kurt@fluke.UUCP (Kurt Guntheroth) (06/04/85)
What happens in a world banking crisis? Money disappears.
Bank A goes under, typically because a large number of loans go non-
performing. Bank A also owes banks B, C, and D money. Banks often take out
loans from one another overnignt to meet unpredictable daily demands for
cash. Banks B, C, and D don't normally look too hard at these loans because
they happen all the time. Now suddenly B, C, and D are out a bunch of
bucks. This is bad by itself, but there is also a law that banks must have
liquid reserves of 10-12% of their total deposits. (The Federal Reserve
determines the actual percent, and varies this percent to achieve social
policy; thereby "loosening" or "tightening" the money supply.) Banks B, C,
and D now have a sudden demand for cash. They borrow money to get it. Also
they call in loans, or don't give out loans, and this is the essence of the
world banking crisis. Banks are taking money out of the economy suddenly to
repair their reserves.
Now money is scarcer so the interest rates go up. Nearly-insolvent companies
needing an additional loan are confronted with higher interest rates too high
to pay, and they go under, taking with them any outstanding loans. Banks B,
C, and D, already saddles with bad debts from bank A, are under more strain,
and bank C becomes insolvent. Now the chain reaction begins. The results
are; interest rates skyrocket, companies begin to fold, first the weak ones,
but eventually even strong companies that just really needed a loan just
then. The economy is depressed, putting more pressure on remaining
companies, banks, and you and I of course.
Naturally the Fed doesn't just sit still. They try to inject cash in
critical places, try to take over bank A as it fails and operate it with
federal money to keep the chain reaction from beginning. They also audit
bank books to look for banks in trouble. However, a really big debtor can
screw up a bank suddenly by going under by surprise. The Fed doesn't really
have all that much cash to shore up banks with, and surprisingly, some of
that cash is actually siphoned off the banking system(!).
That's just a banking crisis, here's the world banking crisis. El Salvador
owes bank A money (a LOT of money). In fact El Salvador (this country
picked on only as an example, there are many such countries) owes everybody
a lot of money. Their economy is in a mess, rebels just wrecked another
power plant or factory, etc. The US dollar is too strong due to the
defecit, and leadership just doesn't know how it is going to pay off those
economic development loans. Strange thing about being a sovereign nation,
though, is that you can just say "I wont pay." Of course your credit rating
goes to hell, but for El Salvador, it already has gone. THey can't get any
more money through loans, but imagine how much there would be if they just
stop making payments. Blam goes US bank A (Lets call it Chase Manhatton).
Now all really big banks in the world loan money to each other, and have
each other's money due to international trade. Also, western countries kind
of pooled financial resources for development loans to 3rd world countries.
When a really big bank (A) folds, banks B, C, and D are in London, Amsterdam,
and Tokyo. The USSR laughs for about six months as the western economy
spirals into oblivion, and then gets very quiet when it finds it can't buy
wheat or steal computers anymore. Soon their economy is hurting too.
What is ugly is that 3rd world nations think interest rates on their
development loans are usurious and occaisionally think "Boy we could really
screw those bastards..." by not paying up. They use this as a threat "Give
us more loans or we'll default." But of course giving them more just makes
the eventual crisis worse.
--
Kurt Guntheroth
John Fluke Mfg. Co., Inc.
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