That’s not all. The Chinese and other emerging countries do not mind seeing the value of their dollar holdings in the US depreciate day after day as the prodigious appetite of the US consumer widens its current account deficit and erodes the value of its currency. In spite of an imploding US banking system and a crumbling economy, the Chinese enthusiasm for US treasury bills shows no signs of flagging. The US may be at the dead centre of a financial earthquake, the rot at the heart of its financial system may have been completely exposed, yet guess what happens when investors panic—they rush to the dollar as a safe haven! Kafka would have been proud to have written this script.

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But this goes way beyond Kafka. For bankers are not content merely to make billions by lending to consumers. They need new ways of making even more money. So they threw away the age-old relationship between a banker and his customer and converted the loan into a product, to be cut up, packaged and sold. But even that was not good enough. And so they invented derivatives. Sure, they are hedging tools. But no dealer at a bank treasury earned his million-dollar bonus merely by hedging underlying transactions. No, to do that you needed to convert your bank’s treasury into a casino. So they created derivatives on all sorts of products, from loans to interest rates and currencies, the only common feature among them being that they were all leveraged.

Eric Fishwick, head of economic research at CLSA Asia Pacific Markets, likens the financial system to an inverted pyramid. At the bottom of the pyramid is “power money" or money created by the central banks. That accounts for 7% of world gross domestic product, or GDP, and 1% of global liquidity. Then we have money created by the banks, which is equal to about 80% of world GDP and 6% of global liquidity. Then we have all the securitized products, equal to 145% of world GDP and accounting for 12% of liquidity. And finally, right on top of this tottering pyramid, we have derivatives, which together make up 976% of world GDP and 81% of global liquidity.

As Bill Gross, bond guru and boss of investment management firm Pacific Investment Management Co. Llc., or Pimco, put it, this was a “shadow banking system" that “craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever".

The pyramid has collapsed. Countries are diversifying their holdings away from the dollar. As economist Brad Setser points out, “In the third quarter of 2008, for the first time in a long time, the US central bank was a net lender to the world." The casino is shutting down. The free lunch is over.

What needs to be done to make the world a more rational place?

First and foremost, the US will have to learn to live within its means. Its total debt has doubled as a percentage of disposable income in the past quarter-century. It must reduce debt and increase savings.

Countries such as China and much of Asia will have to look inwards, put in place social security systems to encourage people to consume and increase the value of their currencies, thus helping the domestic economy rather than exports.

Russell Napier, consultant with CLSA, sums it up best: “How could more than 40% of the world hope to attain developed world levels of wealth when they had to sell their products to that developed world, which comprised just 14% of the global population... if China, the former USSR and India want to continue to improve their economic condition, they must find somebody else to sell their products to. Given the size of their populations, they have only one choice and that is to sell their products to their own citizens. When the history of the 21st century is written, the events of 2008 will be primarily remembered not as the birth of a new, more interventionist economic model in the West but as the birth of consumerism in the East."

But here’s where the game reaches its apogee of zaniness.

What are policymakers doing to solve this problem created by this explosion of debt?

Why, try their best to reopen the casino, urge US consumers to continue spending, flood the markets with money so that its cost comes down and people start borrowing again. Private debt is being replaced with public debt. They are desperately trying to pump air back into the bubble.

Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at