"Banks back from the Brink"

That was the pronouncement I saw crawling across the screen this morning on CNBC. The "brink" is the near collapse of the financial system and credit markets which were (supposedly) triggered by the demise of Lehman Brothers a year ago.

Its nice to know that CNBC--not known for the depth of its financial analysis or
its economic forecasting prowess--thinks that the banking system is on the mend.

Perhaps. But liberal economist Joseph Stiglitz has a different view. The iconoclastic former World Bank executive and Clinton economic advisor has been sharply critical of the government's failure to "fix" the banks. He says that the "too big-to-fail" banks have become even bigger since Lehman's demise, thanks to government bailouts, guarantees and the sweet credit spreads owing to the Fed's zero bound monetary policy.

In Stiglitz's view, the banks must shrink in size and their structures must be simplified in order for them to find their way to back to health. He also believes that executive compensation, bonuses and incentives need to be drastically curtailed through regulation--not surprising for a critic of free market economics. Despite the Obama administration's threatening tone regarding oversight of the financial sector, Stiglitz says Obama proposes nothing that will fix the problem.

I don't agree with Stiglitz's politics, his economic orientation or his solutions, which depend far too much on the regulatory machinery of the U.S. and foreign governments than on free market principles. But he is clearly right when he suggests that the banking crisis has not been solved or ameliorated by anything the government has done in the past year.

Stiglitz, a former advisor to President Obama, is reported to have said that whoever designed the Obama administration's bank rescue plan is “either in the pocket of the banks or they’re incompetent." Maybe he was wrong. Maybe its both.

*****************************

Speaking of Lehman Brothers, the U.K. Telegraph's Ambrose Evans-Pritchard admonishes media types who claim that the Lehman collapse caused the "great credit contraction" of 2008-2009. The demise of the investment bank--and the near collapse of Merrill, Goldman and Morgan Stanley--was the inevitable result of a western economy mired in debt and an Asian economy addicted to exports.

For its part, the western economies engaged in what he calls "Greenspanism--"

Central banks rescued assets each time there was a hiccup, but let booms run unchecked. They pulled "real" rates ever lower, creating addiction to monetary stimulus. Larger doses were required with each cycle, until we hit zero, and it is still not enough.

--while the Asian economies poured their 5 trillion dollars in reserves into western government bonds, accelerating the fall in interest rates and feeding the growing global credit bubble.

Evans-Pritchard notes that the bursting of that bubble continues to roil the global economy, as evidenced by contracting consumer credit in the U.S., a dearth of global demand for manufactured goods and a glut of industrial capacity. The dismal effects of all this have been masked--somewhat--by massive worldwide government stimulus.

At some point the limits of fiscal stimulus will have been reached. The question is: where do we go from there?

************************

As if to lend credence to Evans-Pritchard's thesis, Tim Congdon of International Monetary Research told the U.K. Telegraph that U.S. bank loans have shrunk by an annualized rate of 14% in the three months ended August 31. "There has been nothing like this in the U.S.A. since the 1930s," he told the Telegraph. "The rapid destruction of money balances is madness."

"Money balances" is a fancy term for "credit," which basically is defined as loans from banks and M3 money supply. The money supply has declined by a 5% annual rate.

The irony is that the effort by monetary authorities to inject massive amounts of capital into the banking sector in order to improve their balance sheets has had a "perverse consequence" of destroying credit.

Inflation may the worst nightmare of consumers and creditors. Not so the central bankers of the world. The thing that wakes them up at night drenched in a cold sweat is the prospect of chronic deflation in credit, wages and assets that no amount of printing and monetization can reverse.

If Evans-Pritchard and Congdon are right, then the world's central bankers may indeed have reason for worry.