Banking: The Next Crises & The Ignorance of the Economic Establishment

Rajib Handa

In over six decades post India’s independence from the British I never recall Repo rates dropping down to 2 per cent and peak rates on 5 year unsecured bank deposits to 7 per cent. Compared to a CPI of 12 per cent banks are now offering negative returns of 5 per cent per annum to depositors, while throwing money at near bankrupt Real Estate concerns at artificially induced low interest rates. The CAPM pricing theory propounded by Nobel laureates Muller and Modigliani professed that the only difference between debt and equity was the tax. So why do investors expect ROEs of 20 per cent on Equity but are willing to settle for 2 per cent income on deposits? If this is not laying the seeds of a gargantuan Real Estate Asset Bubble and everything else connected with it, then what else is it? The repercussions of easy money will be felt over a number of years, but the disaster will strike investors in many forms. So Brace yourself up. It’s easy to understand how loose monetary policy causes inflation and/or speculative bubbles. But the economic establishment in Washington, on Wall Street, and more or less all over the world refuses to acknowledge the cause and effect relationship! They insist on Keynesian theories of macro managing the economy mainly by monetary and fiscal policies, thereby rapidly increasing the government’s influence. Their models and theories totally missed the importance of the real estate bubble and its aftermath … the most severe crisis since the Great Depression. And they were incapable of forecasting the meltdown of the banking system. It should be clear that following the wrong models and theories leads to the wrong conclusions and wrong policies. And that’s exactly what’s going on today. The policy prescriptions since this crisis erupted are the very same that laid the foundation for the real estate bubble. So the toxin that caused the crisis is being given as the antidote! This has led to a postponement of the next stage of the current crisis. Yet if governments keep throwing trillions down these rat holes, we’ll end up with a financial and economic catastrophe much larger than the current one. So although I suggest you take a bullish medium-term view, you should remain very bearish about the long-term. Remember … Secular Bear Markets Consist of Cyclical Swings I believe that the stock market and the economy entered a secular bear market in 2000 when the technology bubble burst. The first recession took place in 2001, and the first cyclical stock bear market ran from 2000 until 2002/03. That’s when governments all over the world implemented extremely easy monetary and fiscal policies. Their strategy worked … the recession stopped in its tracks. But it came at a very high price … starting a real estate bubble. This artificial and unsound boom lasted until 2007. Then the bubble burst and all hell broke loose! And the second recession and the second cyclical stock bear market began. Again governments stepped in, but to a much larger degree than in 2001-2004. And, for now at least, they’ve rescued the banking system by bailing out nearly all big banks and initiated a medium-term uptrend in the world’s stock markets. The long-term analysis is simple and easy: With each round of counter crisis policy, governments are upping the ante. So each crisis is getting more expensive and more damaging than its predecessor. The severity of the 2007/08 crisis should make it clear what an even worse version could look like: The total collapse of the banking system and of the world’s dollar-based financial system, probably including the bankruptcy of some states. Even hyperinflation seems to be a probable outcome of these policies.