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Can the Problem be the Solution?

The current financial crisis is due to excess money being thrown around & bringing in more money won’t solve it

The events of last week have forever buried the ghost of 'decoupling'. In fact, you may actually have forgotten that such a word existed. 'Decoupling' was greatly in vogue during the second half of last year. When the sub-prime crisis first became surfaced in the the USA last July, decoupling became the flavour of the month in Indian financial circles. The US markets were tanking and many people thought the effects would be felt across the globe. Anyone who wanted to prove that the Indian markets would stay unaffected by events in the US said that we were decoupled. At the time, I got the clear feeling that the decoupling idea was basically hype drummed up by brokers and other market types in order to keep the punters interested.

Whatever be the long-term coupling of the economy at large, foreign money plays a pivotal role in driving stock prices. The short- and medium-term fate of your stock investments is inexorably coupled to the amount of foreign money that flows in or out of the markets. The events of the previous week have demonstrated that not only is our (and most of the world's) economy firmly coupled with that of the US, the direction and nature of decisions taken by the US government to tackle the current financial crisis has great bearing on how things turn out for everybody.

Over the last year or so, the scope of this crisis has expanded inexorably. What started as a loan default problem in a sub-section of the American housing loan market first became a Wall Street problem and then a global financial crisis which can paralyse economic activity across the world. The question is not of the stock markets or housing now, but that of the drying up of credit that drives economic activity. Even Mr. Chidambaram, whose statements in the face of market turmoil are always resolute, said that Indian banks were safe but India couldn't stay insulated from a global credit squeeze.

In some ways the global money crunch is 'fair', in the sense that it is a comeback, a reversion of mean for the money glut that the world has had since about 2002. A lot of this has been invested in productive assets like industries and infrastructure while the rest has just caused a massive increase in the prices of existing assets due to increased demand. The ballooning prices of real estate and stocks probably have elements of both. Asset prices have inflated because there was easy money to be had to purchase them at prices which were driven by the easy money. That sounds circular because the cycle was circular, and was getting bigger by feeding on itself.

Over the last year this cycle has broken down. Moreover, the excesses that had accumulated were so horrendous and so widespread that the winding down has been disastrous. However, at this point in time, we are in the middle of what is being hailed as the US Government's masterful rescue plan that will save the world. Basically, the wise men in Washington have made it clear that they will throw money at this problem till it goes away. They will assume ownership of as much bad debt as needed, thereby freeing up banks and others' capital. While the headlines are uniformly laudatory, what they are basically doing is to solve problems caused by excess easy money by providing more money. Any ideas on whether the same problems will be back in an even bigger version somewhere down the line?