Global Economic Crisis

According to the U.S. Treasury Department, America’s federal government set a record for red ink in February 2010, accumulating a deficit in just that one month of  $221 billion. In comparison, the deficit for February 2009 was $194 billion.  Year on year, the February deficit grew by 14%. No doubt, the Obama administration is spending and borrowing at a record pace, in order to put as much of a dent as possible in America’s staggering unemployment number before the midterm election in November. Thus, short term political expediency is given a higher priority than the long term fiscal health of the nation.

The massive U.S. government deficits are not only a function of rapacious federal spending, but also a reflection of plummeting revenues. In the year to date corporate tax receipts were $45.4 billion, compared to $52.8 billion during  the same period in FY 2009, while individual income tax receipts declined by 14%. Where does this end? Bar an economic miracle leading to instant double-digit real growth, fiscal doomsday lies before us, as policymakers in the United States and other advanced economies sail on at flank speed towards the mother of all sovereign debt crises.

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Economic and financial history seems to be repeating itself, in an utterly surreal example of hubris and mockery. When residential real estate prices in the U.S. began collapsing and the sub-prime mortgage market imploded, Federal Reserve Chairman Ben Bernanke and his then sidekick, Treasury Secretary Hank Paulson, boasted that their brilliant intervention had “contained” the crisis, preventing it from spreading into the broader American economy. Well, in hindsight, they were partially right. The sub-prime debacle did quite spread, or rather only spread, to the wider U.S. economy. It merely metastasized across the world, bringing about the global economic crisis. It now appears that the head of the International Monetary Fund is doing the same thing.

Dominique Strauss-Kahn, the scandal-prone managing director of the IMF (he had previously been involved in a highly publicized intimate tryst with a female employee at the IMF, triggering a legal investigation into his conduct) has just offered his pontification on the potential systemic risks connected with the ongoing Greek public debt and deficit crisis. He told the news agency Reuters that “there was no reason to expect that Spain and Portugal will need external financial support to get to grips with their public debt.” The IMF boss, in essence, claims that the Greek debt crisis will not spread to other regions of the Eurozone experiencing high levels of public debt to GDP.

His calming words will probably fool few investors. Obviously, Dominique Strauss-Kahn has engaged in PR spin, as his attempts at downplaying the growing public debt to GDP ratios throughout the Eurozone and in the UK, not to mention the United States, are absurd beyond all measure. More importantly, he has illustrated  in his own uniquely obtuse fashion that the IMF is an increasingly irrelevant institution as the mounting public debt levels ensure that a massive sovereign debt crisis is ahead of us all.

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High noon in the high Arctic is fast approaching, as the people of Iceland get set to vote on March 6 in a national referendum on a plan to compensate the British and Dutch governments for their payments to deposits in their respective countries who lost money in the collapse of  Iceland’s banks. It was one of these banks, Landsbanki, which ran Icesave as an online bank that enticed foreign depositors by offering above market rates of interest on accounts. Under immense pressure from the UK and the Netherlands, the government in Reykjavik agreed to pay back more than $5 billion to the two governments, representing a significant part of Iceland’s GDP over several years.

Widespread disapproval of the agreement by the people of Iceland led the nation’s president to decide not to approve the agreement, but rather allow the people of Iceland to exercise their sovereign right on the fate of the Icesave agreement through a national referendum. Despite warnings of economic and financial isolation parallel with economic disintegration emanating from the Icelandic government and the UK and Dutch authorities, it seems almost certain that the Icesave agreement will be overwhelmingly repudiated by Iceland’s voters.

What is occurring in Iceland is noteworthy for the following reason: after politicians throughout the world have adopted the policy that taxpayers must bear the financial costs of failure in the private sector by so-called “too big to fail” businesses, for the first time an aroused citizenry is utilizing the ballot box to say to the policymakers: “Enough!”

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In 1953, manufacturing comprised 28.3 % of America’s total economic output. This was a postwar high, capping the immense industrial build-up that occurred during World War II, when the United States became the world’s “arsenal of democracy.” The industrial might of America and her massive manufacturing base is what ultimately led the USA out of the Great Depression.

Unfortunately, the once might American industrial capacity has been allowed to wither on the vine, as a new elite engineered the rise of the financial sector as America’s most significant economic field. In the interim, U.S. industrial plants have been “outsourced,” that euphemism for the nation’s deindustrialization. By 2006, just prior to the onset of the Great Recession and global economic crisis, manufacturing represented only 12% of America’s GDP.

Financial engineering has replaced industrial engineering in the United States, while the government proportion of the total economy surges simultaneously with the shrinkage in manufacturing capacity. The very nature of the taxpayer funded automobile manufacturers’ bailout, involving the government subsidized downsizing of the industry, is a metaphor for the apparently irreversible decline of the once-mighty manufacturing and industrial behemoth that existed in America.

According to the elites running America’s economic policymaking, it makes sense to accumulate massive public debt  to save the financiers and Wall Street bankers from their own costly mistakes, while ignoring the decline and fall of the U.S. industrial empire. I believe history will render a most harsh and unforgiving verdict on this myopic and irrational policy of economic suicide.

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Just over a year ago, simultaneously with the implosion of Lehman Brothers, the U.S. Federal Reserve and Treasury Department decided not to let American International Group  fail, no matter the cost. That bill has been heavy; $182.3 billion of U.S. taxpayers money has been injected into AIG to ensure its survival amidst massive losses on its London-based credit default swap business. Each and every citizen of the United States has been billed more than $600 to cover AIG’s losses. In effect, the Fed and U.S. Treasury have used the zombie-like subsidized life support of AIG as a pass-though, transferring billions of dollars to investment and foreign banks. The largest recipient of American taxpayers money transferred through AIG was Goldman Sachs, which received a $12.9 billion payoff, which seems to have gone straight into bonuses for its senior executives. Was it mere coincidence that Goldman Sachs CEO Lloyd Blankfein sat in on a meeting with Ben Bernanke and Hank Paulson to decide on the scope of the taxpayer’s subsidy to AIG?

The Fed and Treasury, which decided on their own to effect a bailout of AIG without any input or sanction from Congress and the American people, have assured us that their infallible judgement can be relied on to make the correct decision for the U.S. taxpayers. Well, that “infallible” decision-making has left the American people tied ball and chain to a private corporate entity that is still losing vast amounts of money. AIG has recently reported its Q4 results: a loss of $8.9 billion. This may be a sign of more red ink to come, as the global economic recovery falters amid mounting concern over high unemployment and sovereign debt crises. AIG apparently is not done as a costly financial liability for the citizens of the United States, despite the fact that not a single one of them had the opportunity to vote in favor of this hideously expensive experiment in corporate socialism.

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The British pound sank like a stone as the Governor of the Bank of England, Mervyn King, issued a grim warning during testimony before the UK Parliament’s Treasury Select Committee. The central fiscal problem is the £178 billion annual deficit incurred by Gordon Brown’s government in the midst of the global economic crisis.

Mervyn King indicated that the Bank of England will have to continue with quantitative easing in the face of the massive government deficits, sending negative signals to investors as to the stability of the nation’s currency. He warned that both the current government, and a likely new government to succeed Brown after the next British general election, must send a clear message to the markets that they have a credible plan to significantly reduce the nation’s fiscal deficits.

I think the current breed of politicians, in the UK and elsewhere, haven’t a clue how to address the massive, unsustainable deficits that plague virtually every major and advanced economy. Which means that it is only a matter of time before the UK, and then the US, follow in the footsteps of Greece down the road of national insolvency.

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A highly tangible outcome of the global economic crisis and its first stage, the so-called Great Recession, has been the deleveraging underway by households and businesses throughout major advanced economies. In the United States and United Kingdom, consumers who boosted consumption on the basis of easy credit as opposed to higher disposable incomes are now tightening their belts and battening down the hatches. The predictable result has been a decline in aggregate demand. This is where the neo-Keynesians enter the fray, preaching the gospel of mega-deficit spending by governments.

The classical economic theory as developed by John Maynard Keynes holds that in times of severe economic contraction in the private economy, it is permissible for the sovereign to go into debt and increase spending to compensate for the falloff in consumer and other private sector expenditures. The rationale is that this short-term increase in the public debt will retard the rise in unemployment, limit the impact and duration of the economic recession and in the long run lead to overall better economic performance, with limited effect on the ratio of public debt to GDP. Though advocates and opponents can offer differing views on the historical validity of Keynes and his counter-cyclical concepts of sovereign  intervention in the economy, there is no doubt that his theory is intellectually cogent and based on a serious analysis of economic problems, particularly in regards to the Great Depression of the 1930s. However, is the current wave of unprecedented sovereign indebtedness equally cogent? If John Maynard Keynes were still alive, he would likely take issue with the massive tidal wave of red ink being unleashed by politicians as their antidote to the global economic crisis.

Though John Maynard Keynes is portrayed as a deficit-loving interventionist, in reality he was not. What is left out of the description of his theory in regards to counter-cyclical fiscal policy is that Keynes also believed that in times of relative prosperity sovereigns should create budget surpluses. He belief was that booms and busts were an integral characteristic of modern capitalism, and that  the accumulation of reserves during times of plenty would enable governments to engage in temporary deficit spending to combat a severe recession, without creating the long-term danger of exploding national debt to GDP ratios. This is an aspect of Keynes’s views on fiscal policy that has been conveniently forgotten by the modern interpreters of Keynesian economics.

Since World War II, the U.S. has seldom run balanced budgets. If generally accepted accounting principles were applied to official U.S. federal government budget reports, which require taking into account future liabilities for Social Security and Medicare, then during this period the United States has always run large fiscal deficits, even during times of relative economic prosperity. What this means in reality is that the conditions laid out by John Maynard Keynes for allowing a sovereign to engage in deficit spending during a recession, namely building budget surpluses during periods of economic expansion, have never been adhered to.

During the Great Depression,  the U.S. government did engage in substantial deficit spending within the framework of the New Deal, but with a ratio to GDP far lower than what is currently occurring on President Obama’s watch. This fiscal policy was engaged in with a cumulative national debt to GDP ratio nowhere near the current level, and with a large base of domestic savers prepared to buy U.S. government debt, in contrast with the present day reliance on foreign buyers of U.S. Treasury Bills.

If John Maynard Keynes were alive today, I suspect he would be horrified at the manner in which his economic theories have been distorted, and the likely outcome of such fiscal profligacy.

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Thomas Hoenig, President of the Federal Reserve Bank of Kansas City, has issued a stark warning regarding the ballooning U.S. federal government annual deficit and cumulative national debt. Hoenig told  the Pew-Peterson Commission on Budget Reform that massive deficits being  projected by the Obama administration would endanger the Fed’s ability to fulfill its mandate of maintaining stable economic growth and price stability.

“Without pre-emptive action, the U.S. risks its next crisis,” stated Hoenig. What this senior Federal Reserve official is saying, on the public record, is that the current U.S. fiscal policies are unsustainable, and unless halted and reversed in short order, will precipitate a hyper-inflationary depression.

Paul Revere has spoken. But who is listening? Certainly not the economic policymakers in Washington DC, who believe only small countries like Greece can face national insolvency. Sooner then they can imagine, they will receive an education  which unfortunately will cost their countrymen dear.

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In my book, “Global Economic Forecast 2010-2015: Recession Into Depression,” I project that a growing sovereign fiscal crisis will transform the current Great Recession into a synchronized global depression. The events currently transpiring in the Eurozone are early indicators that my forecast is on track.
 
At the recent summit of European Union leaders in Brussels, which included the head of the European Central Bank, the PR spin doctors released what can best be described as ambiguity in the form of a communiqué, offering unspecified assurances that the Eurozone’s major actors will not permit Greece to succumb to its current sovereign debt crisis. The hope was that the markets would buy this assurance, thus preventing a further slide in the euro.

Not only are the markets, at least terms of the euro’s relative value, not being reassured by the happy talk that emanated out of Brussels; upon his return to Athens, Greek Prime Minister George Papandreou  was harshly critical at the lukewarm words of EU reassurance. He said, “in the battle against the impressions and the psychology of the market, it was at the very least timid, ” in referring to the EU communiqué.

The bottom line is that without a massive bailout by the big guns in the Eurozone, in particular Germany and France, Greece faces fiscal collapse, which in turn will prove destructive to the whole Eurozone. However, if indeed Greece is bailed out, a host of other insolvent EU members using the euro will be lining up for their bailouts. Even ignoring the feelings of the German and French taxpayers (which is not politically tenable) there simply is not fiscal capacity within the Eurozone to backstop the other potential sovereign basket cases.

I foresee no possible scenario that allows for a soft landing from this escalating sovereign fiscal and debt crisis.

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Greece is in the midst of its worst fiscal crisis since the end of World War II, with a budget deficit now officially stated as being 12.7% of GDP. However, given the past shenanigans when it comes to government bookkeeping in Athens, it would not surprise many if the true deficit ratio to GDP is even higher than currently admitted. The Greek government cannot employ monetary policy as a means to inflate down the value of its national debt, as it is part of the Eurozone. The primary policy option it has left is reducing its budget to sustainable levels, but that would require sacrifices on the part of the population that would likely lead to social disintegration on a massive scale. Already, mass waves of strikes are being planned, in protest at austerity measures being promised by Greek politicians.

Athens is hoping and praying that the wealthier and less profligate members of the Eurozone will bailout Greece, reducing the level of austerity that will be imposed on Greek citizens. Greek political circles clearly hope that the systemic risk posed to the entire European monetary union by its fiscal crisis will compel German and French politicians in particular to swallow the risk of moral hazard, and have their taxpayers bailout Greece. The news that the President of the European Central Bank, Jean Claude Trichet, will be attending an emergency European summit on February 11 in Brussels sent stock markets around the globe soaring, in the hope that Germany and France will bailout Greece. It should not surprise anyone at this stage in the global economic crisis that the best news for investors seems to be taxpayer funded bailouts, as opposed to real economic progress.

The speculation is that the ECB and key Eurozone actors will capitulate, and sacrifice their concern over moral hazard for the sake of preserving the euro. However, this is at best short-term thinking. The fiscal catastrophe Greece finds itself in today, and which Iceland has been experiencing for more than a year, threatens many other European countries. Spain, Portugal, Italy and Ireland, not to mention Eastern Europe and the UK, are all wrestling with exploding levels of sovereign debt. Even if the Eurozone political leaders and the ECB cobble together a bailout of Greece, they simply lack the financial resources to bailout the next wave of European sovereigns that will feel the wrath of a savage fiscal crisis that is actually being made worse by the cumulative taxpayer liabilities that are now expanding towards infinity.

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