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classical liberalism and global financial flows « Previous | |Next »
August 10, 2007

I just love classical liberals. They construct their elegant theorems from human nature to show that the good government depends on the functions of government being minimal---strictly confined to ensuring security of life, liberty and property--and that other functions, such as the redistribution of wealth, are morally impermissible. So is the welfare state as it represents gargantuan government.

So how are global markets to be governed? We have a global market turmoil turning ugly today forcing the ECB and the Fed and central banks in Japan and Australia to inject liquidity--$100's of billions--- in the financial system. The concerns about subprime mortgages, credit and debt have turned into a full blown liquidity run and crisis. Liquidity is drying up and cash rates are soaring. So the central banks are pumping in lots of cash .

In my understanding that kind of intervention into free markets to address toxic debt---is not warranted by classical liberalism. So how would classical liberalism deal with this kind of turmoil? Talk in terms of market corrections? Market corrections of a high base. They ---Peter Costello--is referring to the falls in the stock markets, and he says that the sub-prime market does not affect Australia. What we have is just normal central bank operations.

On that scale? Give me a break. This global market turmoil is more than a liquidity crisis. It looks as if classical liberalism is going to be mugged by economic reality.

Is the global market turmoil a situation where the risks of a systemic crisis continue to rise. Presumably, the liquidity injections and lender of last resort are designed to bail out insolvent borrowers - however necessary and unavoidable during a liquidity panic. Will they work? Or will they only postpone and exacerbate the eventual and unavoidable insolvencies?

| Posted by Gary Sauer-Thompson at 9:04 PM | | Comments (6)


Chris Aylmer, the deputy head of the Reserve Bank's financial stability department, told a House of Representatives Economics Committee that the growth in Australia's debt was unsustainable as the share slide was happening. He that at some point the growth in debt levels would have to stop and banks would restrict lending. "It can't continue to grow the way it has," he said.

Earlier, University of Western Sydney economist Steve Keen told the House of Representatives Economics Committee, which is enquiring into loan lending practices and processes that if the ratio of debt to gross domestic product kept rising at current rates, by 2040 the interest bill would swallow up our entire GDP.

In the year to June alone, Australians went another $215 billion into debt. Household debt has soared from 45 per cent of disposable income in 1987 to 75 per cent in 1997 to 160 per cent now.

Professor Keen said Australia was heading towards a crisis. "It is an unsustainable trend," he said, warning that Australia could go into recession.

Public Servant,
well something sure is happening in relation to debt both here in Australia and overseas that is more than the bit of correction Costello is talking about.

The Reserve Bank of Australia injected around $5 billion into Australia's banking system, double the normal daily injection.

The European Central Bank injected $152 billion on Thursday night---the only previous intervention of this magnitude was after the 9/11.

The finger can be pointed to the US Federal Reserve which left interest rates too low for too long. With money close to costless in the US an entire industry grew offering money to people who were in no position to repay when interest rates rose and house prices stalled.

First, your remark "Presumably, the liquidity injections and lender of last resort are designed to bail out of insolvent borrowers..." seems off the mark. I think the aim is to bail out insolvent lenders, ie. financial intermediaries, not homeowners.

Second, "The Age" piece you link to has Costello saying: "The market has been underpricing risk...In the US there was far too much lending to people with bad credit histories, and when these people got into trouble, there has [sic] been large defaults."

If central banks are going to bail out rash lenders, where is the risk Costello is talking about? The old saw that "if you owe the bank a thousand, the bank owns you; if you owe the bank a billion, you own the bank" seems to be as true as ever.

It's getting ugly... The only people I feel sorry for are those who didn't borrow but lose their jobs when the borrowers realise they can't keep spending and borrowing any more.

At least Keating's recession-we-had-to-have got some restructuring done, and the time was of Australia's choosing.

I've been saying for a while now, Oz has been like somebody falling of a skyscraper saying "Look, I've fallen 20 floors and I'm still fine. I'm having fun. The 20 floors left to go ought to be a real hoot. Whaddya worried about?"

on 1.
yes you are right the aim to bail out insolvent lenders, ie. financial intermediaries, not homeowners.But hedge funds are borrowers. They borrow money to buy the sub-prime mortgager off the non-bank lenders.

on 2. The risk is the credit squeeze resulting from the money drying up. Who would buy the ssubprime loas off the hedge funds wanting to sell them to off load their risk?

I feel sorry for the desperate people trying to get into the housing market, and those who are in but find that their mortgage is higher than the capital value of their house.The dreams come crashing down.

Debt can be like a wrecking ball.