Which Way Is Up?

Posted January 20, 2009

It is becoming clearer the global banking system is still fragile as governments work on developing more effective stimulus programs. The UK pound fell against most major currencies when the Prime Minister announced a new bank rescue plan.


You can almost see the economy as a big brown box with the arrows on it that say "this way up" except someone turned the box upside down.  All the economic pointers seem to be turned the wrong way as conditions continue to deteriorate.  Now politicians such as US President-elect Barack Obama (officially becoming President tomorrow 20/January/2009) are saying it will take years to recover from this US inspired economic collapse. 

These kinds of statements may be unpalatable, but they are honest.  It is becoming clearer by the day the global banking system remains fragile and one more misstep could bring collapse of many country financial systems.  The stimulus packages to date have prevented the failure of many banks, but they have not re-established stability.  It apparently is going to take a lot more money.

At least that is what UK's Prime Minister Gordon Brown has decided.  He is introducing a second rescue package for Britain's banking system.  The goal is to inject enough cash into the system to kick start consumer lending again.  The UK is having the same problem as the US banking system in that the cash handed to banks so far is not easing consumer lending.  That is why Obama in the US is talking about using the second half of the Troubled Asset Relief Program (TARP) to slow down housing foreclosures and increase consumer credit availability. 

A good example of the reality of the problem in its most basic terms can be summed up as follows: You can't save a floundering auto industry if people are unable to get loans to buy new cars. 

As a result of the UK bank bailout news announced by British Chancellor of the Exchequer Alistair Darling, the pound declined against the US dollar, the euro and the yen. This was due to investors seeing the need for this additional stimulus package as proof the banking system remains weak.  The pound weakened to 90.03 pence per euro; to 132.61 yen per pound; and to $1.3346 in terms of the US dollar.  The pressure on the pound is expected to continue until there is an indication the banking system is responding to bailout efforts. 

The Russian ruble is the other currency under the most pressure.  The Bank of Rossii has devalued the ruble six times in response to investors draining bank accounts.  In less than 6 months, there has been $245 billion withdrawn from bank accounts and the country's currency reserve account has decreased by $171.6 billion.  Russia is attempting to prevent sharp swings in the value of the ruble, but their political policies are certainly not helping.  In the last 6 months, Russia has invaded Georgia and turned off the gas pipeline running through the Ukraine to Europe. 

The ruble weakened to R37.8013 against the US dollar and to R43.8880 per euro.  The price of crude oil barrels continues to remain extremely low also hitting a little over $35.  This is adding to the ruble's troubles. 

The Australian and New Zealand currencies are responding favourably to the news the US is going to use the remaining $350 billion TARP funds in the very near future in addition to starting a public works stimulus program worth approximately $850 billion give or take a billion.  Both currencies strengthened against the yen with the Aussie rising to 62.19 yen and the kiwi increasing to 50.50 yen. 

The banking system is still in an upside down box with the arrow pointing the wrong way. As the UK and the USA, two of the strongest world economies, continue to battle the economic crisis it is becoming clear the banking system needs a lot of help.  The box is still too heavy to lift right now as it remains loaded with declining house prices, increasing foreclosures, falling consumer spending, increasing business insolvencies, and lower-than-expected corporate earnings.  Hopefully the next round of stimulus packages will lighten the load.