I will cut right to the point. A point that few people get or are even willing to acknowledge. The point is that "the financial system as we know it can not be saved." The evidence is everywhere and mounting.
It is really quite simple. The real world is finite with limits that natural laws, such as physics and chemistry, dictate. Its behaviour is governed by negative feedback, which keep things in check. Unfortunately we have designed a financial system that is based on sophisticated economic theories, which assume away inconvenient problems of the real world and essentially has no limits. Until that is, it bumps up against the very real limits of the real world.
We also seem to have forgotten that money itself is not wealth but merely a yardstick by which we measure wealth. The net result is that the financial system has become increasingly abstract, divorced from the realities of the real world. Through the seemingly innocuous process of loaning money into existence, we have created an electronic pile of debt in various forms that will never be repaid.
Take for example derivatives. The Bank for International Settlements recently announced the largest ever financial number (to date): $707,568,901,000,000. This is the amount of outstanding financial derivatives. Amazingly, in just six months an additional $107 trillion (yes that's right, trillion) worth of derivatives were created. Global GDP for 2010-11 was only around $65 trillion.
Governments and private citizens around the world are either spending too much, holding too much debt or both. For example the US Government is spending about US$3.5 trillion a year whilst revenue is just over US$ 2 trillion. With government debt already over the $15 trillion mark, it is heading for bankruptcy. The same story is repeated in nation after nation. The recent action of central banks to offer cheap loans to struggling banks might solve their short term liquidity problems; unfortunately it will do nothing to solve the root cause of our current predicament, namely the insolvency of many governments, banks and individuals.
As each increasingly pathetic and futile attempt to "resolve" the global debt crisis fails within days or weeks of its announcement, it seems increasingly likely that we are approaching a global credit event, such as sovereign defaults, a credit freeze or cascading bank failures, the outcomes of which no-one can predict. This event is likely to be much more severe than the near freezing of financial markets in 2008. Whilst governments bailed the banks out back then, who will bail the governments out?
When the global economy was in its growth stage, relatively unconstrained by the limits of the natural world, the increasing interconnectedness, particularly of financial matters, proved beneficial to a portion of humanity.
Now that it appears that we are at the limits to growth, this interconnectedness means that the outcome of any credit event will affect virtually every nation, business and individual. The opaqueness, complexity and sheer size of the financial world means that it is virtually impossible to predict how a credit event will unfold. We can however assume that the outcome will at the very least be extremely disruptive.
I really hope that I am wrong, but as a far from disinterested observer, it appears to me that the global financial system is ready to topple over. How this unfolds is yet to be seen. Will it be a continuation of the slow train wreck spreading from Europe to the rest of the world, or a rather more dramatic global crash? Will it happen next month, a year from now or will it keep muddling along for years to come?
No-one can answer these questions. We can however safely assume that as the global financial system continues to implode, whether rapidly or in slow time, the impacts will sooner or later touch every part of our daily lives. In an environment where we torture ourselves through a CRAP load of risk management over the most inane of risks, what risk management measures have governments taken to manage a major credit event?
Perhaps there are bureaucrats in the bowels of Treasury or at the Reserve Bank who are working on just such a scenario. But given that both the major political parties kyboshed a motion to prepare a plan for peak oil, it is doubtful that a plan to prepare for a global financial system collapse will have been prepared.
Is it possible that such a collapse could occur? Of course it is. Is it certain? No, it is not. But what can be safely stated is that the probability of such an event occurring is as high as it has ever been and is increasing as time rolls by.
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