Untested Solutions

The magnitude of the global financial crisis may be such that only the earth’s geological history can provide an adequate metaphor for comparison. What happened in Wall Street last September was the financial equivalent of the gigantic asteroid strike that ended the reign of dinosaurs on the planet. This analogy may not be as far-fetched as it seems. The effort of G20 leaders trying to save the planet’s economy might be prefiguring the type of solutions scientists are talking about to prevent global warming.

Some 65 million years ago, a giant asteroid struck off the coast of Mexico’s Yucatan peninsula with such force that the carbon deep in the earth’s crust liquefied, and was hurled into the sky, forming tiny airborne beads that blanketed the planet. These beads prevented sunlight from reaching the earth for months, killing the planet’s vegetation along with the life forms dependent on it.

The banking crisis that cratered Wall Street last year can be seen to have done something similar in the financial world. It felled some behemoths such as Bear Stearns and Lehman Brothers, and from the ruins of toxic subprime mortgages and the detritus of insolvent banks were hurled into the economic biosphere. Like the carbon particles of prehistoric times, the miasma spread by the banking collapse has blocked the sunlight of credit, the primary supply of ‘energy’ for businesses. In the first three months of this year, syndicated loans from banks have fallen by 61 per cent. Fear about the future has stricken economic activities that were not necessarily affected by Wall Street’s travails.

Although no hard data is yet available to assess the impact on businesses of diminishing credit, a joint survey by the IMF and the Bankers’ Association for Finance and Trade provides some early indications. It shows that more than 70 per cent of respondents believe prices of various types of letters of credit have risen. About 90 per cent of banks report increased prices of both short and medium-term lending facilities, in which the goods being traded serve as collateral. More than 90 per cent of banks in advanced economies and 70 per cent in emerging markets report they have changed lending criteria for trade transaction. Falling demand has precipitated a sharp decline in industrial output. Japanese exports have dropped nearly 50 per cent since the crisis broke. The high cost of letter of credit has hurt Asia’s suppliers of low-margin products to the global supply chains. China’s February exports dropped 26 per cent compared to the same month last year.

Afraid of being left with unsold inventories amid an avalanche of pink slips and evaporating consumer demand, businesses are slashing production, and retailers have cut orders or shuttered stores. The net result of the shroud of toxic assets and debris covering the planet has been a collapse in global demand, which, according to the World Bank, will drive export volumes down by roughly 9 per cent in 2009.

Faced with an asphyxiating world economy, the G20 has taken steps that can be compared to desperate measures climatologists talk about in their plans to reverse global warming caused by greenhouse gases. Like those scientists that have proposed geo-engineering to filter sunlight reaching the planet, the London summit has sought to bring about the reverse effect by blasting holes in the choking shroud of toxic clouds to let in the sun rays of credit and confidence.

The G20 has agreed upon a package to provide $250 billion for trade finance over two years. They hope that blockage of trade caused by cash flow shortages can be alleviated by providing access to cheap short-term finance. In total, they have pledged $1.1 trillion to restore credit and growth in the world economy. Is it likely to succeed?

Scientists have talked about countering global warming through geo-engineering (the deliberate change of the earth’s climate) by scattering incoming solar energy with spraying chemicals in stratosphere. Like such untested solutions, the G20’s plan to create supercharged beams of light to cut through the toxic miasma remains a dubious proposition. As long as zombie banks are not laid to rest, and balance sheets of other banks and financial institutions are not restored to health, there will be little confidence about a recovery that could encourage factories to resume production or retailers to place orders. Maybe the outlook will be clearer after some of the banking and finance dinosaurs disappear and toxicity is sucked out of the air.