to happen as the financial markets make the necessary corrections and go through the painful process of adjustment, stabilisation and restructuring. To be sure, during this period there will be a slowdown, perhaps even a prolonged recession, and this will have an adverse impact on the international business environment.

In the end, the international financial system may emerge stronger. More importantly, the sort of voodoo financial instruments and innovations that brought matters to the brink of collapse will become history, as will the unrestrained and unreal speculation and hedonism propelled by the availability of easy and limitless supply of other peoples' money.

    While the bubble lasted, it brought in unprecedented prosperity in large parts of the world. The availability of easy and cheap money allowed millions of people to buy houses, which fuelled the construction boom, which in turn led to massive growth in employment and investment in basic goods industries like steel and cement. Many entrepreneurs built huge fortunes on the back of cheap credit. Trade and travel grew in pace with the flow of capital around the world. The bubble, built on asset price inflation and some very innovative (even if whacky) financial jugglery, kept growing until it became unsustainable. Only, it had grown so big that it could not be allowed to burst.

There is quite clearly a certain critical mass in the bubble size beyond which they might get deflated but will not burst, simply because if they burst, these black holes will annihilate everything with them. Take China for example. No one can really make any sense of Chinese pricing of goods, and many have predicted that China will one day have to pay the cost for its voodoo pricing. But clearly, today the Chinese bubble has grown so big that it can't burst. The case of the current global financial crisis is no different.

Tomes will be written as to how and why things came to such a pass. There is, however, a beguilingly simple and non-technical explanation: That the economic decisions were being taken business graduates or MBAs. Professor Mrinal Dutt Chaudhry of Delhi School of Economics described an MBA course as nothing more than 'structured common sense'. Somewhere along the line, the financial geniuses with fancy MBA degrees started indulging in financial innovations and practises that can only be described as unstructured nonsense elegantly packaged with attractive jargon which was really nothing more than mumbo jumbo. And once they started running amok, the famed 'animal spirits' took over. Since the entire structure was a pyramid, the party couldn't last forever. It was only a matter of time before the people who would normally never qualify for fat loans they had got, started defaulting. The end result is that the entire global financial system came perilously close to a complete meltdown.

The governments have, to a large extent, addressed the crisis of confidence that threatened to snowball into a run on the financial system by committing to inject enormous funds – almost equal to the worst estimates of exposure of the failed financial corporations. And they got together as so widespread was the imprudence of the financial institutions that it was no longer the problem of only one country, namely the US. Almost every country in the world has a stake in the system and unless all countries acted in concert it would not have been possible to contain the domino effect that the financial contagion would create, devastating the global economy.

As things stand, unless there is another massive shock (a credit card debt default?), the current crisis seems to have bottomed out. Of course, the immensely painful transition to a more prudent, and perhaps, conservative financial system (both because of stricter regulatory mechanisms and part nationalisation of most financial giants) is yet to come. People will lose jobs, brokerage houses will close down, credit will get squeezed as will international capital flows and investments, smaller builders will go bankrupt, lifestyles will be tempered down (no more weekend holidays in Singapore or Dubai), speculation in stocks, commodities and property will have a huge cost attached to it and the Rs 1 Cr salary packages will become a thing of the past, as will the trend of treating the golf course as an extension of the board room. There will however remain the danger that once things settle down after a few years, new financial innovations that promote profligacy will once again be introduced to meet the needs of an ever-changing global economy.

Finally, there are two unmistakable lessons from the current crisis: One, at the end of the day, there will always be a bailout if the crisis is so big that it effects the entire world; and Second, the domination of Europe and US over the international financial system is so overwhelming that even the emerging economies like the BRIC group and cash-rich middle-east Shiekhdoms are so helplessly dependent that they will have no option but to continue hitching their lot with the West. The Ahmedinijads, Karats and Chavezs' of this world can continue to rave and rant and create their oil bourses to challenge Western domination, but when push comes to shove the Dollar and the Euro will together continue to rule the world.

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    <1025 Words>                    15th October, 2008

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