Sunday, February 08, 2009

Understanding the Crisis

Gavin Kennedy is an excellent author , and I would have my Readers contemplate this article. He discusses the ‘Risk-aversion’ of Banks for lending, especially to other banks. I am going to let the Reader study him, and go into a discussion of economic development. Original economic speculation through the Great Depression of the 1930s had determined an ‘Either-Or’ economy where Capital and Materials had either to be spent on Consumption, or on Investment; due to the limitation of Resources and the limited degree of Profitability of previous economic expansion. Economic Thought alters under the impact of Keynes and Keynesians to a position where Consumption should be maximized, and Investment should be accomplished by debt assumption; never stated, the Resources are considered inexhaustible (what discussion is made, talks of magnitudes where Resources are far in excess of limited amount of usage). Economic expansion, under this set of Expectations, seems unlimited and self-sustaining, as long as there is a flow of Cash to make repayments of the debts assumed. The trouble comes when Reality reasserts that there is indeed a shortage of Resources, the prices of those Resources rise in response, and the Profitability of previous successful enterprise is lost; the Profits necessary to repay the assumed debt gone into the expenditure Land, Labor, and Maintenance. Here, the House of Cards made of whatever is the Currency of the Moment collapses.

The sense of the above Argument answers the Question of Why, under Boom conditions, there is such pressure to expand to new Markets; reducing the repayment Costs in real terms by more Product sold in fresh Consumption areas. The Problem starts when the Debt is also spread to new markets to establish Distribution markets and obtain Resources; check of Product sales leads immediately to great fear of further debt aggregation, when no new markets can be explored and with heavy debt in all markets. Banks, the repositories of debt obligations, are the first to be shaken; realizing the huge draft of Profits which had to drawn to pay for the huge debt, when Product sales was indeed highly limited per market sector. Here is the real source of the Risk-aversion.

There is no sense in provision of more Cash to Banks, without actually buying the toxic debt. Banks realize that Business will never repay that toxic structure, based upon the limited Product marketing capability. Banks are even more averse to extending like debt instruments to Businesses which they know market structure will never support on current debt obligations, let alone drafting higher repayment Costs. Bankers are the first to recognize a economic Downturn, as they witness balance sheets unable to balance. lgl

1 comment:

Real estate from Toronto said...

It all makes sense. If the whole logic of today economic system starts with the assumption that the resources are inexhaustible, when they clearly are NOT, then it's only a matter of time when the whole system collapses. But this is the first time I've seen the whole problem explained so simply and clearly. Thank you.
Elli