-- From Titanic first-class passenger Edith Russell's account of the immediate aftermath of the ship's collision with the iceberg
At Davos, former Mexican president Ernesto Zedillo warned that heavy U.S. borrowing was starting to crowd developing countries out of the capital markets. On February 8 I passed along Zedillo's warning. After I snapped and growled for several paragraphs about the need to work out a plan for orderly borrowing, I had a sort of Edith Russell moment. I decided that the G7 nations would somehow keep the poorer nations above water while they borrowed themselves away from the cliff.
Last week came another shower of ice on the deck. I was walking by the TV set and lo and behold, there was Niall Ferguson on the Glenn Beck show. Just a few days before I'd read his There will be blood interview with Canada's Globe and Mail about the financial crisis. It seemed Beck had also read the interview. I plopped down to listen to the discussion.
At one point Ferguson said almost in passing that Britain couldn't borrow because it was crowded out by the massive U.S. borrowings.
I sat for a moment, trying to digest the enormous implications of Ferguson's observation. Britain wasn't a developing country, and with all its problems it was still a finance powerhouse. If they were being crowded out of the capital markets --
The rest of the thought trailed off, my mind refusing to finish it.
Yesterday, after hearing that Gordon Brown's speech in Congress had mentioned the dangers of protectionism, it struck me that the most serious issue connected with financial crisis was being dodged.
Borrowing wars, not trade wars, are the gravest danger.
Yet eerily, as I'd noted in the February 8 post, there was almost no public discussion about the impact of massive U.S. borrowing on other countries trying to borrow.
Turning to the internet I looked for mentions of the borrowing issue. That's how I found Warren Buffet's warning that government borrowing was crowding out private borrowers. From his new annual letter to Berkshire Hathaway shareholders: (H/T Gurufocus)
[...] Funders that have access to any sort of government guarantee -- banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella -- have money costs that are minimal.Wednesday also saw the news that China's government was launching their own domestic stimulus plan. The news gave a boost to the Asian financial markets and was met with relief in the USA.
Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be.
This unprecedented “spread” in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with a favored status. Government is determining the “haves” and “have-nots.” That is why companies are rushing to convert to bank holding companies, not a course feasible for Berkshire.
Though Berkshire’s credit is pristine -- we are one of only seven AAA corporations in the country -- our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.
There was also concern here that Beijing might cut back on their purchases of T-bills in order to fund their spending program. Yet by the evening Bloomberg had reported that China's finance ministry would be selling bonds to raise the $29 billion needed for the economic stimulus programs.
$29 billion is a drop in the bucket next to the borrowing that the United States is doing, but if you add the drops from all the governments competing to borrow --
Titanic buffs correct me if I'm wrong, but I seem to recall a theory that it was the sharp turn to avoid the iceberg that spelled doom for the ship. If they'd let the ship crash head-on into the iceberg, the ship would have been badly damaged but would have taken the hit without sinking.
Whether or not the theory is right it might be applied to the cascading mortgage/banking/credit crises. It's possible that the governments that reacted first to the crises by borrowing huge amounts didn't factor in that the sheer size of their interventions was creating secondary effects that could be worse than the original crises.
However, by now it's clear that the massive amounts of money that need to be borrowed are creating unprecedented competition between borrowers for scarce funds, driving interest rates through the roof -- and crowding out all but the wealthiest governments.
The secondary effects are already emerging:
After first striking the advanced economies and then emerging markets, a third wave of the global financial crisis has begun to hit the world’s poorest and most vulnerable countries, threatening to undermine recent economic gains and to create a humanitarian crisis, IMF Managing Director Dominique Strauss-Kahn said in Washington DC. [...] financing problems are also beginning to affect developing countries, Strauss-Kahn stated. Foreign direct investment is expected to fall by 20 percent this year. The cost of borrowing has risen significantly, and in some cases may be unavailable.[...]If we stay with the Titanic metaphor, what is it about a financial crisis that's analogous to the submerged part of the iceberg?
I think that the submerged part is called reality. To show you what the IMF thinks of reality:
[...] Strauss-Kahn said the IMF hopes to have in place shortly the capacity to make concessional loans of $11 billion over the next five years, about twice its current ability.How are donor countries going to come up with that kind of money, on top of increasing their financial commitment to the IMF, when they're having to borrow heavily just to keep their own economies afloat?
But the main responsibility for meeting the financing needs of the poorest countries lies with donor countries, he said. The donor countries must find some room to help poor countries in stimulus packages they are putting in place and must live up their 2005 commitment to double annual aid to Africa to $50 billion by 2010 and raise it to $75 billion by 2015.[...]
They'll have to borrow it. As he said, the money to help the poorest countries will have to be included in the donor countries' stimulus packages, which they're having to borrow to create.
Has Messr Strauss-Kahn got any idea how to manage all that borrowing without touching off global hyperinflation?
That's an off-limits question because it's a reality question, which doesn't actually exist until -- well, until the ship is sinking.