The international propagation of the
financial crisis of 2008 and a
comparison with 1931
We have suggested a number of ways in which the financial crisis of 2008 was propagated internationally. We argue that the collateral squeeze in the United States, which became intense after the failure of Lehman Brothers created doubts about the stability of other financial companies in the United States, was an important propagator. The provision of large-scale swap lines by the Federal Reserve relieved many of the financial stresses in other countries that had followed Lehman Brothers’ failure. The unwinding of carry trades, particularly yen carry trades, is also likely to have transmitted market volatility to the countries that had been the destination of the carry trades when they were first put in place. It seems likely that, at the time of writing, there is still a large quantity of yen carry trades to be unwound.
In both crises, deposit outflows were not the only important sources of liquidity pressure on banks: in 1931, the central European acceptances of the London merchant banks were a serious problem, as, in 2008, were the liquidity commitments that commercial banks had provided to shadow banks. And in both crises, the behaviour of creditors towards debtors and the valuation of assets by creditors, were all very important. Flight to liquidity and safety was an important common feature of the crises of 1931 and 2008. In both episodes, the management of central banks’ international reserves appears to have had pro-cyclical effects. However, there was a crucial difference, in that the supply of assets that were regarded as liquid and safe in 1931 was inelastic and became narrower with the passage of time, whereas in 2008, it could be, and was, expanded quickly in such as way as to contain the effects of the crisis. The understanding that the role of governments and central banks in a crisis is to enable such assets to be supplied was perhaps the most important lesson of 1931, and the experience of 2008 showed that it had been learned.
Having learned an important lesson in 2008, there being a strong likelihood that future market volatility will be transmitted to the countries that had been the destination of the carry trades, and there being still an elastic supply of assets that are regarded as liquid and safe ... I see a strong likelihood that all future market volatility will be dealt with in the same manner it was dealt with in 2008.
The bigger the problem, the more valuable the collateral needs to become.
In a crisis, something's gotta give. It will be the value of gold, rising to absorb folly so that the cost of one's mistakes are not borne by others, socializing the losses into assets rather than debt.
Many people see the Germans calling time on the euro bailouts, but the way I see it the Germans are being prepared for a big push into gold for any of them with significant savings to protect. Given their relatively recent experience with hyperinflation, I imagine it wouldn't take much to convince most of them to be wary of holding onto currency savings for too long.
They also still have goods and services for trade that are in demand, and they still have a trade surplus. Capital continues to flow into the country. When the time is right the surplus will also find its way into the sponge of gold that is setup and waiting for the job.
Far from taking a bath in the same dirty water as the PIIGS, their stored capital will float to the surface like cream. Gold will flow into their borders from their neighbours, while freshly-printed euros will flow in the opposite direction from the basement in Frankfurt.
This is all it takes... other eurozone countries are not going to just stand idly by if Germany goes on the buy for physical, are they?
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