Cees Bruggemans, chief economist of FNB, takes us back down memory lane why and how the financial crisis erupted and what is likely to emerge from all this:
Two years ago at this time, one could be forgiven for only extrapolating good times. The (SA)economy was completing its fourth year of over 5% growth, formal employment was expanding robustly, state revenue was growing in leaps and bounds making all kinds of social spending feasible even as the national debt was steadily whittled down, and the budget was heading for surplus territory.
Yet at the time a worm was already at work in the woodwork. Inflation was rising as a global commodity price surge was steadily taking shape on the back of an enormous global growth wave, much of it arising in the Asian East, but aided and abetted by fantastic credit and asset bubbles originating mainly in the Anglo-Saxon West.
It had called into being a monetary response already the year before, with the SARB since mid-2006 in tightening mode, gradually if persistently raising interest rates.
Between them, rising inflation and interest rates would within another twelve months erode household purchasing power and the means to sustain the growth wave.
Thus, instead of extrapolating the recent past at the time, it would have made eminent sense by late 2007 to have projected the end of an eight-year expansion cycle and the possibility of recession.
For long business cycle expansions rarely die of old age. Instead they get murdered, nearly always by central banks which, responding to dire need, only do it for our best will, mostly to tame inflationary impulses.
Of course, these two major undertakers, rising inflation and interest rates, would very shortly be joined by a third undertaker, electricity shortages. Its origins were 15 years in the making because of a persistent unwillingness to plan and built new generating capacity for when the operating surpluses would finally ran out. The resulting mayhem would seriously hamper industrial activity and deeply undermine confidence by early 2008.
Between them, these many forces would set in motion an economic deceleration which by late 2008 could have created a mild recession quite easily.
This was already being speculated openly about by mid-2008, yet believed by few.
For surely the long prosperity wave would continue indefinitely? Such is the momentum of good times, in which exuberance of mood rules, and in which the obvious is hardly ever recognized early.
But if all of this weren't enough, by that springtime moment in 2007 the water had already broken on an even more momentous development. Mutual trust among global banks had been brutally dissolved by the bankruptcy of a minor investment vehicle in France.
The realization dawned nearly simultaneously in many a banking boardroom that events, but mainly their own behaviour, had delivered them into the middle of a gigantic minefield from which there was no easy escaping.
Many bankers, especially Americans, British and Europeans, by then realized that, given what had happened to their own balance sheets, and extrapolating this worldwide to other banks' balance sheets, absolutely nobody's paper could any longer be trusted.
And so those with surplus cash held on to it on the day, starting an old-fashioned hoarding with unbelievable consequences, for banks in deficit on the day had to turn to their central banks, as traditional lenders of last resort, to tidy them over with needed liquidity.
Happily, modern central banks don't tend to panic and are able to lend when so many private agents are losing their heads. On that day the ECB in Europe, the Fed in the US and the Japanese central bank between them injected over $250bn into their banking systems to keep things afloat.
From that moment on, the global banking system, its capital providers and clients, and not least its many regulators, central banks and governments, embarked on a discovery process to try to understand the extent of the damage and its implications.
It would take more than a full year, to our springtime in 2008, for the full ramifications of what had really happened, to sink in and divulge its awful truth.
Throughout this discovery process, the deep confidence of the long global expansion became rattled and eroded, financial markets peaked as blue chip names went under and needed to be rescued, credit access started to tighten, and economic growth worldwide started to slide, initially only gradually, but steadily none the less.
The awful truth was that the leading banks of the rich industrial world were effectively bankrupt, brought down by two sets of behaviour, namely wild, untested, unstable financial innovation, and the greed and suspension of rules that tends to accompany such hubris.
The problem was fundamentally bigger, more complex and more intractable compared to what had gone wrong in 1929 and the subsequent years in which the Great Depression of the 1930s had its origin.
Then, a catastrophic loss of confidence giving way to panic (nothing unusual in the history of free market finance) had resulted in a run on banks, creating a liquidity squeeze, setting in motion bank defaults, business bankruptcies and spreading unemployment.
Unfortunately, neither inexperienced central banks nor inept governments at the time had the knowledge, the skill or for that matter the means or even the political will to resist these falling dominoes.
Like a simple flu can develop into pneumonia, followed by death if not treated timely with medication (in our time known as antibiotics) the economic policymakers of those days had to stand by helplessly as this terrifying financial spectacle destroyed the underpinnings of the global economy of its day, with terrible social and political ramifications worldwide.
By springtime 2008 was history to repeat it self?
This time things were far worse, for it wasn't primarily a liquidity problem at banks that central banks in the interim had learned to treat with adequate doses of their support (a simple matter of providing banks with cash).
Instead, banks had made decisions that would prove disastrous in that many of their assets would turn out to be less valuable than thought. Solvency was the main issue in 2008, not liquidity. And bank insolvency you can only treat by injecting new capital, writing off the asset losses, replace management, restore trust (that ultimate currency) and then start anew.
But instead of this happening to a single minor bank, whole banking systems crucial to the global economy had to be rescued and repaired simultaneously. This was like wanting to change all four tyres AND the engine on a car still driving at full speed.
Predictably, the panic deepened and spread, culminating in a firestorm of epic global proportions. The end had apparently come in finance, jeopardizing houses, portfolio investments, jobs and pensions of hundreds of millions of people who previously had thought of themselves as well off, even rich.
The stampede set in motion this time last year has been without equal in world history. Credit effectively dried up globally for anything, buying a house, funding a foreign trade, financing business expansion but also working capital.
When confronted by danger, we have basically two options, to fight or flee. If the danger is big enough, there is only one option, fleeing and hoping to survive to fight another day.
Across industries, across time zones, nearly instantly everywhere, being internet linked and all watching the same global television, and with industrial processes finely meshed by just-in-time calculations, managements across the globe took ultra defensive actions. Shooting first and asking questions later. Not wanting to be caught napping by events.
One had to preserve cash flow, jettison unwanted ballast, cut all spending plans, become independent of retreating banks, prevent becoming a banker to one's debtors.
And so the Greatest Recession since the Great Depression was born, around October last year, as everyone in steel, cars, chemicals, furniture, computer chips, travel, mining, transport and thousands of other activities all had the same bright ideas.
Cut production by 30%, start to reduce inventories, cut back on unneeded spending, savage capex and budget plans. Hoard cash. Survival was to be key, everywhere.
Of course, if we all do this together, it is like ritually all slashing the own throat. And as nearly everyone's output fell by 30% on the first round, everyone's sales in the second round would fall yet more disastrously, setting in motion yet another cutting round. And another. And another. Diving to the bottom entwined in a common death struggle.
These were exciting times indeed.
Private individuals are prone to the greatest fantasies, happiness, exuberance and hubris, just as they are capable of shock realizations that everything isn't quite right, the onset of fear, panic and the deep skepticism that then rules all.
In a word, we are human, emotionally, and so are the businesses and institutions we run, as they are run by human beings who have money and livelihoods at risk and try desperately to prevent losing it all.
If you are going to panic, do so early and in style, being the first out of the door. Of course, if all try doing so, the results are predictable. Very few will leave the room alive.
Governments, for all their shortcomings, have one fine characteristic. They aren't supposed to panic, not having as much personally at stake as individual economic agents.
Even better, governments represent all of society and thereby control our collective tax base and the ability to leverage debt thereon. Yet better in modern times, they ultimately control central banks which in turn straddle the money printing presses.
For in our day all currency is basically paper based, indeed only an electronic entry and transfer away.
And thus these past twelve months we have been in the grip of the greatest rescue mission in history. What it required was the political will, to mobilize society's resources and to go out and undo the institutional failures that threatened to pull all down with it.
This rescue mission of central banks and governments has not been a simple tale. For as on the first day of any war, one throws away all carefully prepared plans as unexpected eventualities decide the shape of the battlefield. Literally, they had to make it up as they went. And they did.
In the process mistakes were made, time was lost, terrible fatalities occurred. After all, some $3-4 trillion in financial assets had been lost, and the worldwide recession would incur another $6-7 trillion in output losses forever gone. Between them the bill came to the equivalent of 4000 Gautrain projects never built. You will agree: the ultimate in global opportunity loss.
There were also house price losses, and halving of equity prices, coming to another $30-40 trillion loss globally, but these were ultimately mostly paper losses for those who didn't transact.
By early March 2009, global financial markets bottomed, central banks had arrested the global freefalls, financial repair was well underway, and governments were underwriting just about everything.
The world was taking a deep breath, and trying to shake its panic. But as with all trauma this takes time. It takes time, proof, success to restore the old trust, confidence and risk-taking at the core of any successful economic system.
To regain one's lost cool isn't a simple matter. Take a deep breath, forget those anxieties, there really is life after death for those lucky enough to have survived the ordeal, now carry on as usual, governed by the old rules that shape our economic behaviour.
This is, of course, questioned at every turn, that life could possibly be the same, that it will be business as usual ere long. Yet we are organized in a certain way, success has its own logic, our behaviours tend to be rule-bound, and once we have regained our composure and our legs, it is once again off to work we go.
It is at times of great catastrophes that deep philosophical questions tend to be re-asked, and rightly so, for why waste a perfectly good crisis? So it is a perfect moment to ask a few searching questions, about the meaning of life (having just survived the ultimate ordeal) and whether the old rules should still apply.
Thus there is much seeking for renewal, reform, but also risk assurance, that this terrible thing may never happen again (as of course it will, as it has on numerous occasions in distant histories mostly only remembered in forgotten books).
But there is a deep searching going on daily in an attempt to come up with better rules, better incentives, less risky behaviour to guide our economic activity. This is all for the good, and indeed an age-old process by which we discovered the keys to long-term development and prosperity.
So how now going forward? Are there any prospects?
There certainly are. The world isn't mainly populated by widows and orphans fearfully seeking out the sidelines and forever staying there. The dance floor may have suddenly emptied last October when the balloon went up and the music died.
But since then, the music has started up again, central bank and government assisted, a few brave souls have been tempted back on the dance floor, as early fashion leaders are apt to do, and the great majority, sufficiently calmed down, seems ready to resume its role, if still somewhat shaken by it all and taking more time to fully recuperate and regain its mental equilibrium.
While this re-engagement is slowly starting up, central banks and governments need to carefully plan their coming exits in turn, as the dance floor can support only so many gyrating couples. And we don't want new accidents, now do we, such as fundamentally overheating our economic spending and resource bases and starting the mother of all hyperinflations. For that would be exchanging the fat for the fire.
The key global policymakers first had to catch the baby and ensure its safe delivery. And once accomplished they need to make themselves scarce again, reduced to their legitimate everyday role, which is much reduced from their crisis role as chief firefighter.
So with economies stabilized, if with enormous increases in slack resources, especially in Western countries, US unemployment heading for 10% whereas 4% would be normal, how does the economy start up again?
There are two sides to this question. The one is internal, the other external (global).
Internally, the deeply recessed economies today enjoy support from government spending, but also favourable incentives such as assisted credit flows and super low interest rates from central banks.
There was overreaction at the onset of crisis late last year, and its unwinding gives a needed lift to activity. Once inventory and output slashing ends, yet with final sales less disturbed than originally imagined, production can start gearing up again. This process has been underway worldwide these past six months, ensuring that economic activity didn't keep falling, spiraling out of control indefinitely.
Indeed, this quarter (3Q2009) is probably the first quarter of growth in the new global expansion cycle getting underway about now.
On a slightly more extended timeframe, postponed replacement decisions are coming back into focus. It was easy to delay purchasing a new car, furniture, appliance or whatever, greatly deepening the onset of recession.
But once less unsure and going back to more normal conditions, these replacement decisions come back into focus. If the means are there (90% of the American labour force will still be employed, interest rates are low, credit flowing again), the durable consumption will gradually come back on stream. And with a bit of time lapse, so will business investment.
It isn't good enough to say that there is much spare capacity and therefore no need to invest. Innovation hasn't stood still. The process of creative destruction very much remains alive and at the centre of all economic development, competitive impulses driving us on the replace and invest. Indeed, consolidation, regrouping and renewal are the key watchwords in today's global economy.
And so the business of risk-taking, expansion, employing and private spending resumes, for there remains much unfinished business in the world.
Which brings me to the global stage, and the real core of the growth story of our time.
The East (Asia) is poor. It is also impatient, having discovered to an ever greater degree this past generation how the few got to be prosperous.
The global banking implosion was mainly a rich world phenomenon. The emerging universe was mostly not affected directly, and some industrializing and commodity-supply parts only indirectly.
China's economy throttled back from 10% growth to 8% growth this year and next year is seen doing 11% growth again as it successfully imitates Japan of old, accelerating domestic demand into a global contraction, temporarily lessening the impact of its usual early export dependency.
China and India have reached a critical mass that allows them to play this leadership role at this juncture. It won't undo the output losses incurred in the rich countries, but it does assist the world to recover more easily from its encounter with disaster.
And thus the world, initially limping in parts, but already again racing in others, with an enormous increase in resource slack, as much spare skilled labour as physical resources, is readying itself for another cycle of economic expansion.
Given the low base from which it is beginning, the spare resources, the slow start in places, the absence of major structural risks (unless you don't like overgearing governments and central banks) and the enticing incentives, the world is probably looking at another major and long expansion.
Certainly not everyone believes this, sensing the Great Moderation and balmy economic times lie behind us, and ahead looms much more volatility, inflation, policy action and therefore business cycle interruption, shortening any growth spurts and keeping the growth down through greater inefficiency brought on as a consequence of the great financial shock and its remedies.
Meanwhile, the East is impatient as ever, and the West not necessarily populated only by widows and orphans. Indeed, all I meet daily is great white sharks on the prowl for the easy opportunity at the bottom of this great cyclical implosion. This is the essence of raw market capitalism and it certainly hasn't died.
That suggests a come-back, even though humpty-dumpty had a great fall and can't be quite put together again in the way he was before. But then doctors have a way of stitching you up and wishing you a nice day as they shoehorn you out the door.
Life goes on. The rules of the game are well known, if somewhat moderated. But it won't prevent a resumption of that great human effort known as getting rich, and less prosaically as human development.
So we are going back to global growth, fast in the East, somewhat slow in the West, surplus capital being generated probably everywhere which still will be looking for an outlet, mostly where the action is hottest (in the growing emerging universe).
