Background

The global financial crisis, triggered in 2007 by the United States housing bubble bursting, has recently passed the five year mark with no end in sight. The crisis, described by many commentators as the worst since the Great Depression of the 1930s, is unlikely to pass without causing more pain for ordinary middle class people and those in the lower economic strata.

The Start of the Crisis

The start of the crisis can be dated back to August 2007 when the French global banking group BNP Paribas terminated withdrawals from three hedge funds citing “a complete evaporation of liquidity”.

The bursting of the US housing bubble followed and caused the values of securities tied to the US to nosedive. In the modern “global village” it rapidly hit financial institutions worldwide.

The crisis exposed the unsustainable situation created by US government policies that encouraged home ownership with loans for sub-prime borrowers, the overvaluation of bundled sub-prime mortgages based on the assumption of a perpetual increase in the value of real estate, and questionable trading practices.

The situation was worsened by over-complicated mathematical formulas used by financial markets and the lack of adequate capital holdings by banks and insurance companies to cover their exposures.

The uncertainty about the solvency of banks and other financial institutions led to the tightening of credit, international trade declined and economies across the globe shrank.

Government & central bank Action

Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and the bail-out of banks and other financial institutions. The net effect of this was the shifting of debt burdens onto the shoulders of taxpayers worldwide, especially in the developed world.

Over time, the eye of the storm morphed into a sovereign debt crisis, particularly in Europe. Fears for sovereign debt defaults by several European countries, and eventually even by the US, remain real.

While central banks are flooding cash-strapped industrialised nations with money it helps governments to reduce their debt load. At the same time however it also erodes the value of people’s income and savings. Some commentators refer to this process as a massive upward redistribution of wealth. And, especially at the bottom of the economic pyramid ordinary people are also at the receiving end of austerity measures taken by governments aimed at softening their deficits.

What governments are effectively doing to lower their debt levels in real terms is what has been done since the time of Cleopatra in Egypt when she replaced gold coins with much cheaper copper coins: they are devaluing their currencies.

Inflation Dangers

In the process huge inflation dangers are waiting in the wings. A poll conducted in September by the German companies Faktenkontor and Toluna found that one in four Germans is already trying to protect his or her savings from the threat of inflation by investing in material assets.

Governments and central banks are constantly buying time by fighting the debt crisis with monetary injections of previously unheard of proportions and the side effect is a slow but dangerous devaluation of money.

While official inflation rates are still moderate (1.7% in the U’S and 2.6% in the euro zone) they are based on consumer price indexes and do not reflect what is happening with major asset purchases such as real estate. This “unofficial” category of inflation in asset values is already taking place in the financial markets and new price bubbles are being fed with cheap money from central banks, as well as by investors and savers fleeing into what they regard as safe material assets.

It is also a reality that in the present extremely low interest environment, even the lowest inflation eats away at people’s reserves and savings.

In the US the Federal Reserve prime rate has been at zero since the end of 2008, and has just been extended at this non rate by chairman Ben Bernanke.

In the meantime US government debt has exceeded the $16 trillion threshold with inflation about the only viable option to reduce it. The alternative of a massive saving through austerity measures and higher unemployment rates is politically most unattractive.

In the wake of the strong global integration of economies in the 1990s the competition for export markets has increased currency devaluation. One of the symptoms of this is the increasing talk of a currency war between the US and China and to a lesser extent Europe. It also creates a gap between the financial economy and the real economy.

Payday will come

For the investor and especially middle-class people attempting to provide for retirement and create wealth for future generations, the biggest challenge has become not return on investment but rather retention of value.

How and when the end of the present financial debt crisis will come about is almost impossible to predict. What is certain is that the settlement of the debt burden cannot be avoided for ever.

One way or another payday will come and it looks to be inevitable that a substantial part of that tab will be picked up by the middle class.

by Piet Coetzer