Why blog about something as banal as a US recession when you can blog about
a fully-blown financial crisis? Barry Eichengreen stays solidly in the
realm of the hypothetical when he explains why any country’s attempt to
leave the euro would result in "the mother of all financial crises".
He does mention Italy by name; he does not mention that Nouriel Roubini, last
year, was already writing
that "Italy may end up like Argentina" and end up exiting the euro
within five years.
But Roubini has moved on from Italy and the euro, if not from crisis-blogging:
he’s now talking about the risk of a "systemic
financial meltdown".
I now see the risk of a severe and worsening liquidity and credit crunch
leading to a generalized meltdown of the financial system of a severity and
magnitude like we have never observed before. In this extreme scenario whose
likelihood is increasing we could see a generalized run on some banks; and
runs on a couple of weaker (non-bank) broker dealers that may go bankrupt
with severe and systemic ripple effects on a mass of highly leveraged derivative
instruments that will lead to a seizure of the derivatives markets (think
of LTCM to the power of three); a collapse of the ABCP market and a disorderly
collapse of the SIVs and conduits; massive losses on money market funds with
a run on both those sponsored by banks and those not sponsored by banks…
Trust me, the list goes on.
What to do in the face of such doomsaying? A systemic financial crisis of the
kind glossed by Eichengreen and Roubini is by its very nature almost unhedgeable.
I suppose you could convert all your assets to gold, make a Jim Rogers-style
long-term secular bet on the Decline of Western Civilization, learn Chinese,
and move to Shanghai. Although that’s not really a hedge, since you’re basically
taking off your long position entirely rather than just trying to protect yourself
against a decline in its value. And besides, there’s bound to be a good chance
that you’ll end up feeling as foolish as those people who sold everything and
moved to the mountains loaded up with guns and water in the run-up to Y2K.
For what it’s worth, I don’t see a big bank-run happening, not in the US, if
only because there’s nowhere for people to put their money once they’ve removed
it from the bank. In much of Europe and Latin America it’s common to have offshore
bank accounts; in the US, by contrast, it’s extremely rare, partly because you
have to pay taxes on your global income in any event. This is weirdly where
fiat money comes into its own: because the dollar isn’t backed by anything,
it’s hard to exit the dollar as an asset class.
A system-wide financial crisis isn’t impossible, of course: almost nothing
is impossible. Almost any financial downturn, taken to its logical conclusion,
can become a crisis. But in practice, in the developed world, that doesn’t seem
to happen.