There’s money in them thar trees

In America this is now happening on a grand scale at the Fed — electronically, at least. The practice will be coming to Britain before you know it. The Old Lady of Threadneedle Street is already gathering up her skirts and sizing up her lumberjack outfit.

Even the austere Trichet of the ECB has been caught lasciviously eyeing up the axe. The Black Forest may not have long to live.

Gordon Brown, who famously once shared a bed with a lady called Prudence, will soon adopt policies widely recommended by Robert Mugabe of Zimbabwe.

The world has succumbed to the Zen-like contradictions of Wonderland. Alice has finally gone through the looking glass.

Almost anything could happen … and probably will.

John Evans

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Relax. The machine has broken down and will not be cranked up again until the spring.

Strange then that another Black Abyss stretches before us today in the shape of a virulent debt deflation of almost unimaginable ferocity.

Take these words by Ambrose Evans-Pritchard in today’s UK Telegraph:

We face extreme danger. Unless there is immediate intervention on every front by all the major powers acting in concert, we risk a disintegration of global finance within days. Nobody will be spared, unless they own gold bars.

In case you think that smacks of hysteria, this is a man who has called this crisis correctly ever since the late summer of 2007. He adds:

“During the past week, we have tipped over the edge, into the middle of the abyss. Systemic collapse is in full train. … Central bankers still paralysed by a misplaced fear of inflation – whether in Europe, Britain, or the US – have become a public menace and should be held to severe account by our democracies. The imminent and massive danger is now self-feeding debt deflation.”

What this crisis shows is that world prosperity was built on a giant illusion: that there was real value in other people’s promises to pay at some future date, and that you could pass the parcel at a vast profit.

Time has run out and a bubble the size of an asteroid has landed and exploded in the centre of our civilization — the banking system.

The Sage of Omaha, Warren Buffett agrees, “In my adult lifetime, I don’t think I’ve ever seen people as fearful.”

Evans-Pritchard is lacerating about the EU and its Central Bank. It offered no “cover” to the Fed when Ben Bernanke slashed rates to 2 percent. The ECB simply raised its rate to 4.25 percent into a steep downturn, making oil inflation even worse.

As a last resort, it seems, the American authorities will use Bernanke’s famous printing press “to expand the menu of assets that it buys.” In the worst case, that could lead to a massive run on the dollar by foreign creditors and no end of misery for us all. But it may be necessary nonetheless.

At home, I have absolutely no confidence in the British government under Gordon Brown and Alistair Darling. They have been woefully slow to act, their policy to hide their heads under a pillow hoping it will all go away.

If Brown had even a small slice of a leader’s courage he would put together a massive package to recapitalize the British banking system; disown the “mark-to-market” accounting agreement, which forces banks into insolvency by estimating their assets on depressed valuations; take immediate control of interest rates by reducing them to 2 percent; begin to prepare for withdrawal from the useless European Union; and work closely with the Americans, who are, at the very least, fully aware of the immense dangers we face.

The Kraken is awake and bearing down on us fast. Over coming months and years we may wish that the Hadron Collider had swallowed us all up when it had the chance.

Update: The British Government has announced a variety of measures to recapitalize the banks and get the inter-bank lending markets working again. It amounts to a $900 billion bailout, eerily identical to the Paulson Plan for a country five times the size of Britain.

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Hard times or better times?

We’re hearing that the City of Vallejo has filed for Chapter 9 bankruptcy, apparently a first for a municipality. Half Moon Bay, home to a few internet big shots, may well be next. According to John Moorlach, Orange County board chief, “This is the tip of the iceberg: everybody is going to line up for Chapter 9 in California.”

What can it mean to people on the ground when their city goes belly up? What of their assets, houses etcetera? It will be interesting to watch this pan out.

According to Goldman Sachs and Lehman Brothers American house prices are likely to fall 25pc from peak to trough. With between 10m and 12m households in negative equity already, there’s still a way to go.

Shares across the developed world are set for big falls too. Albert Edward Société Générale’s global strategist says, “Nowhere and nothing will be immune. We are on the cusp of an equity meltdown that will slash and shred portfolios. We see a global recession unfolding. Liquidity will drain away and crush the twin emerging market and commodity bubbles. The recent hope that ‘the worst might be over’ is truly staggering. Profits are disintegrating.”

Ambrose Evans Pritchard of the Telegraph (UK) — ever the Cassandra — says pointedly, “Britain, Europe, Japan, and China will go down before America comes back up. This is turning into a synchronised bust, after all. The Global Slump of 2008-09 is under way.”

The Bank of England and the European Central Bank are still stubbornly refusing to cut rates because of inflation fears, which will be the least of our miseries in the next two years and should abate soon as global demand falls off the much-imagined cliff.

It’s probably true that Ben Bernanke’s Federal Reserve has saved the U.S. and other countries from another Great Depression. But nothing can stop a slump now because it’s already happening.

U.S. rates are expected to be cut by a whopping 1pc to 2pc today giving America an effective zero interest rate when inflation is taken into account.

The flight from the dollar will only get worse, especially with the ECB giving a two-fingered salute to the American authorities. It’s said that the eurozone (which does not include Britain) is in no mood to help the Americans — a situation similar to 1987, when the Bundesbank let the dollar slip into freefall, spooking the markets into a catastrophic drop.

Let’s not beat about the bush, Europe is engaging in a financial war with the U.S. As long as the ECB refuses to join in the rescue package, the dollar will fall spreading even more gloom around the markets. Some very senior commentators in the UK are now discussing the potential for a collapse of the entire banking system in the West and elsewhere.

Jean-Michel Six, Chief Europe Economist at Standard and Poor’s says, “There is a monetary war going on. The ECB view is that the Fed is a victim of its own mistakes and should pay for its past crimes. Frankly, they don’t see why they should be cutting rates when inflation is accelerating.”

British inflation measured on the CPI index, which doesn’t include mortgage costs, has risen to 2.5pc this morning. However, core inflation is down to 1.2pc, indicating that, apart from headline price rises in food and energy, deflationary pressures may be the real enemy in the months ahead.

Bernard Connolly of AIG thinks the ECB is making the same mistakes that led to the Great Depression in the 1930s. “The ECB represents the 1930s element in world central banking right now. It is adding to the atmosphere of panic in the foreign exchange markets and ensuring the collapse of the credit bubble in southern Europe and Ireland will be even worse.”

How long before cries of “Cheese-eating surrender monkeys,” are heard once again?

Not so good? Don’t worry, you’re not alone. But this is likely to be one of the world’s biggest talking points in coming months and years.

I was reminded of the Depression yesterday by the appearance of one of the legendary names from that distant era in the rescue of U.S. bank Bear Stearns.

J.P. Morgan was the renowned banker called on by the President to sort out the financial mess during one of the slumps of the period. Morgan set about systematically weeding out the companies that should be allowed to go to the wall, and those that were too important to allow to fail.

Yesterday the old feller’s bank, JP Morgan Chase and the New York Federal Reserve combined to stuff funds back into failing giant Bear Stearns, brought low by the gathering credit crunch.

The problem this time around is one of leverage and its effects on banks’ lending ratios — the multiple of lending to capital reserves a financial institution is allowed to build up by the authorities. The Geneva standard is that a bank’s capital must not fall below 8 percent of its lending. That number has been around a long time — I remember it from Alfred Marshall’s ancient classic textbook on economics during my university days.

Eight percent represents a ratio of 12.5 of lending to capital. These days it’s the norm for private equity companies to leverage many times more than that — supported by banks, of course, which then calculate their capital on a hugely inflated valuation for partly subprime debt. When the bubble bursts — as is now happening — both sides of the deal collapse.

Recently-bust Carlyle Capital Corporation (CCC) leveraged its equity 32 times to finance a $21.7bn portfolio of residential mortgage-backed securities issued by Freddie Mac and Fannie Mae. These instruments were financed by some of the biggest names in world banking.

With the housing market going south with a vengeance, it’s said that many banks’ capital reserves to lending ratios have slipped close to zero. The global financial system is floating on a cushion of fresh air.

There are always the consolations of philosophy for us to fall back on. Not the nitpicking academic variety which parses the meaning of words to death, but the active philosophy of Socrates whose adage, “The unexamined life is not worth living” should be a talisman of the financial sector.

In Britain, Gordon Brown’s Financial Services Authority (FSA), set up by him ten years ago to police the financial markets and the banks, completely missed the Northern Rock collapse, which was due to the bank raising money solely on the money markets and bundling the debts — many subprime — into packages and selling the risk on. When the money markets dried up, the bank had nowhere to go but to the Government to bail it out and eventually to nationalize it.

“The unexamined life is not worth living”. It seems the FSA did not examine the fifth largest bank in the UK, or spot the snake oil splashing around its floors.

Now consider what happened next as an example of both hubris and the reverse of Socrates’s dictum. Brown is calling for a “global financial watchdog” to perform for the entire planet what his FSA did for Britain.

Self-knowledge where art thou? The man has the richest fantasy life since Walt Disney.

Since we can’t have financial stability, or even politicians who examine their actions carefully, we must fall back on the real consolations of philosophy — everything changes and nothing remains the same.

Except death and taxes, of course.