Cutting to the chase

By Raoul Ruiz Martinez [email protected]

Raoul Ruiz Martinez is a resident financial consultant for Finesco Financial Services Ltd., Glasgow. Finesco Financial Services Ltd is authorised and regulated by the Financial Services Authority (FSA).

Under circumstances such as today’s, with households striving to cut debt and interest rates at zero, economies can behave in strange ways.

Even after all the extensive moves made by the US to revive their own economy, optimists acknowledge it will take a while for consumers to cut debt to comfortable levels, for the housing market to stabilise and for other aftershocks of the financial crisis to be worked out.

The housing slump and its equally unwelcome partner of negative equity have aggravated this by making it harder for the unemployed to move to find work. The reality is that long-term joblessness erodes skills and employability.

In a US tabloid paper last year, a Princeton academic and banker from the New York Federal Reserve discussed the possibility of a “paradox of toil” or “paradox of thrift” whereby if everyone tries to save more, the economy shrinks and so does aggregate saving. The logic begins where the supply of labour increases or productivity rises. Initially, prices would tend to fall and if nominal interest rates are stuck at zero (which is still the case), the real interest rate and burden of debt both rise.

This leads overleveraged consumers to cut spending even further and, therefore, demand is not just slow to respond and the economy shrinks.

Europe has a different overview but remains as hapless with a similar lack of short-term direction that leaves the longer term outlook uncertain.

To keep Greece within the programme of the European Union and the International Monetary Fund, Athens must comply with their conditions. So far it has been too reliant on austerity but austerity cannot work things out on its own. A new package is at present being played out in what could this time around become a veritable Greek tragedy. How will it end?

Many pessimists are predicting a premature default which would cut the country off from EU-IMF aid, from international capital markets, and possibly also from ECB lending. It would lead to an immediate collapse of the state.

The government would not be able to pay salaries and pensions, then there would be a real problem as the wildfire of huge losses would spread to other Eurozone countries and banks.

For Europe a more consolidated move is necessary from the main debtor – Germany. An announcement of partial debt forgiveness, a eurozone bond and a small fiscal union could possibly end their crisis.

The financial press and other forms of media coverage on the global financial crisis would have us believe that our world revolves around these two continents. 

The dogma that the US and European governments, politicians, bankers, technocrats and bureaucrats are collectively and supremely global is, frankly, rather misleading.

There are many pieces to the global picture. Thank you very much Messieurs Canada, Australia, China, India, etc.

This article is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investments or course of action.