The current crisis started as a crisis of subprime loans in USA in early 2007, transformed into an interbank funding crisis in late 2007, and moved on to transform into a full blown global recession in 2008. It then morphed in the sovereign crisis in Dubai in late 2009 which awakened investors to sovereign risks in Europe, where the saga still continues and is now threatening to engulf India soon.
However, a closer examination of the crisis, its causes, and the response of officialdom and markets would let us believe that it is basically a crisis of ideology. It is a crisis of ideology because it stems from the faulty design of economic order - the structural faults in the capital allocation process and incentives surrounding it.
Longtime readers of this weekly will remember our assertion that capitalism in the current structure is a failed ideology because the world has been witnessing banking crisis continuously since the fall of Bretton Woods. Well, recently the IMF has published a collectioni of all banking failures in recent history, which more or less matches with our understanding of the situation. The chart below shows the number of countries in banking crisis.
Chart 1: Number of countries in banking crisis
Source: Decimal Point Analytics Estimates based on IMF and other sourcesii
The “Banking System” performs a very critical role in capitalism through allocation of scarce capital resources among competing uses. A crisis in the banking system is an indication of gross failure of either the allocation process or the incentive structure around the banking system or both. By incentive structure here, we do not merely refer to the popular anger over bank bonuses, but more critically to the system of fractional reserve banking and to the system of assurance of depositors’ capital. The assertion that we make here is simple; if the process of capital allocation is so fraught with risks that there never is a period without a banking crisis in recent history, then the system of fractional reserve banking and safety of depositors’ capital should be anathema to capitalism.
The fall of communism in 1989 was cheered by the entire free world, with the belief that the ghost of communism would never be revived. However, capitalism in the current form is rapidly losing value in the eyes of ordinary citizens. A time has come to rethink a new global order and agree on the new blueprint of world economic structure – one with pure capitalism, with minimum state intervention and one without commercial banks. This new world order needs to throw out the concept of stability – be it in the form of guarantee of deposits or in the form of social financial security.
The earlier we realize that the old order has become redundant and is likely to degenerate into a rapid collapse, the better prepared we will be for installing a new meaningful, everlasting order in that void. If the world fails to do so, it may descent into economic anarchy.
The most interesting aspect of this IMF database is total lack of any attempt to find root causes of banking crisis. One wonders why…
The start date of chart is deliberately choosen so as to cover period where pure capitalism (or state capitalism aka China) dominated the world; in order to negate any effect of communism.