A tightening in financial conditions continues while the economy stumbles and unemployment rises in an environment where a rapidly expanding young population is fast becoming restless and explosive for want of jobs and a decent living. As if this was not enough the government over the last couple of years has consciously crowded out the private sector by its heavy borrowing spree - The domestic lending institutions for their part preferring to lend to the state rather than the private entrepreneurs since they feel that they stand to gain more at a lower risk from the government as a client. Not only does this defeat the very purpose for which these financial institutions were established in the first place, but it also creates a very unhealthy flow of money that diverts it away from sectors where the usage of money supply tends to be most productive - The private sector as we know is the most efficient multiplier of wealth and profit. ~ Schumpeter. We simply have to look in our neighborhood, China, to realise that the above is a very risky model as the Chinese fight a local battle against rampant lending, albeit in their case they themselves are the culprits of state-to-state lending, as transaction by transaction they realise that lending to governments is not always so risk free However, of fundamental importance amidst all this is the lesson that mere dependence or rather over dependence on monetary tightening as a tool to fight inflation not only carries grave risks, but more often than not can also be ineffective and dangerous, if the asset risk basket is not prudently evaluated. What we in Pakistan need to quickly wake up to is the danger that our entire money direction in the last few years has been erroneous, because unlike the present mindset of the lenders, the reality is that the real risk does not lie with the private sector but on the contrary in the state assets. Catering to the governments unsatiable appetite for liquidity at the expense of the private sector invariably causes a market imbalance that eventually results in an economic collapse, for example like what was witnessed in the USSR and in its allied Eastern European economies. Also, it is noteworthy that higher the level of such an imbalance climbs, higher becomes the inflation index. For example, even in a developed economy like the USA, we saw that the core consumer prices, which exclude those for food and energy, fell in January 2010 for the first time since 1982, driven mainly by, falling rents and car prices and less expensive clothing; however, the energy costs (which till today are largely state driven) drove the overall inflation significantly higher. Meaning, if the state expands so does the inflation. Now just imagine the havoc the larger than life state-run enterprises in Pakistan (relating to energy, food, power, transport and others) must be playing with our inflation at home - Support them more and in return get higher inflation A Morgan Stanley equity strategist, Graham Secker, argues that concerns about the ability of countries to service their debt is driving up the premium investors demand to hold risk-free government paper. Greece is a prime example of that, but the real risk is not so much in Greece as in what Greece stands for - the failure of confidence in sovereign borrowers. According to Mr. Secker, the post meltdown and recession lesson for the financial institutions is, regardless of the country they are placed in, to resist the temptation of overt safety and instead take a deeper view by spreading their portfolio in a manner where the lifeline cash flow is driven by the private and not the public sector. Sadly, not many financial institutions in Pakistan seem to be taking his advice. Lastly, as mentioned above, the scare that unhealthy debt financing crowds out private market borrowing is fast becoming a reality in Pakistan. A phenomenon, which one would argue is causing a lot of damage to the economic health of the country, as we see more and more domestic banks choose to hold government debt rather than make business or consumer loans. This kind of crowding happens when government borrowing commands so much capital that private enterprise must pay more to borrow. So what happens then when you combine a higher cost of capital with weak employment (or rather racing unemployment), a fast growing population that carries an extremely high percentage of employable youth, and a widespread inflation as a result of states inefficient use of capital? Answer: Disaster. e-mail: kamalmannoo @ hotmail.com.