Is the sky falling? I think you know what I mean. Yesterday JP Morgan Chase and Co announced plans to buy Bear Stearns a once hot (fifth largest in the US) investment bank for $240 million US. Bear Stearns last year was worth $22 billion US. JP, with backing by the American government was seen saving the day. Meanwhile stocks jittered, the US dollar tanked, ditto for the loonie, commodities plummeted and there was a hint of a run on the banks.
For those of you tired reading about this, I offer you another view. Think of it this way. Imagine you are in a boat in the Atlantic Ocean. Maybe you have a few friends with you. The boat springs a leak late last year as you are rowing into shore. You and all your mates start bailing water, trying to keep the boat a float as you look toward the shore. Miraculously, it works but the current changes and you are blown away from shore. Leaks spring up again and you keep bailing. You get closer to shore but then the current changes again.
Around you are other boats with the same problems. There are even bigger boats that are leaking as they lurch toward shore. The current changes again. More leaks are patched. Everybody is still alive, but you’re growing tired. Patching those leaks seems to be a never-ending process. You all hope you have the stamina to keep it up. As of this moment you see shore, but still you just can’t get there.
That’s what’s going on but put the US Federal Reserve and the American government is in the leak fixing business. It’s pretty serious business when a large American bank fails and that is essentially what was avoided over the weekend as Bear Stearns was “bailed out” by the US government in the conduit of JP Morgan. Today, as I write this, the US Federal Reserve is set to cut American interest rates down a full 100 basis points.
What’s this mean? Simply put, it’s again, a Hail Mary all hands on deck emergency move to plug all the leaky boats. The danger of course is that at a certain point the US Federal Reserve and the American government will run out of ways of fixing the leaky boats. For instance how much more can American interest rates be cut? If the US Federal Reserve cuts their lending rate to American banks, it’ll be 2%. Yes, it’s a great stimulus to the American economy but at a certain point they are going to lose their leverage to stimulate and cut interest rates again. There is only so far to go before you reach zero and borrowing money is “free and easy”. Inflation will rocket up like it’s the Space shuttle.
To make it even more succinct, this time “THE BOATS MIGHT SINK!” In my career except for 9/11 I have never seen anything like this. If you’ve read my past two columns, yes its capitalism run amok, yes, it is crazy times. However, the events of the last week have had a much more ominous overtone.
Thankfully in Canada we’re much better off. For instance we have fewer banks, which on a good day is a bad thing, but in this current situation is a good thing. We are rich in commodities, which are a tangible, genuine thing, which has real value. Our federal and provincial government’s debt has been lowered with both governments running a surplus. Our personal level of debt per capita is much lower than our American counterparts and our housing market has not collapsed like much of the American market. In short, our boat is pretty sturdy.
However, all those leaky American boats are causing a lot of bad economic waves lapping up on our shores. That cannot be discounted. Eastern Canada is being hit hard by an American economy, which is reeling. Even the loonie got swiped last Monday on a day when the US greenback reached record lows. In normal times, it would have soared. In Canada the economic activity generated by our relationship with our American friends is clearly at risk. If you weren’t hanging on to your wallet after last week’s column, this week you’re probably looking for a chain to attach it to your pants.
That however, this time around won’t help. The current American economic meltdown has the capacity to melt down a tremendous amount of wealth. It’s disappearing from those Canadian wallets as I write. The good news is all those boats are still a float. The bad news is they continue to leak badly and the American government and the US Federal Reserve are running out of options.