HOW LONG WILL MARKETS STILL ACCEPT GOVERNMENTAL GUARANTEES? Battles Of The Past, Battles Of The Future

Irrespective of whether they manage emergent or developed economies, political and monetary authorities continue to fight wars of the past. Much like generals in World War I, central banks have engaged in a war of endurance fought from the trenches, against an enemy with machine guns. In an era of automatic monetary guns, the result will be similar: millions of victims will be sacrificed for nothing, in an unprecedented inflationary "barrage."

The unprecedented monetary injections have not yet taken effect on consumer prices as the wave of destruction currently grinding financial institutions has not yet climaxed. The results reported a few days ago by major international banks, such as Bank of America, Deutsche Bank or Citigroup demonstrate it.

A year and a half after the start of the financial crisis, the markets are still waiting for quarterly reports that include all the losses and a realistic evaluation of the assets. The precipitated fall of Barclays and Royal Bank of Scotland stock on the London Stock Exchange shows that only full transparency of financial reporting can restore confidence on the market. A recent analysis from the Royal Bank of Scotland, appropriately titled "Living On A Prayer," shows that "the domestic UK banks are technically insolvent on a fully marked-to-market basis."

The 130 billion GBP debt of the leading British banks, maturing in 2009, shows that a lending revival is out of question for the near future. Talks about creating a bad bank to take over the bad assets of the banking system indicate that the British Government is determined to transform banking insolvency into national bankruptcy.

In the United States, the Federal Reserve"s balance continues to grow, as bad assets have been transferred from commercial banks. William Poole, the former President of the Federal Reserve Bank of St. Louis, told MarketWatch that he was concerned with the Fed"s unrestricted lending. "In the Soviet Union and Eastern Europe during the Cold War era, economies were inefficient because they had a soft-budget constraint. If a firm got into trouble, the banking system would give them more money," Poole said, comparing the current status of the Federal Reserve to the communist-time finances. Much like then, governments are forgetting that supporting an enderprise in trouble might work on short term, but will never work for an entire economy.

The Irish Government is about to discover just that, because the 400 billion EUR guarantee issued to the banking system last autumn is showing its true value these days. The nationalization of the Anglo Irish Bank was necessary, as its default would have turned into a sovereign default. Are the markets no longer accepting even governmental guarantees issued by a country in the EuroZone?

After the financial reporting season for Q4:2008 is over, we will have to count other hundreds of billions worth of aid for the financial sector and further increase in the governments" financing requirements. The market is already displaying a worrisome trend to increase the CDS quotations for countries and to decrease them for major financial institutions.

Deutsche Bank"s Jim Reid shows that the trend to transfer the lending risk from the banks" balances to the countries" budget will continue in the predictable future. Societe Generale"s Albert Edwards is not as optimistic. His latest report includes an analysis on the leading indicators of OECD which are intended to detect trend shifts in economic activities (see chart). In Edwards" opinion, 2009 will bring a much greater shockwave to investors than 2008 because the OECD indicators are showing a rapid and total collapse of the economic growth in China.