YOU are intelligent, educated, and keep up with current events. Yet all of your experience does not help in genuinely understanding what explains the global crisis. June 30, 2012, is another turning point as was June 1st.
You go to the bank and borrow money to buy a condominium. If you do not pay the loan, the bank takes the property and sells it to someone else to repay the loan. Simple.
A bank borrows money from depositors and loans the money to other people. If the other people do not pay the loans, the bank may not have enough cash, liquidity, to pay depositors’ withdrawals. Another bank must come in with cash, assume the loans and assume the responsibility of paying the depositors. Also simple.
There are constant “debt crises” of this type but they are always resolved. In extreme cases, government or private deposit insurance protects the depositors. The bank dies when its assets, the loans, become worthless and no one wants to buy them.
Historically, governments (mainly monarchies) borrowed money from banks to fund wars or economic exploration. Win the war, take the other king’s money and the loans were paid off. Find a new, rich country like the Philippines, set up trade, make money, and pay the loans back.
Financial crises, on the other hand, are always the result of governments devaluing the currency. Borrow a coin made of 100 percent gold and try to pay it back with a coin made of 50 percent gold, the lender now wants two of the less-valued coins. What used to cost one coin now costs two; it is called currency induced cost-push inflation.
On August 30, 2008, the US Federal Reserve had assets of $870 billion. On May 30, 2012, its assets were $2.870 trillion. The increase of $2 trillion came from just adding $2 trillion to the Fed’s Assets Column on its balance sheet, sort of like if there was a special button on your ATM machine that let you set your balance at whatever amount you desired.
Whenever a bank needed extra money because its loans were bad like in the housing sector, the Fed loaned them the money and, therefore, put all that $2 trillion into the economy. It was supposed to get economic activity going again. Except, because the US government has a huge budget deficit, the banks loaned the money they borrowed back the government.
June 1st was the wake-up call that the policy was a failure. By June 30th, the central banks will either walk away, letting dozens of major banks and a couple of countries go out of business, or they will put more money into the system.
Between now and June 30th, the government of Greece will run out of money. Spain’s banks and governments will by then need at least $500 billion to survive. Both the European Central Bank and the Federal Reserve will meet and decide what to do.
There is very little major global economic activity. This new round of money infusion will not create economic activity any more than it did between 2009 and 2012. June 30th will mark the day the global economy starts going into a recession with nations seeing economic activity shrinking. This is because of three years of population growth and three years of increasing government deficits. Governments have no monetary power nor can afford to “stimulate.”
That June 30th date will also mark the beginning of major price inflation although the inflation will not start becoming apparent for 12 to 18 months.
The reason there has been low inflation for three years was the belief that increased economic activity could soak up all the excess cheap money. In a year, that belief will be totally destroyed. Commodity prices will go up. Stock markets will rally and emerging-market currencies will go to levels not seen since 1997.
This will all become clear by June 30th. Mark your calendar.