Bailouts are over: debtors will fail, banks go bust and economies contract, then what?

Posted on 25 November 2011 with 6 comments from readers

Try to standback and take the position of the guys emerging from the isolation of the Mars 500 Project. Instead of looking at day-to-day market fluctuations look at the bigger picture. It takes a while to focus but actually you can then see where we have come from since the 2007 crisis and where we are most likely going.

The global response to the 2007 and much more severe 2008-9 crises was to bail everybody out. The banks were too big to fail and so every debtor deserved support.

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It’s madness really and some home-owners have never been better off with interest rates so low and enterprises with very poor internal economics have staggered on regardless.

The Endgame

All that is about to end as global interest rates rise in a bond market crash. That is what the gradual blowing up of interest rates in Europe and the contagion that has now reached Germany tells you.

Those who have relied upon low interest rates to stay afloat with big debts are therefore about to get their comeuppance. On the otherside of this trade if you are a creditor with a weak balance sheet then you will be dragged under too by these debts going bad.

Banks in the eurozone look particularly vulnerable but as the contagion spreads around the world this will be true for banks all over the globe. It is a global banking trauma of a kind we have not seen before, or at least not since the 1930s when something very similar did happen.

Credit will freeze up for two reasons: the banks capital will be under severe pressure and interest rates will be much higher. Without credit the flow of trade and business will decline and economies will contract. How bad will it get?

One thing is for sure, there will be an end to the crisis. The Great Depression of the 1930s eventually corrected and then came the Second World War. This is a downward spiral and there will not be an equal sharing of the burden this time.

Winner takes all

The spoils will go to the cash-rich and credit-worthy who will buy up the cheap assets from the bankrupt, and that will restart the economic cycle, although it may take some time to get moving again. Eventually interest rates will fall back as the demand for money will be low.

Hopefully the authorities will at this point put measures in place to ensure that borrowing can never again be allowed to spiral so out-of-control. Most likely every central banker in the world will have lost his job by then.

Then the bounce back will actually be stronger and faster than most people think possible now and a new age of peace and prosperity should dawn. Well why should there be another major war when there are no obvious opponents or at least none that are remotely equally matched?