28 January 2009

How could we get out of this mess?

Working on my predictions for 2009, got me thinking about how we could negotiate a way out of the mess we have got ourselves into. The only way I can see of doing this is through an unprecedented degree of co-operation between central banks and with a reordering of the global system for settling international exchange.

Here is the situation as I see it:

1. Systemic banking failure is best avoided and it is worth the effort to avoid if it can be done sensibly.

2. The level of debt in the global economy is just ridiculously high and has to be brought right down.

3. Foreign currency-denominated debt on the books of banks means that purely national solutions to the problem of excessive and under-performing debt may well not be possible.

4. There is a relatively high probability of private cross-border sources of finance drying up.

Here is a solution:

1. Government-backed insurance against losses above a certain percentage of book value of existing—and only existing—loans should be offered to banks that request it.

2. The central banks that issue the major trading currencies—the dollar, the euro, sterling and yen—should stand by to provide short-term financing across borders to any bank that requests it on an indefinite and unlimited basis, to cover existing—and only existing—loans denominated in their currencies. In other words, existing currency swap agreements will have to stay in place and, if and when necessary, be extended.

3. Interest rates should be kept low enough to ensure that banks can manage their liabilities, that mortgage holders with stable incomes can service their payments and that profitable businesses are not dissuaded from seeking loans.

4. Central banks should temporarily target inflation rates significantly above current levels in order to reduce the real value of debt over time.

5. Supranational institutions should be mandated to seek solutions capable of bringing international trade into balance in the manner of the International Credit Union proposed by Keynes at Bretton Woods in 1944.

6. Any international markets that interfere with the smooth running of any new system agreed for managing international payments (forex comes to mind) should be closed down.

That’s it. I think it could work. I can’t think of anything else that might do.

Updated: 30 January.

d. sofer