TCA Srinivasa-Raghavan: Panic quelled, now rebuild trust

LINE & LENGTH

Central banks have won the first round in the current crisis. They have successfully prevented panic.

The pursuit of distant and difficult objectives, whether large scores in cricket or a long desert trek or climbing high mountains, that is, the probability of sighting the proverbial light at the end of tunnel draws three types of responses. One is of resigned hopelessness and giving up; another is of naïve optimism and remaining unprepared for the worst; and the third is of plodding on steadily towards the target without wondering about whether you will ever get there. In cricket it is called playing it ball by ball, over by over, session by session.

The ongoing crisis in the Western financial world is similar and has attracted all three responses, with the first category in a clear, if not yet quite overwhelming, majority. These pessimists have also been shouting the loudest, thus attracting the most attention. They have in their ranks speculators posing as wise men who claim that they had, as it were, told you so. There is schadenfreude amongst some and greed amongst the rest. The second category, the optimists, is also out there but their numbers are dwindling rapidly as it must when so much news keeps on coming in. However, it is the third type that matters most. They do what needs to be done by making small adjustments from time to time and plodding on, never giving up.

The world's central banks fall in this last category. Ignoring most of the accompanying running commentary from the first category, they have been doing what needs to be done by continually making the small adjustments that any plodder makes. To understand just how successful they have been "" and believe me, this is success on a scale never witnessed before "" you have to appreciate how well they have prevented the worst of all possible things, panic.

It is common knowledge that the first task of anyone charged with disaster management is to prevent panic because panic causes more damage than the actual problem itself. Those who prevent panic usually win in the end, and central banks, in my view at least, have succeeded in keeping things calm. There is worry, yes, concern, too; but panic? If you claim you see it, you are lying, like the chap who cries fire.

Underlying any financial crisis is the fear of not getting paid what you are owed. If this fear is not allayed quickly and persistently, you get panic. And there is only one way to ensure that debts are paid off "" you make enough cash available to those debtors who are basically ok. This is the most important lesson of all the financial crises so far "" and we have had about 2,000 years of them.

If any further proof were needed that panic prevention needs a flood of money, it came during the Asian crisis. A chap having a heart attack needs more oxygen, not less. The half-wits at the IMF choked off the money to Asia in 1998 and hugely worsened the problem. Thankfully, that has not happened this time, and even if we attribute racial motives, everyone is better off for it, motives be damned.

There were always two aspects to the crisis. The main threat was to financial stability, that is, the threat that the international payments system would collapse as banks went under. The other, lesser threat, was to get credit going again. Now that the stability of the global financial system has been preserved "" without it, the payments system would have collapsed and that would have been catastrophic "" the next step has to be to rebuild trust, after which credit will slowly start to be extended again. This needs the rotten eggs to be taken out of the basket, in exactly the same way as a surgeon cuts out the diseased parts of your body.

This too requires expert intervention, and people who say that the job is best left to the markets are like captains who rely excessively on pinch-hitters. Pinch-hitting succeeds only about 5 per cent of the time. For the remaining 95 per cent, you need solid skill and judgement, and however much you may hate central banks, it is they who have the collective experience and power.

The fact that panic was prevented will, by itself, go a long way in reinstating trust. I think we will see the patient out of the ICU and back in the ward by the end of June. Credit will start flowing "" slowly of course "" after that. By the end of this year, the crisis will be a thing of the past, with recovery having begun by about October or early November.

What is the key lesson, though, of this crisis? It is that the most sophisticated of financial systems can be brought to its knees by fraud that generates mistrust. The benefit of the current system "" the diversification of risk "" has now turned into its biggest drawback because mistrust has also gone system-wide. So much, then, for the votaries of blind financial liberalisation. They blindly assume that everyone is honest. That is the one assumption that central banks don't make. Thank god.