Global Economic Crisis

Treasury departments and central banks far and near assured their publics that this speedy borrowing spree by the decision-makers had rescued the world’s financial system, thus serving the interests of the now heavily-leveraged taxpayer. Now, only three months later, it is clear that at a terrible financial cost, at most a short respite was purchased. The temporary lull in the LIBOR rate cannot, however, camouflage the essential truth; the major banks and financial institutions in many major economies, particularly in the United States and United Kingdom, are for all practical purposes insolvent.

A banking system that is insolvent is dysfunctional in the extreme. That is the core of the credit crunch that has now precipitated a Global Economic Crisis so egregiously destructive, it will likely exceed the Great Depression of the 1930s in its impact. This is why all the costly deficit spending on economic stimulus packages being enacted in the G7, BRIC and eurozone countries are doomed to failure. The key decision makers are aware of this conundrum, which is why they are frantically searching for a solution to the banking disaster that has frozen normal credit flows throughout the global economy.

The new U.S. Treasury Secretary, Timothy Geithner, postponed his speech on how the Obama administration intended to resolve the banking and credit crisis by 24 hours. Whatever solution he ultimately proposes it will probably, like TARP before it, be insufficient and require further interventions by the Treasury Department and the U.S. taxpayer. Indeed, dark clouds are obscuring an horrific reality; the American banking sector is insolvent to such an immense degree, it would in all likelihood require recapitalization at a level counted not in hundreds of billions, but rather trillions of dollars.

The paradox is that the U.S. economy, as with any other, cannot function without a solvent banking sector. At the same time, it cannot afford the cost of salvaging its banks. Consider what Professor Nouriel Roubini said in a recent interview with the Financial Times: “In many countries the banks may be too big to fail but also too big to save, as the fiscal/financial resources of the sovereign may not be large enough to rescue such large insolvencies in the financial system.”

Thus, the United States created a banking system with large institutions that are too big to fail, due to the systemic risk such a collapse would impose on the national and even global economy. It compounded this roll of the dice by removing any coherent regulatory regimes, instead trusting in the “self-correcting” character of the unregulated marketplace, which encouraged risky behaviors, otherwise known as “innovation,” leading to the creation of unsustainable asset bubbles.

Geithner may try to sugar-coat what in effect will be a TARP II, knowing that the public and its congressional representatives will be reluctant to mortgage the financial future of their children for the sake of another bank bailout. However, no matter how the Obama administration packages its own TARP II bank rescue effort, it is increasingly likely that the foreign credit markets the United States relies on for financing its grandiose deficit spending will simply lack the capacity to loan all the money needed to recapitalize America’s banks.

In the event the credit markets are unable to finance the rescue of the U.S. banking sector, then the lender of last resort will undoubtedly be the Federal Reserve. By resorting to quantitative easing, the Fed may purchase Treasury bills with bank notes it simply generates off of its printing press. In essence this is legal counterfeiting, conjuring up fiat money out of thin air. It may lead to the recapitalization of the banks, on paper. But the net cost will be the destruction of the U.S. dollar as the world’s reserve currency, along with the displacement of the current trend of deflation with a virulent and potentially uncontrollable outbreak of hyperinflation.

The bank rescue mission the U.S. Treasury Department and the Fed are currently embarked upon reminds me of what a U.S. Army spokesman once told journalists during the Vietnam War: “We had to destroy the village in order to save it.”

I fear that this same reasoning may be at work among the policy-makers in Washington, through the enactment of decisions that will destroy what remains of the U.S. economy in order to bailout the “too big to fail banks.” In this instance, however, it is not a village, but the whole global economy that hangs precariously in the balance.

It is not only those who were myopic a year ago that want to avoid talk of a depression, at all costs. Even the most prescient analysts and experts have held back on their vocabulary in defining the Global Economic Crisis. However, more and more credible economists and experts have begun describing our current economic catastrophe as a depression. The Economist magazine was one such authority, as was the most recent recipient for the Nobel Prize for economics, Paul Krugman.

Perhaps the most astute observer of the unfolding disaster resulting from the implosion of the U.S. housing bubble has been NYU economics professor Nouriel Roubini. A year ago, amid the happy talk being proffered by Hank Paulson and Ben Bernanke, he accurately warned of the systemic financial collapse that would ensue in short order, unless urgent, coordinated steps of global intervention were swiftly undertaken. History vindicated the judgement of Roubini, while also applying to him the moniker of “Dr. Doom.”

As clear-cut as Nouriel Roubini has been in assessing the Global Economic Crisis, even he has been reluctant to use the “D” word. Now, however, he is warning that the worldwide economic crisis will get much worse, and in the absence of effective global intervention that is coherent and synchronized, a “near depression” was a serious possibility. His most recent warning comes in conjunction with his current assessment of the losses he projects for the global financial system due to “toxic assets,” in the range of $3.6 trillion. His conclusion is chilling in the extreme: the banking system in the U.S. is effectively insolvent.

Added to the mounting evidence of banking insolvency, not only in the United States but other major economies, in particular the U.K., are the horrendous unemployment numbers. The U.S. Labor Department has released its statistics on job losses for January of this year, indicating that another 600,000 Americans joined the ranks of the unemployed. This translates into an official unemployment rate of 7.6%. However, in reality, the situation is far worse than those numbers indicate. In the first place, the Labor Department’s monthly reports are never complete, owing to lagging tabulations from small firms and businesses. This is reflected in that the current report revised substantially higher the unemployment numbers for November and December of 2008. In all probability, more than 700,000 Americans were terminated in January, with every indication that this trend will continue far into 2009. In addition, the official unemployment rate, since the 1960s, subtracts “discouraged” workers, meaning the permanently unemployed, as well as part-time workers unable to find full-time employment. If these numbers are added into the unemployment figure, it exceeds 14%.

At its worst level, the unemployment rate in the U.S. during the Great Depression stood at 25%. After the advent of the New Deal of President Franklin Roosevelt, it temporally declined to near 10%, but then rose to a much higher level, reaching the range of 16-17% prior World War II. Accordingly, a true current unemployment rate of 14% is within the levels experienced by the United States during the 1930s. Factor in the structural insolvency of the American banking sector, the rampant demand destruction infecting the global economy and other catastrophic asset bubbles set to burst during the next several months, and it becomes clear that the United States and the rest of the world have now entered a dark economic territory that can no longer be defined as merely a recession.

The Global Economic Crisis has now achieved levels of economic contraction in all major indices that can only be described as a depression of worldwide dimensions. The global depression train has left the station, and will bring a level of economic and financial carnage to every corner of our world on a scale so staggering, it would have been unimaginable to even the most sober pessimists-until recently.

The inept policy-makers and their legions of technocrats, as with the alchemists of so long ago, are claiming that their own permutation of economics will somehow create gold out of thin air, thus terminating the Global Economic Crisis and restoring prosperity. They tried monetary policy, however with interest rates on central bank funds in many major economies at effectively a rate of zero, and the global economy only falling further into the abyss, a new bag of tricks must be offered to the pubic.

The massive debt-driven stimulus spending plans being unveiled with monotonous regularity by the political leaders of the major economies are nothing more than fiscal chemotherapy. With the Global Economic Crisis having metastasized beyond the point of containment, this disastrous flirtation with national insolvency by policy-makers will only accelerate the path to global economic disintegration.

The major proponent of fiscal chemotherapy is the United States, which will in the near future pass a so-called “economic recovery plan” that will initially cost one trillion dollars over two years. However, even without this stimulus plan, the U.S. federal budget is already projected to incur a deficit of $1.2 trillion. Add in the stimulus, plus hundreds of billions of more dollars required for bank bailouts beyond the $700 billion TARP fiasco, then factor in the sharp decline in revenue from taxation as businesses go bankrupt and millions more Americans lose their jobs, and it is clear that the U.S. Treasury will have to borrow far more than even the stratospheric projection of $1.2 trillion. But it gets worse.

Politicians close to the Obama administration, as well as some economists who stand by the Keynesian formula for combating economic recessions, have already strongly hinted that the $1 trillion stimulus package will not be nearly enough to resolve the economic crisis, and will have to be massively enlarged and repeated. What this in effect means is that the United States will be compelled to borrow untold trillions of dollars for years to come. Now, with domestic credit possibilities utterly exhausted, it is to foreign creditors that the U.S. Treasury must look to for financing the profligate budgetary deficits of the United States.

Unfortunately for the U.S. Treasury Department, virtually every major economic actor on the planet is also replicating grandiose deficit spending wrapped up as stimulus packages. This includes almost all the G7 and BRIC countries. More alarming for the U.S., one of those nations is China, looked upon as the major source of available credit by the Treasury Department. However, China currently has its own priorities, now that the Global Economic Crisis is beginning to batter the world’s third largest economy in severe ways. A normally reticent Chinese government has disclosed that the number of unemployed migrant workers in their country now tops 20 million. It is for that reason that the authorities in China have begun a stimulus-spending program currently budgeted at $600 billion, but almost certainly to grow substantially beyond that figure.

The economic contraction hitting China means far fewer surplus dollars generated by Chinese savers. The credit pool in China is now shrinking, and most of those funds will logically be used to finance the government’s operating deficit in China, as opposed to the United States.

If China dries up as a source of credit for the U.S. government, where is the alternative? The Gulf Arab states are also being lacerated by the Global Economic Crisis, as the implosion of oil commodity prices has created severe budgetary constraints in the previously abundant coffers of OPEC. As with China, whatever sovereign wealth or other surplus funds are still available will be directed in the first instance towards enhanced domestic spending deemed necessary to maintain social cohesion.

The essential point is that the fiscal chemotherapy that suggests that, as with a cancer patient, the toxicity of the medicine, in this case budgetary deficits, must be absorbed for the short-term to preserve the long-term health of the patient is nonsensical in the extreme. There simply will not be enough credit in the entire world to finance the budgetary deficits that are likely to arise in the United States as well as other major economies. Rather than pursue the only sane fiscal option available, namely radical budgetary surgery (as with massive trimming of bloated U.S. military spending), the mediocre elites dominating U.S. decision-making circles have chosen to go down the route of fiscal chemotherapy and economic alchemy, which can only result in terminal consequences for the American economy.

The Global Economic Crisis is fully revealed by a combination of a systemic financial meltdown contributing to uncontrolled demand destruction in a continual negative feedback loop. This is not just demand destruction, but a global economic death spiral.

To take the example of the 4^th quarter GDP figures released by the U.S. Commerce Department, they reflect a consumer base that has been stripped of its financial capacity to consume, thus displacing demand by staggering levels of contraction. In just one quarter we are seeing the American consumer, who represents 72% of the totality of all American economic activity, curtailing purchases in major categories at double-digit rates. The cutbacks by individual consumers are being replicated by the means of production, reflected by businesses in the manufacturing and distribution arenas. These enterprises are cutting back sharply on orders for durable goods, other products and services, be it machine tools, imported fabric, transportation services or inventory for supply to retailers. As Q4 GDP statistics from the U.S. indicate that the business sector is only in the initial phases of correlating its output with consumer demand contraction, these numbers will get much worse in the first and second quarters of 2009.

The American consumer, over-leveraged with debt but always beckoned to purchase more by easy access to credit, has now been denied his fiscal narcotics and is experiencing the writhing pain of withdrawal symptoms. Upon such a slender reed was the global economy constructed. With the collapse of consumer demand in the United States, factories in vast numbers throughout China, Japan, Taiwan and Southeast Asia are shuttering their doors, throwing multitudes of employees out of work. This in turn is collapsing internal consumer demand in those countries, further exacerbating the virulence of the Global Economic Crisis. The Asian contraction in comsumption is leading to global demand destruction in commodities, facilitating the deadly virus of global deflation.

It is now chillingly clear that this global economic disaster can no longer be contained. The cancer stimulated by banking and credit systems contaminated by toxic assets based on subprime mortgages in the United States, has now metastasized into the mainstream world economy and no variation of radical surgery or fiscal chemotherapy can bring this man-made catastrophe into remission.

Policy makers throughout the world are reacting in panic. Their prescriptions are the usual doses of debt-funded stimulus spending, while borrowing even more money to throw into the black hole created by the Wall Street magicians and banking sector. However, it is now the rampaging demand destruction throughout the world that is cementing the insolvency of the credit system. No amount of money that can conceivably be borrowed, begged or conjured out of thin air by central bankers and hysterical politicians has even a snowball’s chance in Dante’s inferno of reversing the tsunami of demand destruction that has now been unleashed by the Global Economic Crisis.