The recent global financial crisis and the resultant great recession really shook the world. The reasons for the crisis vary, depending on who you ask. However, some favourites can be identified.

The blame game

A sure front-runner in the blame game is insufficient regulations on financial institutions. The fact however is that financial institutions have never been as tightly regulated and yet politicians and other non-financial role-players continue to call for yet more regulation, especially on financial intermediaries. President Obama has just signed a bill to regulate banks more effectively and more and more regulations are sure to follow. This will add to the cost of financial transactions; costs that will eventually be passed on to the clients, which includes you of course. The truth is that more regulations and the associated costs are unlikely to guarantee that a financial crisis will be averted in future.

Greed has also been blamed for the world’s economic woes. On closer inspection however, greed is clearly not the real problem. Greed, within the set norms and laws of a society, simply refers to the best allocation of resources. A greedy businessman allocates his available resources as best he can for his own benefit, and that of the wider society. From this point of view, the exact opposite of greed is waste, a far more likely reason for our current economic challenges.

While speculators have also been targeted as causing global financial collapse, they are merely messengers who point out misalignment in financial markets. Those speculators who are right in their assessments can potentially benefit handsomely and those who are wrong often lose their shirts. Actually, to blame speculators is like blaming the mirror for your ugly face.

Artificial wealth

Forget the above excuses; the real reason for the greatest recession in 70 years lies largely within the structure of economic policy and the authorities were mostly to blame!

For a long time before the financial crisis, interest rates, as set by the world’s central banks, were exceptionally accommodating (read: low). Low interest rates artificially stimulated the average American (and European and South African) to borrow more and more in order to maintain elevated living standards, which included buying houses. Although people lived with massive amounts of debt that would be hard to repay, it wasn’t considered a problem because much of this debt was tied up in fixed property (houses), which is considered to grow its value over time. In fact, rising house prices fuelled demand which, in turn, fuelled further property price increases. Low interest rates contributed to a property bubble.

Government guarantees

Another mistake was the unintended consequence coming from the American policy to assist sub-prime lenders to buy their own houses. Financial institutions, like Freddie Mac and Fannie May, were specifically created for this purpose. These loans were government guaranteed and handed out simply on the assumption that house prices never fall. By the time the housing bubble burst and debtors defaulted on their loans, these mortgages were already so deeply entrenched in global financial derivatives that the dominoes started falling one by one.

In a nutshell, the financial crisis was created by too low interest rates and the encouragement of people, who could least afford it, to buy houses.

Surviving the cycle

So how is the global environment (mostly America, Europe and to a lesser degree other countries like South Africa) dealing with the recession? It does what it always does… make use of quantitive easing (essentially the printing of money), cutting interest rates to close to zero and governments borrow massive amounts of money to assist the GMs and Fords of the day.

In short, monetary policy is exceptionally accommodating to lure borrowers back, while governments step in to do the borrowing when the private sector is reluctant to go on another borrowing spree.

Scenario planning

These steps are likely to eventually lead to a weaker dollar and Euro, something which has already happened in relation to the gold price for instance. Another likely driving force in the world is the revaluation of the Chinese currency, the Renminbi. Over the past few years market and political pressure has been mounting on the Chinese government to appreciate its very competitive currency. This year, the Chinese authorities announced that the Renminbi will be allowed to swerve in a 5% band around its pegged value. This wasn’t really a revaluation as much as it was an attempt to release some of the growing political pressure on China to strengthen its currency.

The above drivers could lead to the following possible scenario. A weaker Euro and Dollar combined with a stronger Renminbi, which is likely to lead to an increase in commodity prices. In the short term, these factors could support the Rand, something South African exporters fear. South Africa’s strong rand has been under a lot of scrutiny this year and there have been several calls to weaken it.

Even though it might be possible it will be very expensive and, in the longer term, lead to inflation which will erode away the benefits of the Rand’s competitiveness. This is a scenario that has to be thought through very carefully before any strategic policy decisions can be made.