ZERKALO NEDELI: GLOBAL FLUTTER IN EGGS
“2010. Russian Finance Minister Alexey Kudrin says Russians do not have to worry about the crisis. They should have worried earlier, and it is too late to worry now.”
The Internet is full of jokes like this, whose authors must be people working for companies that are losing clients and thinking of downsizing. One could go on joking, but few people feel like it today. We can laugh at different things: ugly or scary, impudent or confrontational, but familiar. As for financial crisis, Ukrainians perceive it as something far-away and blurred, or as short-term trouble caused by neuropaths who bought up all the hard currency from banks.
We saw such neuropaths in 2004: they rushed to withdraw money from bank before the elections but after Arseniy Yatseniuk’s intervention, thought better of it and brought the money back, ashamed of their spinelessness.
The panic will subside, and life will resume its normal course. Wages and salaries will grow slowly, prices will rise rapidly, but we have gotten used to it and will continue to blame the government. Within a month or so, banks will get over it and start lending again. And again, nothing will change. In this country, nothing ever changes, no matter who is in power. Is that what you think?
I have got bad news for you: the old world has ceased to exist. Of course, the world did not change overnight, or within one day, as on September 11, 2001. In fact, it is a pity that it did not change overnight. The old world is dying hard and slowly. So the new world is being born – hard and slowly.
Ukraine is part of this world, despite the prime minister’s painstaking efforts to reassure us that the country is not integrated in the global financial system and, therefore, is out of harm’s way.
Yulia Tymoshenko’s advisors must have failed to explain to her that the current crisis is potentially harmful to everyone, except, perhaps, for a nomad shepherd on the Mongolian steppe. The crisis cannot but affect the country whose private sector’s currency debt amounts to 35% of GDP (according to S&P); whose current account deficit (in dollar terms) grew six-fold over the first six months of 2008 – 7% of GDP – and continues growing; whose current account payments and foreign debt maturing in the next 12 months exceed currency reserves by 1.5 times (according to S&P again); whose negative trade balance in the first eight months of 2008 reached USD 12.5 billion; whose banking system is 40%-penetrated by foreign capital; and whose export-oriented metallurgy is a major employer and donor to local budgets and the Pension Fund.
The global economy is in the midst of a hard and long-term financial crisis, likely to grow into a recession. For those who do not know: a “long-term crisis and recession” last years, rather than a couple of months.
The current crisis toppled powerful institutions universally regarded as pillars of the world market, destroyed investment banks and cut the asset value of the world’s largest companies.
What started as a stock market crisis turned into a financial one and, later, into a broader economic one. When economic analysts and historians write books about this crisis, they will begin its chronology with the American “First Home” program designed by the US administration to settle immigrants and low-income families. Those individuals and families received loans they were incapable of repaying. Loans were pooled and securities issued, bad and good loans were mixed, etc.
Today, however, it does not matter how it all started. An ever more popular opinion is that the global financial system would have collapsed in any case, subprime mortgage defaults or no subprime mortgage defaults. As this article is not about the root-causes of the global crisis (you can find lots of materials in the global media about that), we would refer you to the opinion of the former US Assistant Secretary of Treasury Paul Craig Roberts. According to him, the crux of the matter is an overabundance of debt relative to wealth: “A fractional reserve banking system based on fiat money appears to be capable of creating debt faster than an economy can create real wealth. Throw in credit card debt, stocks purchased on margin and leveraged derivatives, and debt is pyramided relative to real assets.”
Another global factor is that money ceased reflecting the true, rather than virtual, value of goods, services and even businesses. What does it mean? Imagine a company floats its securities on the stock market and their starting price is consistent with the actual value of the company, including the value of its assets, rate of return, market share, etc. Then the securities start living a life of their own: falling and rising in value due to demand fluctuations, which can be objective (e.g. expectations of high profits) or subjective (artificially incited by hedge funds or the company itself).
Fluctuations in capitalization are further used in getting loans, selling bonds and other market instruments. To the same end, turnover is inflated; this allows for raising new capital and, at the end of the day, the price of the company has nothing to do with its real value. One day the number of such companies grew too large and the disproportion – too striking for the world's economy to bear.
Too readily have we accepted the postulate that “every single thing costs as much as people can pay for it”. It is a quote from Shorty, a famous character of Jack London’s short story “A Flutter in Eggs”. You will remember that Wild Water had to pay 10 dollars per eggs that he bought to entertain his sweetheart Lucille Arral, though the true price was 2 dollars. In fact, the eggs proved to be bad anyway; the “egg trust” went bust; Smoke and Shorty lost 16,000 dollars on the transaction and swore they would never engage get rich quick schemes anymore.
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The fire can be put out in two ways – either by pouring water on it or by blocking access to oxygen. The world’s developed economies are putting down the fire in their financial systems with water: they do their best to facilitate their banks’ access to liquidity, i.e. capital. They unblock interbank lending. They inject taxpayers’ money into the banking systems, which, on one hand, enables those systems to operate but, on the other, carries the crisis over to public finance and the macroeconomy. The total amount of so-called 'bailout' funds in the world has reached USD 3 trillion.
In Ukraine, the National Bank chose to close access to oxygen by hindering, to the greatest possible extent, the withdrawal of funds from banks as a short-term firefighting measure. However, one should bear in mind, as NBU Supervisory Board Chair Petro Poroshenko noted correctly, that in Ukraine the crisis did not originate in the banking sector; nor does it affect this sector alone.
Blaming all of Ukraine's troubles on the global crisis is neither fair nor helpful. Over the last few years, large disproportions have evolved in the national economy. It pertains, first and foremost, to unsubstantiated consumption. Salaries in the public sector have been increasing while labour productivity has not. Lending has grown by 64% per year, together with the number of bad borrowers. Some banks planned the rate of unpaid loans at 30% per year, to still consider lending profitable. As a result, in 2007 the total outstanding loans amounted to almost USD 11 billion.
The inflow of unearned money triggered a rise in the prices for goods and services for middle-income and wealthy consumers. Real estate prices, fueled by mortgage lending, skyrocketed. As a result, a small apartment in Kyiv cost as much as a mid-size house in the UK. Unrealistic apartment prices tempted banks to overvalue their borrowers’ collateral. In the summer, auditors analyzing the credit portfolio in a bank asked the managers in charge: “Why did you appraise the apartment in Yaroslaviv Val Street at USD 1.5 million?” The answer was, “We read the AVISO newspaper.”
No coherent domestic market was formed in the country and growth in imports washed the money out of the country. It is not a banking problem, true. Banks did contribute to the current crisis but it is not only their fault. At fault are the owners of large businesses, including mining and metallurgical companies, spoilt with the 2007 rise in metal prices and reluctant to modernize their export-oriented enterprises.
At fault are several successive governments rejoicing at their electoral successes and ignoring the need to build up the domestic market. At fault are all leading political forces that have been eroding political stability and corrupting voters with gratuities on the eve of elections.
Now we can expect the global recession to hit Ukraine much harder than many other countries. The IMF can cushion the blow: according to unofficial data, Ukraine wants to get USD 9 billion from it. However, the IMF also has other economies to support, too.
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Oddly, the Ukrainian people are not getting any meaningful and dependable information about the economic situation in the country. Bankers of various ranks lullaby them daily with optimistic reports and forecasts: yes, there are minor problems, they say, but on the whole “tout vas tres bien, tout vas tres bien”. We understand they have to protect deposits from early withdrawal. As famous satirist Mikhail Zhvanetsky said back in 1985, a “rumor was floated that eggs would disappear from the market tomorrow. Everyone rushed to buy eggs, and they have disappeared today”.
Of course, panic can kill any banking system. So the less panic, the better. Yet the public deserves to be treated fairly and honestly, because having lied once, this and subsequent governments will undermine people’s confidence in governments and banks for years to come. Confidence and trust, as we all know, take years to build and weeks to ruin.
It does not mean they should predict a disaster – that would be equally unfair and dishonest. Nobody in this country and beyond is capable of predicting professionally the further course of events because the world has never faced a crisis of similar severity and scale. Yet they should publicly recognize that the world has changed, and all of us – the nation and every individual – should learn to live within their means.
The country should stop trying to evade economic laws and pay out unearned money, taking it away later through incredibly high prices for goods and services. Banks should admit that they have turned from financial intermediaries into issue centers. Every person should weigh all their incomes and expenditures carefully and get ready to cut expenses where possible.
Those who have no savings will lose less. Yet if one has no savings for a rainy day, they should cling to their income sources because their job could be jeopardized in the times of personnel cuts. Those who have savings should realize that crisis is a time to preserve, rather than amass wealth. All should understand, without panicking or cherishing vain hopes - that we are in for difficult times.
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Meanwhile, our national leaders are playing politics, attacking or liquidating courts, trying to call, cancel or postpone elections. The NSDC meets urgently to demand that the government allocate money for elections from its reserve fund. Only the next day does it find time to discuss how this country can survive when the global economy is collapsing.
Volunteers in Kyiv form task forces, like a council under the Verkhovna Rada chairman, to develop an action plan. Oligarchs ply between the president and prime minister, trying to resolve their companies’ problems. That is understandable – every man for himself.
Only the state and those in power do nothing. Lacking in understanding, information or responsibility, the authorities have failed to do their duty. Their primary duty was to start addressing the challenge in early September, at the latest. They should have set up working groups to (1) monitor the situation in the world, response by foreign governments and central banks, (2) learn from their experience and practice, and (3) propose the most effective measures to the top officials who, in turn, should have taken action.
Instead, some of them were busy plotting how to exclude the prime minister from the next presidential race; others were trying to drop the president’s ratings even more; others still were waiting until the president and prime minister annihilate each other so that they will be able to return to the prime minister's office.
Doing so, they show a lack of wisdom again: if they are truly concerned about their political prospects, they should be looking for ways not to come to power next year! They should stop thinking of the prime minister's post as a springboard to a successful presidential campaign. It could be, but in the times of growth, rather than recession. When will they ever learn that recession will force the government, inter alia, to cut public expenditures and freeze wages and pensions?
If they decide to spite economic laws again and spend lavish money on potential voters, they will have to resort to printing more money, thus, devaluing the national currency dramatically. Do they hope to return to an administrative economy and order price caps? In this case, they will get a huge shortage of foodstuffs, goods and services, “black market” and all the other attributes of the early 1990s.
Of course, each competing force can take the lead in counteracting the crisis if they believe that “only the bold and daring win in politics” and “difficulties mold character”. It would be a commendable step. Yet before doing so, they should assess the scope of problem and understand what difficulties they are going to face.
Next year, the nation will need capable crisis managers: not those who specialize in raising tempests in a teapot with the only purpose of drowning their political contenders, but real strategic thinkers and troubleshooters. People claiming their right to lead the country in 2009 should be fully aware that in the best case scenario it will damage their political career, and in the worst case scenario – ruin it. Yet leading the nation in difficult times they will do things crucial for the survival of independent Ukraine. Now we need to find those people.
Oleksandr MAKAROV
“Zerkalo Nedeli”, Ukraine’s International Social Political Weekly, № 39 (718), 18-24 October 2008
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