This week, Britain and, because of its financial weight, the rest of the world were in a lot of financial trouble. It's hard to say how bad it was. We were only a few inches aw...
This week, Britain and, because of its financial weight, the rest of the world were in a lot of financial trouble. It's hard to say how bad it was.
We were only a few inches away from a "global financial crisis mark 2." This is not an exaggeration.
By the end of 2008, it was clear that many investment banks on Wall Street were about to fail.
They were sitting on worthless assets worth tens of billions of dollars, such as mortgage-backed securities tied to properties whose prices were going down.
When the US government let Lehman Brothers fail, it caused a credit crunch. It had a lot of these things that weren't worth anything.
Suddenly, it became hard to tell who could pay back loans and who couldn't.
We just came close to a situation of a similar size.
The problem is that the flirting is still going on.
Liz Truss, who replaced Boris Johnson as British prime minister, took over a country that was on the verge of a long, deep recession.
Last week, Truss gave a "mini-budget" that included a lot more spending by the government and the biggest package of tax cuts in 50 years. These were meant to help the economy.
Excellent, right? No, not really. The financial markets asked the obvious question, "How are you going to pay for this?" since the UK's budget deficit (or net borrowing) is already in the hundreds of billions of pounds.
The BBC said that after the mini-budget was passed, conservative MPs were walking around "in shock."
The last thing the money markets did was give the fiscal package a vote of "no confidence." The market for bonds "sold off." On the fixed income market, the prices of bonds fell sharply.
When bond prices go down, yields go up. It's not really important to understand how the bond market works, but it is important to get to the next point.
That is, for Britain's pension plan to work or stay in business, interest rates can't go up too quickly and too high. But that's exactly what happened.
The pension funds were unable to pay out pensions because their investments were losing too much money.
To stop this, the Bank of England stepped in and bought a huge number of bonds, which drove up the price of bonds and lowered their interest rates.
"To do this, starting September 28, the Bank will buy long-term UK government bonds for a short time. The goal of these purchases is to bring order back to the market "said the Bank of England.
"The purchases will be made in whatever amounts are needed to reach this goal. HM Treasury will cover all of the costs of the operation."
But here's the line that really makes the story.
"The UK's financial stability would be at risk if this market's problems kept getting worse or stayed the same."
Henry Jennings, a former trader in London City, says that what the Bank of England was saying was that these pension funds could face margin calls if the bond market moved violently against them.
Trade With Trustworthy Broker
That is, a lot of funds borrowed money in order to make more money. They took on a lot of debt to increase their profits.
They would soon have to "pay up."
If they had been asked to pay, they would have had to sell their assets. This, he says, would have caused a "death spiral" in the financial markets.
Jennings thought that the amount of assets being sold around the world would have caused a "confidence crisis" around the world.
Problem not going anywhere any time soon
The Bank of England can only do so much to help save Britain's pension plans.
The BofE said that people will only be able to buy these bonds for a certain amount of time. "They are meant to solve a certain problem in the market for long-term government bonds. From now until October 14, there will be auctions."
So, what happens if they stop buying gilts, which are also called British bonds?
The head of economics at the National Australia Bank says that the factors that pushed Britain's financial system to the edge of collapse are still in place.
Alan Oster says, "The markets are starting to worry a little bit."
He says that Britain's interest rates will keep going up, and they may do so quickly in the coming months.
"The markets are talking, and it's scary because they're starting from a cash rate of about 2% and talking about raising interest rates by 1.25 or 1.5% at the next Bank of England meeting."
"It's crazy, and the pound is, of course, getting killed."
In other words, the problem that the pension fund scheme is trying to solve is likely to come back.
It's serious stuff
So, let's just take a moment to stop and check, because this is heavy stuff.
The UK is still at risk of a financial crisis because a major investment scheme is still vulnerable to a bond market that is still at risk of falling because of the UK's economic problems (in part created by a dire mini-budget).
All of this can be seen in the recent fall of the pound.
Analysts say that a financial crisis in the UK would send the world economy into a free fall.
No, it's not.
The Australian dollar is nearing two-year lows against the US dollar, and the stock market is down 15% from peak to trough.
We're getting closer to a share "bear market."
This has obvious implications for those who are in or nearing retirement.
A global financial system destabilization, on the other hand, would produce the same shock waves as in 2008 and 2009.
It results in increased unemployment and a recession.
The issue this time is that the Australian government, as well as the Reserve Bank, are unable to engage in extraordinary economic stimulus measures.
So far everything seems good
However, it appears that the majority of Australians currently have the financial means to carry on in a relatively normal manner.
According to Retail Trade figures released earlier this week by the Australian Bureau of Statistics, Australian retail turnover increased by 0.6% in August.
The August increase was the eighth in a row, following a 1.3% increase in July and a 0.2% increase in June.
"This month's increase was driven by a combined increase in food-related industries, with cafes, restaurants, and takeaway food services up 1.3% and food retailing up 1.1%," said Ben Dorber, ABS head of retail statistics.
According to NAB chief economist Alan Oster, the dark cost-of-living clouds looming over millions of Australians are "being balanced by people saying, 'well, I'm not going to lose my job.'"
"The economy is doing fantastically well."
But, and this is a big but, he warns, "the next four weeks will be interesting."
That's a reference to the fact that the majority of the Reserve Bank's already-announced interest rate hikes will be reflected in bank accounts over the next few months.
Most observers are unsure how this would harm the Australian economy.
However, work is already being done to put policymakers in a better position to make the right decisions when it comes to pulling the levers.
For example, the ABS now provides monthly inflation or cost of living data.
The first monthly Consumer Price Index (CPI) indicator increased 7.0 percent year on year to July and 6.8 percent year on year to August.
In the year to August, the largest contributors were new dwelling construction (20.7%) and automotive fuel (15.0%).
The Reserve Bank is now in a better, or more timely, position to see how its policy tightening is influencing economic prices.
In practice, this is intended to keep interest rates from rising too far.
The RBA will meet on Tuesday.
At the moment, whether the bank raises its cash rate target by 0.25 or 0.5 percentage points is a coin toss.
Naturally, the question with any major financial event is, "Do I need to worry about this?"
The answer is that you must continue to follow this story.
According to AMP's chief economist, Shane Oliver, while the Bank of England's short-term effort to bring the UK financial system back from the brink of collapse was successful, the country's financial system is set to go right back there again soon.
"The Bank of England's intervention to calm the gilt market (which was threatening financial problems for UK pension funds) by buying bonds (i.e. restarting QE) has helped calm things - directly in the UK and indirectly elsewhere by demonstrating that authorities will still intervene in a crisis," said Dr Oliver.
Read More From ForexIntels:
"Unfortunately, the return to QE [bond buying] may simply add to inflationary pressures if it is sustained for an extended period of time, which may necessitate an even higher interest rate hike when the BoE next meets in early November, with many expecting a 1.25 percent hike, leaving the BoE in the absurd position of easing and tightening at the same time."
So the options are for the Bank of England to continue rescuing the UK financial system, risking exacerbating inflation and leading to much higher interest rates, or for the market to take over, risking a full-fledged financial crisis when the bond market collapses again.
Australia appears to be in a reasonable position to deal with a financial shock right now, but it's unclear whether that will be the case in a few weeks.
There are still significant risks.
Printing trillions of dollars of money to support the global economy during the pandemic was always risky.
As things stand, we cannot remove that economic support without causing the entire system to collapse, but we must do so before we cause even more economic problems.
It's an extremely uncomfortable situation.