Voters will rise up against short-sighted decision-makers, says Andrew Gawith. Your view?

Voters will rise up against short-sighted decision-makers, says Andrew Gawith. Your view?

By Andrew Gawith

The global financial crisis is proving worryingly difficult to shrug off.

That partly reflects the nature of the crisis and partly political dysfunction that continues to dog effective responses.

The crisis was triggered by a monumental build-up of debt, helped along by a fair bit of financial chicanery and the bursting of the housing bubble.

In November 2008, a few months into the crisis, a group of IMF economists (Claessons, Kose and Terrones) concluded from an analysis of previous financial crises that they tend to be long-lasting - much longer than the accompanying recessions which also tend to be relatively long and deep.

Moreover, house price collapses lead to more costly recessions and financial crises are often global or synchronised.

In a paper published in January 2009, Reinhart and Rogoff were more explicit about the likely impacts of the financial crisis and asset price implosion.

Analysis of previous financial crises showed that real house prices fall 35 per cent from peak to trough and that downswing lasts six years, and equity prices collapse on average by 55 per cent over about 3 years.

Further, they argued: "Banking crises are associated with profound declines in output and employment. The unemployment rate rises an average 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls an average of over 9 per cent."

Interestingly, they also noted that the "real value of government debt tends to explode, rising an average of 86 per cent ... The main cause of debt explosions is usually not the widely cited costs of bailing out and recapitalising the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis."

The clear conclusion from these two pieces of research is that we shouldn't be particularly surprised that we are struggling to shake off the global financial crisis. It's a doozy, almost certainly the most severe and widespread economic crisis since the 1930s depression.

Let's look at US data to see how prescient Reinhart and Rogoff's analysis has turned out to be, roughly four years after it started:

* Real house prices in the US have fallen 31.1 per cent in nominal terms from their most recent peak in the first quarter of 2007.

Consumer price inflation over that period has totalled nearly 10 per cent implying a 40 per cent-plus fall in real house prices so far in this cycle - somewhat higher than the above analysis suggests, and the current cycle may still have a year to run.

* Equity prices, as measured by the S&P 500 index, fell 58 per cent between October 2007 and March 2009. Since then the S&P 500 has risen significantly (81.5 per cent), but as maths students will know that percentage rise still leaves the index around 30 per cent short of the level it was in October 2007.

* The unemployment rate in the US bottomed out around the first quarter of 2007 at 4.5 per cent and peaked at 10.1 per cent in October 2009. It has subsequently edged back to 9.1 per cent as at August 2011. So not quite the 7 percentage points blowout, but dramatic nonetheless.

* Output, as measured by industrial production, fell by 15.8 per cent over the 15 months to March 2009. A broader measure of output, GDP, fell a little more than 5 per cent over the six quarters to June 2009. Industrial production in the US is still 6.6 per cent below its late 2007 peak.

* US government debt has risen significantly since 2007, but not by 86 per cent ... yet.

So in a number of respects this crisis has already exceeded in severity (at least in the US) what we might have expected based on the outcomes of previous financial crises. The emphasis on "already" reflects the fact that this crisis is not over yet.

We are in the early stages of unwinding a three-decade rise in debt that spurred trade, asset prices and economic growth. It would be naive to think it can be unwound over five years without massive economic pain. Most governments are still racking up more debt as they try to keep their economies from sliding back into recession.

But there's another factor weighing on this crisis - political cramp. As Christine Lagarde, the new head of the IMF, observed recently: "This vicious cycle is gaining momentum and, frankly, it has been exacerbated by policy indecision and political dysfunction."

The debt crisis shifted to sovereigns - most acutely Greece - well over a year ago, but much like the emperor's total wardrobe malfunction, Greece's obvious insolvency has been staunchly denied by Europe's political leaders.

To be fair, it is now more to do with achieving an orderly default than any thought that Greece could actually avoid one.

Europe is a cumbersome political beast at the best of times, but this crisis has highlighted the alarming cost to its citizens and investors of its drawn out decision-making processes.

A fundamental political question for Europe is retaining unanimity when the burden of any solution is going to be so unevenly shared - Germany is still digesting the stresses of its own unification, and is now staring at the huge costs of achieving genuine monetary and fiscal union.

US politics look only marginally less scary. The poisonous atmosphere that dogs resolution of their sizeable fiscal deficits is likely to persist until after the presidential election late next year.

The nascent protests against banks and hyper-salaried executives could easily trigger wider unrest.

This grinding crisis is testing the patience of voters and investors - they will eventually exact revenge on dithering and shortsighted politicians.


Andrew Gawith is a director at Gareth Morgan Investments
This article was first published in the NZ Herald.

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 "...protests against banks and hyper-salaried executives could easily trigger wider unrest."

Oh I think it will be worse than "wider unrest"....I see collapse of control...!...and to the hyper salaried executives we need to add salary bloated govt employees including SOE bosses.

What makes me certain that this crisis will deepen not ease is the cause.  It is a sebt crisis and none of the debt has been taken out of the system.  It has merely been shuffled around onto various other blance sheets, been obscured with false accounting, and completely downplayed by politicians and any media my parents or other normal New Zealanders watch or listen to.

House price collapse has not removed the debt.  This has not even begun to be over.  The US debt GDP is unprecedented, and dodgy reporting overstates real gdp by about 30%.  Resolving this crisis hinges on addressing the debt, as long as debt keeps going up the crisis will not even start to be resolved.  It will remain hidden and the effects put off.  There are real limits to debt, and they are fast approaching.

Tell you what I'll do parky....keep well out of the way because I see no "diplomatic" anything emerging from this sewage pit where the banks own the economy and dictate policy.  You need to redirect your entire lifes work into teaching/encouraging peasantry to stay away from bank know bloody well the real fault is the peasant attitude of 'I want it now'.

We need to see the use of credit in this economy slide by 90%. Bollard could speed that up but he is prisoner to bank profit policy.

"You need to redirect your entire lifes work into teaching/encouraging peasantry to stay away from bank drugs"

Beautifully put. I am in awe of your eloquence. Comment of the decade I reckon.

Western citizen are realising...they are going to out-live the future; and they are going to panic ( if they haven't already !) They are seeing that they 'don't have enough' to make it to the end, and are going to pay down debt; reduce spending; sell non-necessities and save like billy-oh. Those with their savings tied up in capital gain type assets are likely to see their worth evapourate faster than those with cash. Asset price inflation is not going to be the problem; Retail price inflation - most likely. But that will just exacerbate the need to 'sell what you have'.

Debt-Serfdom Is Now the New American Norm

Trapped assets are not capital. They cannot be moved into more productive uses that yield income streams that add to current income, which is the definition of capital. Borrowed money that is sunk into trapped assets is not borrowed capital; it is simply debt that must be serviced.

If we set aside assets trapped in real estate and retirement accounts, a truer picture of the American household's actual productive capital emerges: most households have essentially no productive capital, and their debts far exceed whatever meager free capital they do own.

In a very real sense, the non-cash, non-small-business assets of the typical American household are invisible, unuseable, inaccessible and thus illusory; they exist as entries on the balance sheet but not as real-world productive capital.

Wealth and income do not flow from servicing debt incurred by trapped assets, it flows from productive free capital.

So true!

And once again the only proposal that I've seen which attempts to free up such trapped capital is the Big Kahuna.  The incentives under that proposal seem to be structured such that if the investment isn't a productive use of capital - people will change tack to avoid paying the tax on it.

"Trapped assets are not capital. They cannot be moved into more productive uses that yield income streams that add to current income, which is the definition of capital."

That's a bit bloody deep isn't it? Sheesh, I'll have to think about that for a bit. Thanks for that.

My only twopence worth is don't forget the subject is political economics. The two are indivisible despite the desire of bankers and their lickspittal academic toadies to make it appear otherwise.

Currently there is a slow painful destruction in the productive and consumtion economy worldwide which the financial sector believes it can escape by forcing the stupid debtors to pay their debts or suffer the consequences. They are deluded.

In the current stalemate the political representatives of those who are suffering are balanced by the political representatives of those who are not.......yet.

What happens next? Well, as the destructive processes continue they start to hit everyone. People who are better off  tend to be affected later (and don't forget, many of these are productive members of society that we desperately need - not all are liars and charlatans). So the next stage is financial collapse of one sort or another, stock market crashes, bankruptcies (note the inclusion of the word "bank" in bankruptcy), that sort of thing.

It then all gets a bit messy. With luck the productive wealthy and the productive poor encourage their respective political representatives to do something sensible to help everyone. The essentially cooperative nature of civilised society is re=established.

There is another possible outcome and that is much darker, it involves miltary coups, revolution, bloodshed, starvation and suffering all round. So go lightly on the anger chaps.




I think people have opened thier eyes a bit wider then just pointing at dithering politicians, there has been some real fraud, and everyone knows who is responsible.  Dithering politicians didn't cause this whole mess.  It was corruption, greed, and a monetary system doomed to cause crisis after crisis, not to mention the bankers/investment bankers playing with depositors money, making predatory loans, all this has come back to bite them in the arse.  It's not over yet.  This crisis is closer to the begining then the end.

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