Global financial system on the precipice

This could bring an end to the system as we know it, based on fiat currencies, sooner than many of us could have imagined.

The global crisis of 2008 has not been resolved. Instead of reforming the financial services sector, regulators have piled up more printed money to arrest the price collapse. They are throwing good money after bad. Without restructuring, the banks have continued to sit on bad assets created by the bubbles over the past decade.

Credit, fuelled by money created by the central banks and the financial institutions, is the root of the cause. At the end of any credit expansion cycle lies a collapse of the financial sector, followed by the real economy, with unemployment and social unrest in that order.

Let's look at the headlines that have dominated over the past few days:

European banking crisis: The International Monetary Fund said on Wednesday that the European debt crisis is affecting its banking system to the point where banks may pull back on lending to conserve cash, which threatens to worsen growth prospects in the region. Europe's debt crisis has increased the risk exposure of banks in the region by 300 billion euros (US$413 billion) and they need to recapitalise to ensure they can weather potential losses.

The Bank of China had stopped trading forwards and swaps with several European banks, possibly including Societe Generale, Credit Agricole and BNP Paribas. The European Central Bank has loaned US$500 million to a single bank for seven days, raising further fears that a major financial institution could be in trouble.

Rating downgrade for US and Italian banks: Moody's cut the debt ratings of Bank of America, Wells Fargo & Co and Citigroup on Wednesday, saying the US government is getting less comfortable with bailing out large troubled lenders. The government is "more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled", the ratings agency said.

In short, the too-big-too-fail banks might be allowed to fail this time, reminiscent of the collapse of Lehman Brothers in 2008 that sent financial shock waves around the globe.

Standard & Poor's has followed up by saying that it has downgraded seven Italian banks because of sovereign debt risk, just a day after the agency downgraded Italy's credit rating. The cut targeted leading banks Mediobanca SpA and Intesa Sanpaolo SpA, as well as Findomestic Banca SpA, Banca IMI SpA, Banca Nazionale del Lavoro SpA, Banca Infrastrutture Innovazione e Sviluppo SpA and Cassa di Risparmio in Bologna SpA.

The agency said it was assigning negative outlooks to the long-term ratings on these seven banks.

Italy is the third largest economy in Europe after Germany and France. If Italy cannot handle its banking and sovereign debt crisis, the eurozone will be under the water due to the interlocking nature of the European banking system.

More quantitative easing from the US Federal Reserve and Bank of England: With the roiling banking crisis and economic growth downgrade, the Fed and the Bank of England will go back to the printing press. On Wednesday, the Fed said it will launch a $400 billion programme to twist its $2.85 trillion balance sheet more heavily towards longer-term securities by selling short-term government debt to purchase longer-dated Treasuries. It also said it will reinvest proceeds from maturing mortgage and housing agency bonds it holds back into the mortgage market to prop up the housing sector.

The Bank of England, which earlier implemented a $320 billion quantitative easing programme, is planning further monetary creation to stimulate a faltering UK recovery. The quantitative easing programme was halted in December 2009 after 200 billion pounds ($320 billion) had been splashed out buying financial assets from banks.

With the eroding of confidence in the global financial markets, investors will further seek safe havens in commodities and other hard assets. We are dangerously entering a period of runaway inflation created by monetary inflation at the hands of the Fed and other western central banks, which have adopted a too-big-to-fail bank policy so far.

Thailand is also starting to feel the pinch. Many shippers have warned that buyers from Europe have delayed purchase of Thai manufactured goods as a result of the economic crisis. The Thai export sector, which posted strong growth in the first seven months of this year, will take a beating in the final quarter of this year, similar to the crisis of 2008 when the financial chaos caused a sudden collapse in global demand.