The ongoing global financial crisis confirms the observation in Ecclesiastes that “there is nothing new under the sun.” Things happening right now are virtually identical to events in 1929, 1907 or 1873. But sometimes there are new variations to old patterns.
In 2009, developing nations are in the same situation as my grandfather was in 1907. That is, a crisis in a big financial center is jerking money away from innocent and honest borrowers somewhere out on the financial periphery.
That sudden retraction of credit caused havoc for U.S. farmers and ranchers in 1907 and during other crises. Now, it will cause severe problems in developing countries that eventually will ricochet back and wound wealthy countries, currently enraptured by their own financial navels.
A century ago, small prairie towns like my home village of Chandler, Minn., were short of capital. Available savings were not sufficient to fund the business borrowing needs of farms and small businesses.
The Federal Reserve did not yet exist, so if the Chandler Bank did not have enough funds available to loan out to sound customers like my grandparents, it would have to borrow from a larger bank, perhaps in Mankato or Sioux Falls, S.D., but probably in the Twin Cities. That bank in turn might borrow from an even larger bank in Chicago that would in turn borrow from the largest national banks in New York. In some cases, Wall Street financial institutions might even borrow in Europe.
This worked well until some disturbance in London or New York rattled the system. New York would call in loans from Chicago that would call in loans from Minneapolis that would call in loans from small towns across Minnesota. Local borrowers like my grandfather would get letters telling them their operating loan was due in 10 business days.
If the crop was in the ground or a semi-annual order of hardware was sitting on the shelves, local borrowers would be in a jam and so would the local bank. It could go broke by defaulting on debts to its larger correspondent bank, or it could pay those loans and then lack money when depositors tried to make withdrawals. Either way, the gearbox of the Minnesota economy suddenly had a shovel full of sand grinding things up.
Fast-forward a century. Multinational banks in New York, London, Frankfurt and Tokyo have lent money in Seoul, Jakarta, Sao Paulo and Johannesburg. Banks there have lent to other smaller banks or businesses throughout South Korea, Indonesia, Brazil and South Africa.
But the growing debacle in world money centers makes the multinational banks pull funds back to their home countries. Fed and Treasury officials, or their counterparts in Europe and Japan, urge them to do so. (Ironically, this desperate retraction temporarily “strengthens” the dollar, leading clueless observers to hail a resurgence of the U.S. economy.) Credit dries up in the developing countries and their business activity contracts.
These countries then buy less from the United States and Europe. Moreover, they don’t have the funds to make the more than $1 trillion in debt service payments due to wealthy nation financial institutions in 2009. This accentuates the financial plight of both lenders and borrowers.
As financier George Soros has pointed out, the Great Depression spread from continent to continent as the United States led rich countries in restricting trade in goods. Now, the crisis is spreading because U.S. and other wealthy country officials are encouraging or even requiring lenders to pull money home.
We created the Federal Reserve to short circuit such domestic vicious-circle credit implosions. The International Monetary Fund can perform that role globally, but it needs more money from its members, funds that are not likely to be forthcoming as each nation focuses on its own problems. We all will pay the price eventually.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.