The answer to this global credit debacle is transparency. There are enormous sums of investor money waiting in the sidelines. The reason they have not been invested yet is due to a lack of transparency within the balance sheets of those institutions that constitute the global financial landscape. Make no mistake; capital needs to be deployed in order to create a return. With such uncertainty surrounding the global capital markets it is entirely normal that investors would pull back until a sense of clarity itself develops.
Our global economy has just hit the mother of all speed bumps – gathering at a pace since the late 1980s, when cross border trade started to grow exponentially. The difficulty is that financial regulation has not kept up. Regulatory oversight is still based upon a patchwork of distant if not poorly related domestic regulators which are given a domestic agenda – they all march to a different tune. Because political power is mostly based on domestic powerbases, national governments still wish to hold on to the reins of power when it comes to policy and legislation with regard to regulatory oversight. This model fails to acknowledge that an increasing portion of domestic transactions regardless of the industry have there genesis with international entities, yet the international entities enjoy relatively little cohesive regulatory oversight.
The world needs transparency and consistency with regard to international financial reporting. Credit spreads notoriously fell in the years proceeding the credit crunch, advocates of the derivative market hailed this as proof that risk had been disseminated with such efficiency that risk in itself was becoming less important and thus less costly – how wrong they were. What in effect was happening was that risk had been obscured via the availability of inter-jurisdictional entities that were designed to improve the appearance of assets by obscuring their liabilities.
It is this derivative based fog, which is now so evident, that is preventing banks and counterparties from taking risks with each other, if they can not have faith in the balance sheets of their own organisation then how on earth can they trust other counterparties. The pumping of vast sums of cash into the system by well meaning but ultimately ill-advised governments will cause enormous systemic risk. They are treating the symptom and not the cause. If G7 governments were serious they would overhaul the financial reporting requirements of all entities that operate within and across their borders. By championing transparency and promoting standardisation of asset and liability pricing – they would soon see the credit markets opening up again. Remember money wants to be put to work; it needs to be put to work.
The alternative is unthinkable. By pumping money into the system the governments of the world or devaluing the cash reserves of investors, this will in turn require these investors to seek a return in excess of the rate of inflation. In a badly wounded global economy such returns will be difficult to find. Thus the solution of quantitative easing will in fact prolong the pain and may even kill the patient.
