Why the modern financial world faces ruin
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Bankruptcy, ruin, revolution and death. People spend their whole lives trying to avoid crises that are either inevitable or actually beneficial. The Roman Empire lasted for hundreds of years. But it did so only by heaving itself out of the ditch every so often… with civil wars, mass murders, coups d’état, rebellions, insurrections, revolutions. Blood ran in the streets of Rome often – long before the city was sacked by barbarians.
And now it is the modern financial world that faces ruin. As Rob Mackrill explains (See: Is the inflation monster about to wreak havoc on world markets?),the Bank of England and America’s Fed have greatly increased the quantity of cash and credit in the world system. Having inflated the money supply, they now attend rising consumer prices like St. Joan of Arc waiting for a match. But what can they do about it? The Fed has stopped reporting increases in M3, the broad money supply, and has redefined ‘inflation’ so as to exclude prices that are going up. The Bank of England leaves out the biggest consumer item of all – housing.
Neither central bank has much room to manoeuvre. If they hike rates much more, they risk not only ruin, but revolution. Recall that Paul Volcker stopped inflation in the early 1980s. He did it by sending rates over 15% and bringing about the worst recession since the 1930s. An angry mob burned him in effigy on the Capitol steps.
Poor Ben Bernanke confronts a world in ARMs way. Adjustable rate mortgages were an innovation that helped the housing industry sell houses to people who couldn’t really afford it. Now those same people – millions of them on both sides of the Atlantic – face automatic increases in their housing costs. From Palm Beach comes news that “Easy-to-get loans cause thousands to lose homes”. From the West Coast we get a similar story: “…Defaults rising; Homeowners feel pinch of adjustable rate loans”. From coast to coast in America, mortgage defaults are running 72% ahead of last year. Here, it looks like interest-only mortgages may become the next big mis-selling scandal).
Ben Bernanke spent his career studying how to avoid a Japanese-style slump – off-again, on-again deflationary recession over a long period of time. And now he has one staring him in the face. He and Mervyn King both desperately want to lower interest rates to head it off. But what about inflation? And if Bernanke tries to pull a Volcker – jacking up rates to squeeze out inflationary expectations – they are likely to burn him for real!
Oh those ARMs! If central bankers fail to tackle inflation, who will lend at adjustable rates? If they increase rates to fight inflation, who will borrow at all? It will take central bank lending rates over 8% to stop inflation, says Crispin Odey. Imagine if Ben Bernanke puts rates up to 8%. First the ARMs would go up. And then the hands, voting for a change in government. And finally, the stakes and tinder… Bernanke can practically smell the smoke already.
For more on adjustable rate mortgages, read: A farewell to ARMs - why the US housing market faces a credit crisis
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