Local Roots of a Global Crisis

Quote of the week:

1 - 'Crises are now different in that they involve very large amounts of very short-term money. That is one aspect. Second, that the economy is highly leveraged around that money, so that when something happens, the whole house of cards collapses. And thirdly, the world economy is deeply global, through the financial structures and that means that when something happens anywhere, it happens everywhere. So that of course makes international financial crises today something really interesting.' - Rudi Dornbusch (Source)
2 - 'The Argentine case would thus seem to call into question just how valuable a modernized banking sector and capital markets actually are for developing countries.' - The Economist (Source)


Commentary of the week:
The Local Roots of a Global Crisis:

Sticking with our favourite cynical theme that the financial world is coming to an ignominious end then, how are we to make sense of this moment in financial history? After all, financial crises are nothing new and if it wasn't for the fact that correspondents like me have to write commentary, there is some merit in the suggestion that these crises would not even make the midnight news. What a simple life we would have then, if we actually didn't have to worry about our savings and investments and could simply outsource that worrying to earnest young men and women whose sole purpose in life was to make untold fortunes for clients such as us. Yes, a worry-free life. But alas my good friends, this financial nirvana escapes us, perhaps for some fault of our own.
What we do have is the exact opposite. Nobody really knows anymore if house prices are going to keep going up in Canada, why the stock markets are so 'up' here but not so 'up' just South of us or even in China anymore and if there is one theme that is evident from the recent spate of bad news, it is that the financial sector (which sadly includes me I think) is hardly as smart as it would have us believe. Such an economic context is of course crippling for any rational (or even pretend rational) long-term decision-making. As some accomplished speakers at a recent conference told us recently (yes, after many promises of good behaviour regarding cutlery [see the Blog], Ittihad is letting me go to conferences again), the Public markets are quite skittish and so private businesses are avoiding an Initial Public Offering (better known as an IPO - where companies raise money for themselves by selling their shares to the general public through exchanges such as the TSX). The one IPO of note, Sprott Asset Management, did not go off as the huge success that it would have been if they had waited for more certain times. As an exquisite and definitive example of what I mean by uncertainty, any Tom, Dick and Harry can now have an opinion on our financial future that is taken seriously (case in point); and you know that we are on dangerous territory indeed when people like me start second-guessing people like Eric Sprott (of the Sprott Business School fame). So why all this uncertainty then, and where does it come from?
Well, my theory is quite simple (and probably just as wrong, but bear with me). The reason there is such institutional paranoia and experiential deficit as to 'what is to be done' about this present crisis, is that this is really the first time since the 1930's that a North American financial crisis has its roots (both obvious and latent) within North America itself. The first crisis after the depression was really in the 40's and driven by events in WWII Europe and I don't really remember anything remarkable about the 50's except for the Korean War and the storied youth of Baby Boomers so we will have to skip that decade. In the 60's (and 70's) we had the Vietnam war which led to the decoupling of Gold and the US Dollar in the early 70's (a seminal event in finance that generates much contemplation and vituperation). Soon after the Gold Standard was abolished (Gold used to be $35/ounce) we had the Yom Kippur War (1974?) and then the Oil Embargo which did some short-term damage to the North American economy through higher energy prices and inflation. There was also the Revolution in Iran in 1979 which created yet higher oil prices and then the Afghan War in the 1980's where you had untold amounts of illicit drug money enter the financial system along with the already enormous amounts of Oil Money. These funds were of course very methodically deposited with large Western banks because they were simply the best at banking, people didn't know any better and also because there were some Faustian bargains made. These banks then turned around and lent this money to poor third world countries where many politicians' pockets and grandiose, no-use pet projects suddenly found 'cheap' funding. These self-same borrowers then, became subject to interest-rate policies of the US Fed and became unable to service their debt once Paul Volcker raised interest rates in 1986 (?) in order to combat the inflation resulting from the higher Oil prices we already mentioned. This debt and the unconscionable interest payments involved then put spending cramps on poor foreign governments and resulted in poor quality of life in debtor countries. These poor countries could not then spend money on health and infrastructure and this in turn increased immigration to the West, creating both a brain drain and other social problems in the West. It also resulted in many musical concerts and campaigns for Debt-forgiveness (such as Bono's Jubilee 2000), which break out and then peter out from time to time because forgiving astronomical amounts of debt really sets bad precedents in International Finance.
This now, is where the plot thickens, so follow closely. In the 1980s' then, we are on the cusp of having a truly global, technologically interlinked financial system; and even though this is a historic achievement for humanity (questionable, but let us concede this point for now), it just seems that this system is quite prone to unforeseen crises that begin from far-flung areas of the world. In Imperial terms, if the capital of world finance is New York, then the many far-flung provinces such as Tokyo, Moscow, London and Buenos Aires have been quite twitchy and problematic over the years. After 1986, there has been the crash in the Japanese Nikkei (1989), the USSR + Ruble Collapse (1991), the British Pound and ERM crisis (1992-3) the Mexican Peso crisis (1994), the Asian Financial Crisis (1997), the LTCM scandal (which was the loudest crash you never heard - 1998), then the Tech crash (2000-1) which was within the US but dismissed as a sectoral failing and the Argentine Collapse in 2002-3. Now, you have the crowning achievement of this financial era in the SubPrime debacle, which has only somewhat inexplicably, not yet turned into a crash.
Yet what we have now is somewhat different in another way as well. In the long history and story of financial episodes, you have many localized crashes in one market or another. In the short history of this kind of a technical, globalized financial system, you have never had a viral attack that started at the heart of the system. We have only had stress and blow-ups at its extremities, never the pervasive crunch at the absolute Center. Each time something like this has happened before, technocrats even more knowledgeable about such things than yours truly (hard to believe but there you have it) are dispatched from the corridors of Washington's own World Bank and IMF to solve the latest problem that those pesky foreign countries have gotten us into this time around. This time, there is no 'foreign' country at fault. The system rots from within its core. Wall Street has nobody else to blame, no sector, no country, no war, no crisis and not even Main Street (which continues to rack up both spending and debt). This time, it is the very business practice of selling off people's loans to others at the back end (technically called securitization) and the explosive addition of leverage to the mix (primarily in the form of derivatives) that are to blame. It is the very thing that has made Wall Street so successful in the past that is causing it such exacting problems today. Who can they send to fix those? Where will they get the required expertise when the expertise itself is questionable? More importantly, what will be the effect on the periphery or economic provinces that we now console ourselves by calling countries, if the capital itself is found to be on shaky ground? The acute crisis in food supply (see Blog) is one effect perhaps, but what will the others be?
At the moment of course, these are somewhat rhetorical questions. There is really nobody that can say how this will turn out in the end with any degree of planned accuracy. What I have tried to do is situate this particular episode historically, not be tastelessly triumphal in the face of peoples' hardship. I think that there is this difference this time around of rottenness even at the core; whether this small difference becomes amplified as further mistakes are made through the blunt instrument of interest rate policy is for the future to reveal. For us, while much of this is out of our hands and over our heads personally, it nevertheless bears some careful collective thought. I won't be trite and ask you to be careful out there, I am sure you are thinking the same thing if you haven't found a chink in this theory already (and no, the Tech bust does not count). As our friend Ms. Schneider would say, 'Sane Finance' anyone?


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The Crescent Entrepreneurial Association (CEA) is hosting a business plan competition that I think many of you will enjoy attending. This is a volunteer organization that is helping the community get a better handle on its economic future. The exposure and insights gained at the competition will be quite priceless IA so if you have daughters, sons, younger nieces and nephews, cousins etc., try and bring them out to this event on the 31st of May. We at Ittihad are both fans and supporters of CEA and would like to see a large turnout. This wonderful organization will help the community build a critical mass of good, ethical businesses that will contribute to society IA. Please register here.

There is also a conference in NY that our Senior Management will be attending. Our CEO's topic of discussion will be 'Ethical Dimensions of Islamic Finance' and how Islamic Finance and Socially Responsible investing are two pieces of a beautiful solution to many of our financial ailments. It is time for the two movements to learn from each other and collaborate. For those who can make it to NY, it may be an excellent working holiday and an educational experience. Please register Here for your 15% discount.

We have been invited by TARIC mosque (near the 400/401) to present our views on Islamic Finance. This seminar will be held on the 21st of June at 7:00 pm. I encourage both brothers and sisters to attend. The interactive discussion will focus on the place that Islam does / does not and perhaps should have in both 'Islamic' Finance and also in our personal financial choices. This is a discussion that will IA take place outside the logic of a sales presentation so you can leave your cheque-book at home. Come with friends and come with difficult questions - hopefully, we will trade in good ideas that will profit our minds. I will be sending out a flyer shortly with directions and the program - I apologize in advance to all the readers outside Toronto who will no doubt be upset about receiving an invitation to an event halfway across the country or the world.


Finance News:

1. Is this the next crisis? Trouble in foreign exchange markets? ... read more here

2. Why is the TSX breaking record highs? Are you confident about this economy? Think about this question a bit ... read more here

3. Trading in Carbon credits takes off in a big way as US companies join the movement ... read more here

4. This is why mining stocks are so risky ... their hold over their mining claims is so tenuous (and borderline illegal pending judgement) that investing in them sometimes approaches pure speculation ... read more here


Economic News:

1. A Harvard Business School article on the future of state-led capitalism ... read more here

2. An FT report on the Economics of Food ... excellent follow-up to the last commentary ... read more here

3. An Economist Special Report on International Banking ... too funny sometimes ... read more here


Islamic / Middle East / Emerging Markets:

1. If you are new to financial economics and want to know in 5 minutes why 'interest' is considered wrong by so many people from so many different faiths and political views (Hat-tip to Siddiq Mohamed) ... read more here

2. This is what happens when Sovereign Wealth Funds invest on the way down. Yes, a whole lot of nothing. Nobody is disciplined, nobody is fired, it all taxpayer money after all and there is plenty more where that came from, except nobody in the ME pays tax and all this is Oil money ... read more here

3. Even China has it's own indigenous cars while we drive Gas-Guzzling Gizzards to and fro from work. Interview with Cherry's CEO ... read more here

4. How did Islamic Finance become a human interest story as opposed to a finance story? (Hat-tip to Imtiaz Ahmed) ... read more here

5. The race is on for investment in Africa. I do not know if you have ever travelled over the grasslands of the Rift Valley, but you better go soon. Before yet more plunder of a beautiful continent ... read more here


Interesting but not all Finance:

1. This article from MIT seeks to answer whether it pays for Companies to be ethical. Of course, I take severe issue with the way this question is framed. Ethics are hardly meant to be a cost to take into account when designing a product, but who in their right mind listens to me? ... Also, this article shows how it really is the fault of the consumer that companies are able to get away with so much ... read more here

2. Startling stats on which countries have the highest cultures of private philanthropy ... read more here
3. Who's to blame for the food crisis? ... read more here or here