Inspiring Obama can’t change the fact we’re in deep trouble: Kohler

Barack Obama’s inauguration was, as expected, a wonderful, inspiring event. It might even have a lasting impact on sentiment in the US, and might, in itself, help the recovery by improving consumer spending and business investment.

But I seriously doubt it, and so does the market. This financial crisis is just not susceptible to rhetoric, no matter how soaring.

It began with the evaporation of bank assets due to the bubble in sub-prime mortgage lending and credit derivatives, and that remains its central fact.

The world’s financial system is now dramatically undercapitalised because its so-called “assets” are nothing but smoke, so that the system may need to be almost entirely nationalised by governments.

The decline in human spirit that is now resulting in a collapse in consumer demand and the horrifying prospect of persistent deflation is a direct consequence of the implosion of the financial system caused by the evaporation of derivative “assets”.

As a result, governments are struggling simultaneously to deal with the bank losses themselves as well as the fiscal implications of their economic impact.

And so the expected Obama inauguration rally on sharemarkets was stillborn, with the new American optimism overwhelmed by gloom about the Old World that first colonised the Americas – Britain and Spain – and the Even Older World – China.

The crisis began in America and it continues to worsen there, with yet another banking shock last night as State Street shares halved after the banking and investment firm reported a 71% decline in fourth quarter profit and a $US10 billion write-down.

But right now the world’s money wants to be nowhere but US dollars. Specifically, there is now a run on the pound that is threatening to get out of control and sink us all.

Britain is a bigger, more dangerous version of Iceland. The $US4.4 trillion in foreign debts built up by British banks is twice the size of the economy, and 73 times Britain’s foreign reserves.

Commentators in Britain are calling for Royal Bank of Scotland, Lloyds and perhaps Barclays to be fully nationalised to overcome the fact that the taxpayers are effectively wearing all the downside, but the banks are still being managed by the same idiots who caused the problem in the first place.

Those idiots have swung 180 degrees, from profligate lending to no lending at all; from frittering capital to hoarding it.

Similar calls for full nationalisation are being made in the US, with the example of Sweden in 1992 most often cited.

But nationalisation, either in Britain or the US, risks overwhelming both governments. Iceland allowed its banks to default because the Government could not afford to bail them out, because the gap between the true value of their assets and their debts was simply too large.

British Prime Minister, Gordon Brown, who, like George W Bush, was part of the problem with huge fiscal deficits during the boom, and Barack Obama, who is part of the solution, may find that the bank losses are beyond them both.

They can absorb them and get control of the banks to force them to lend, as arms of the government, or they can alleviate the misery caused by those losses and increase budget deficits with Keynesian fiscal stimulus, but not both.

Yesterday I was postulating that perhaps, if all major governments reflate at the same time, then no individual currency would collapse because all would effectively decline together, with the US leading the way like a pied piper of money-printing.

This morning that idea already looks hopelessly optimistic. Britain is suffering a run on sterling because its banks’ losses look too great for its Government.

This article first appeared in Business Spectator