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The recent news about anti-Chinese riots in Xinjiang follow those in Tibet in 2008 and have similar causes. Xinjiang is in the far west of China. It should be seen as part of the wider Chinese Empire rather than an integral part of China. Its population was originally Uigher, a Central Asian people who are mostly Muslim, in contrast to the bulk of the Chinese population who are Han. It was originally occupied by China under the Ching Dynasty as a means of protecting China from incursions by the Central Asian tribes. It was essentially a buffer between China and the very real threats at the time from Central Asia, particularly from the Mongol tribes. However, in recent times the Chinese government has been persuading Han people with incentives and subsidies to migrate to Xinjiang and other parts of China’s western empire. The scale of migration has been such that the Uighers like the Tibetans are now a minority in their own lands. Full-scale Sinification of these provinces is the aim of China’s “West” Policy. While there can be no doubt that China has brought much needed infrastructural development to the “West”, the process of sinification has been of great detriment to the Uigher’s culture. As in Tibet in 2008, there is now a revolt against this sinification policy. This why the attacks have not just been on the visible signs of Chinese authority, particularly the police and government officials, but also on the Han population. The Han migrations are seen as a policy of ethnic cleansing. While the Chinese authorities can probably put this revolt down, the simmering discontent will continue and the repression of the Uighers intensify.

The 50th Anniversary of the flight of the Dalai Lama from Tibet, gives us cause to reflect on the outrageous claims made by China to justify their annexation of Tibet. China claims that Tibet has been part of China since the 13th Century. This is untrue. The reality is that China was invaded by the Mongols in the 13th Century and it became part of the latter’s extensive empire. Far from Tibet becoming part of China, Tibet was part of the Mongol Confederacy, which conquered China. When the peasant uprising that expelled the Mongols consolidated itself and became the Ming Dynasty in 1368, Tibet ceased to be part of China, as even the most cursory glance at maps of the time would show, and was never part of China throughout the Ming period (1368-1644). In 1750, the Ching Dynasty managed to make Tibet a protectorate after 30 years of skirmishes. However, this did not last long as China ability to exert power at distance declined in the 19th Century. During the Second World War, China maintained a legation in the Tibetan capital, Lhasa, which was now in the British sphere of influence. China gained control of Tibet by invasion in 1952.

What is true is that part of the wider Tibetan cultural region, as opposed to the political region centred on Lhasa, in Qinghai, Sichuan, Gansu and Yunnan have been part of China for some time. However, the claim to Tibet, the political entity, is based upon a three card trick. Some parts of Tibet have been part of China for some time, therefore, it is all part of China.

Why the international community lets China get away with these monstrous claims beggars belief.

For the last year, and more intensively in the last six months, governments and central banks have been pouring money into the banking system. However, despite the massive liquidity this has created within the banking system, banks are still reluctant to lend. This latter has created a credit crunch wherein borrowing even for the best of customers has become increasingly difficult. Why have we got this contradiction of banks flush with money but unwilling to lend?

There are two reasons. The first is that the problem for the banks is not liquidity but technical insolvency. The crisis has wiped out most of their capital. In reality, the only capital many banks have is the money pumped in by governments. Thus, banks are retaining as much liquidity as they can against any calls from depositors and, knowing the extent of bad and doubtful debts in their books, both real and potential, have become so risk averse that they will not lend even to each other.

The second reason is in the changing structure of bank balance sheets. In the old days, banks took deposits and loaned them to clients. Deposits from clients made up more than 90% of the banks liabilities, effectively the money they had to lend to customers. This is no longer so. Deposits now make up no more than 40-50% of bank liabilities with a similar amount coming from loans from other banks and financial institutions. This change has come about for three principal reasons.

First, there is increasing competition for savings from ther financial institutions with highly competitive products: superannuation funds, mutual funds, insurance bonds and many others.

Second in order to increase the size of their balance sheets and market share, they have increasingly borrowed money from banks and these other financial institutions. This had become increasingly easy as more and more banks sought to internationalise their operations, moving from being domestic banks to become international banks a part of the overall process of globalisation. However, establishing foreign branches, even if the parent bank had large amounts of money it wished to lend, did not lead easily to creating a client base. The domestic banks with their widespread branch systems held most of the best clients and prising them away was difficult. Many international banks found that lending to domestic banks and other financial institutions became the largest part of their business. Thus, another need for banks to maintain high levels of liquidity. They need these high levels as a hedge against any calls from their bank creditors. With most of the global banking system in trouble, calls for repayment became more likely.  

Left to the market, the credit crunch is likely to continue, which is why governments are increasingly coming to the conclusion that they will be forced to intervene directly. Expect more outright and semi bank nationalisations and other direct policy interventions.

This week’s Israeli election highlights the daunting problems facing the Obama Administration if it wishes to bring the “Peace Process” closer to an acceptable solution for all parties involved. We are continually faced with an analysis biased towards seeing the Palestinians as the major obstacle to any settlement. Their fracured politics means that the Israelis can continue to claim that “they have no credible partner for peace”. Mahmoud Abbas’ Fatah Administration in the West Bank cannot control Hamas in Gaza and, after the recent conflict in Gaza, has almost certainly lost support because of its lack of response to the plight of the Gazans. Hamas refuses to recognise Israel’s “right to exist” and continues to wage a low-level war of home made rockets against Israeli towns in the south. How can Israel negotiate in these circumstances?

This week’s election demonstrates, just as clearly, that the problems on the Israeli side are as bad if not worse. Israel’s system of strict proportional representation has delivered a result making it almost ungovernable. No party has gained even 25% of the vote meaning that any coalition put together from these fractious parties is going to include at least four of them, each requiring its own particular polices and constituency to be acknowledged and catered for. Even an unlikely  “grand coalition” including the two largest parties, Kadima and Likud, would require at least one further party to give it a thin majority in the Knesset.  Any dispute among the coalition parties could lead to withdrawal of support and the fall of the government at any time. Any coalition is unlikely to survive for long. Given the diversity of views on such matters as borders, settlements in the West Bank, the Golan Heights, what to do about Hamas and now even the status of Israel’s Arab citizens, any negotiations on a “two-state solution” acceptable to the Palestinians, and hopefully to the international community, are unlikely to get far.

The upshot is that the Israeli- Palestinian dispute is likely to remain at an impasse and a festering sore on all attempts to stabilise the Middle East region while more conflict in Gaza and posibly with Lebanon beckons. Does it now need to be acknowledged that the parties are incapable of resolving the conflict and that the international community needs to think about imposing a solution as fair as possible to both sides. To go back to the future, and to quote the remark made by George Ball back in the late 1970s, is the problem for Israel’s friends in the international community “how to save Israel in spite of itself”.

A Minsky Moment

Noel Tracy
Associate Professor in Political and International Studies
Flinders University

Paper delivered at the International Workshop on the Sub-prime Mortgage Crisis, Adelaide, 16th May 2008

Why do I describe the onset of the current crisis in the Sub-prime Mortgage market, or more accurately originating in the securitization of that market, as a “Minsky Moment”? Minsky had always seen the origin of financial crises in the fragility of the credit system. As the economy grows strongly, a “bubble” develops in the property or stock market or both from exuberance regarding the prospects for substantial gains in asset values. Both the growth of the economy and the “bubble” are financed by rapidly increasing growth in credit. As credit is increasingly used to finance this speculation, assets are frequently pledged to obtain further credit for more purchases of similar assets. As a result, a debt mountain grows backed by these “bubble”- valued assets as collateral. Two things become unsustainable – the “bubble” and the debt mountain .

Suddenly in response to either fears in the market that the “bubble” has peaked or some shock to the system – like a major default – the market turns into a tailspin. Suddenly everyone is in trouble. The exuberance and euphoria of the “bubble” now turn into revulsion. What had been a sellers’ market now turns into a buyers’ market but with few buyers despite the bargains available. Owners of assets must sell to cut their losses sending the market down still further. Many investors now have negative equity or face margin calls that they cannot meet. While the client borrowers are in deep trouble, it is the banks, which face the deepest crisis. Having loaned irresponsibly, they are now left holding collateral worth less than the loans advanced against them. Many of their clients will not be able to advance funds to cover the difference while those with negative equity in the assets will be tempted to walk away and let the bank deal with the problem by repossessing the asset, be it a residence, an investment property or shares. The banks are now filled with bad and doubtful debts. In severe crises, these may well exceed the capital of the banks making them technically insolvent. Banks now need more capital. Banks, which previously had been anxious to lend are now desperate to get money back into the bank to cover these losses and avoid bankruptcy or, even if that is not a genuine risk, to avoid making new calls for capital to their shareholders. Even those still solvent now turn risk averse. Credit is now at a premium. Even the best corporations cannot borrow on favourable terms. Loans that they had assumed could be rolled over are called in. Soon we have a credit crunch and the economy is heading for recession.

While there are a number of new factors in the current crisis the overall picture is the same. This is the latest in a long line of financial crises produced by irresponsible lending and borrowing – The Third World Debt Crisis  of the early 1980s, the Global Stock Market Crash of 1987, the Japanese Meltdown of 1990-91 with a second round in 1997-98, the Asian Financial Crash of 1997-99, the Dot.Com Crash of 2001 – in which “bubbles” financed by the growth of debt mountains burst and threatened the global financial system with meltdown. In all of these crises, including the current one, the management of risk in the financial system has been nothing short of disastrous while the regulation of the financial sector has been found wanting.

What is interesting about all these crises is that despite all the talk about “the efficiency of market mechanisms”, these have never been able or permitted to resolve any of these crises. It has always been governments, central banks and international financial institutions that have had to pick up the pieces to prevent major bankruptcies among the leading international banks and likely resultant global financial panic. The market solution to insolvency is bankruptcy but while this can be allowed to occur for the small players, it is too dangerous to permit it to occur for major banks. Thus “bailouts” on generous terms have been, are and will be the norm. Where even these measures fail, as in the UK with Northern Rock, failed banks will be taken into public ownership. This is already happening on a gigantic scale in the current crisis. Central banks have pumped vast amounts of new money into the system to boost liquidity. Interest rates have been lowered in the United States to a point where money for the banks is free. Major banks have had to sell large amounts of preferential stock to re-capitalize their depleted treasuries, most of it to “sovereign funds” from China, the Gulf States and Singapore.

Why is there a credit crunch despite all the injections of new money into the system? The problem for the banks is not liquidity, it is insolvency. Were the banks to be forced to revalue their assets to realistic levels based upon realisable value, many, including some of the largest global players, would face bankruptcy. Thus they must keep the new money in the bank. The liquidity crisis will continue.

This adds an additional problem. Despite the substantial liquidity pumped into the financial system by Central Banks, banks are unwilling even to lend to each other – the inter-bank market has dried up. Given their knowledge about their own dubious assets, they fear other banks are an equally poor risk because they may have a similar exposure or worse. The system is grinding to a halt.

While the underlining fundamentals of this crisis are not much different from those of past crises and easily fit into the Minsky model, there are some new elements. This is the first crisis engendered by the brave new world of securitization. This time the “investment euphoria” has been in the dubious paper of securitized sub-prime mortgages backed by an “ever rising” real estate market. It is also the first crisis with its roots in the “over-the counter” market. This latter has had a poisonous impact on the overall securities market. Transactions in this “market” now far exceed those on the world’s stock exchanges. Unlike the stock market, where securities can be instantly valued and where the causes of rises and falls can be identified in the actions of known buyers and sellers, there is no such system of clear valuation nor of buyers and sellers of the securities traded on the “over-the counter” market. It is opaque in the extreme and almost totally unregulated. Thus, valuing bank assets, and those of other financial institutions, has become more difficult and, therefore, quantifying the extent of losses much more difficult.

The danger, given the difficulties of valuing and the extent of these assets in their balance sheets, is that banks will be tempted to avoid writing off the losses from these now near worthless securities. This is the situation, which occurred in Japan after the crash of 1990-91, when the banks hid their losses. The result of those disastrous decisions was to produce decade-long stagnation in the Japanese economy. Banks exposed to these risks, must be forced to face up to the extent of their losses, write these off and seek new capital if this outcome is to be avoided.

While the more optimistic commentators are suggesting the worst is over, the last word should perhaps be left to the IMF. In its Global Stability Report released in April 2008, it suggests total losses from the crisis will reach US$1trillion. If this is true, and the evidence tends to suggest it is, the worst is still to come and the question is how far the financial crisis will drag the rest of the US and global economy down.

Tracy/A Minsky Moment/May 2008

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