Global Economic Crisis

In  the last 100 years, encountering a year in which the U.S. federal government has achieved a balanced  budget has been as rare as the chance that Vladimir and Estragon will actually meet Godot. As with most Western economies as well as Japan, fiscal deficits by sovereign governments have become so normative that a term has long been in vogue to describe this phenomenon, the co-called “structural deficit.” But all that was prior to the onset  of the global financial and economic crisis, which erupted in 2008 with the collapse of Lehman Brothers. We are all now in new territory, never before encountered  by sovereign governments on such a prolific scale. Welcome to the era of the structural mega-deficit.

In compiling data for my new book, “Global Economic Forecast 2010-2015: Recession Into Depression” (http://www.createspace.com/3403422), I recognized that the size of current and projected fiscal deficits for the United States and other advanced and major economies was so much greater than typical structural deficits, a new terminology was required. The term I have adopted  in my report, “structural mega-deficit,” implies a whole new and unprecedented reality for public financing. In essence, a deficit which approaches or exceeds 10% of a national economy’s GDP, and has an aspect of permanence similar to previously tolerated structural deficits, has entered the fiscally turbulent terrain of structural mega-deficits.

As with private consumers, sovereign economic policymakers have become addicted to debt, nowhere more so than in the United States, Western Europe and Japan. For example, when the Eurozone was established with a single currency, participants were expected to show “prudent” fiscal management of the public finances, by ensuring that their national deficits did not exceed 3% of national GDP. Heaven forbid a balanced budget had even been suggested as an ideal target. Now, however, even the Eurozone’s supposedly responsible 3% cap on annual deficit to GDP ratios is coming apart at the seams, witnessed most recently by the  fiscal crisis in Greece, where the current  budget deficit is expected to reach 12.7% of that nation’s GDP.

It is the United States, however, where the emergence of the structural mega-deficit reaps the most tangible dangers for the global economy. In the past, key economic policymakers throughout the world maintained that a structural deficit of around 3% of GDP could be easily sustained  as long as the national economy produced a modest level of growth. However, there exists no mathematical models that demonstrate how any nation’s economy, including that of the U.S., can sustain structural mega-deficits. With the official U.S. deficit for  the 2009 fiscal year having reached 10% of GDP and the 2010 federal budget likely to produce a deficit in the range of $1.5 trillion, America’s public finances are clearly in a debt trap that is unsustainable by any logical measure. The Congressional Budget Office projects a cumulative deficit of $9 trillion over the next decade; based on the CBO’s track record, the actual deficit is likely to be much worse.

One of the strange paradoxes for the U.S. economy is that in 2009, even with a tripling of the national deficit, the annual payment by the federal government for interest on the national debt was actually lower than the prior year. This was due to the unique and anomalous conjunction of much of America’s national debt being financed by short-term Treasuries with historically low interest rates established by the Federal Reserve. However, with growing doubts on the part of foreign lenders as to the long-term credit worthiness of the United States, it is inevitable that the days when much of America’s growing debt load could be financed at almost zero interest rates will soon end. With  the public debt of the United States  based on an average turnover for refinancing  of four years, the shortest timeframe of any large indebted economy, a spike in bond yields will add potentially hundreds of billions of dollars to the annual U.S. deficit. A time may not be far off when current taxes and other federal government revenue will cover less than half of the annual expenditures of the federal government. All this will be occurring as outlays for Social Security and Medicare begin to exceed revenues, adding further to the structural mega-deficit, and at a rate that will become increasingly voracious.

The ultimate tragedy about the present and future danger of structural mega-deficits in the United States and other major economies is that this is an impending train wreck that can be viewed  from a great distance before its catastrophic impact. Yet, in spite of the clear and obvious unsustainability of structural mega-deficits, with very few exceptions the political leadership in the United States, in both the Democratic and Republican parties, is conspicuously silent.

Economics is a social science, not an exact science.  Theories on how a nation’s economy and financial system should function  proliferate the body politic, ranging from Reagonomics to Keynesian pump-priming. However, as the past year’s global economic crisis has demonstrated, dogmas and theories, such as market fundamentalism, are largely impotent in the face of brutal economic realities. It was not out of conformity with a particular economic dogma, but rather sheer panic, which drove  key policymakers in major advanced and developing economies throughout the world to plunge their nations into unprecedented levels of public debt, all in a frantic effort aimed at halting the free fall collapse of the global financial system that had erupted after the downfall of the investment bank Lehman Brothers.

One year later, throughout the world and especially in the United States, political decision makers are proclaiming to their constituents that the worst of the economic crisis is behind us, “green shoots,” in the words of Fed Chairman Ben Bernanke, are starting to emerge, and the stock market has regained much of its losses. Yet, as Wall Street awards record bonuses to many of its stakeholders, unemployment in the U.S. and other developed countries continues to rise, while the credit crunch constricts small and medium size businesses. Amid the contradictory images regarding the Great Recession, I have written “Global Economic Forecast 2010-2015:Recession Into Depression,” http://www.createspace.com/3403422 , in which I look at the likely economic trends over the next 5 years. As the title suggests, my projection is not an optimistic one.

While the trillions of dollars poured into the global financial system by the United States and other sovereigns did prevent a total financial collapse in late 2008, this achievement has not come without a high cost, and growing danger.  The level of public debt being accumulated by governments across the globe in response to the global economic crisis, and especially in the U.S., will reach a point of unsustainability, likely by 2012. This will occur simultaneously with continuing high rates of unemployment, which equates with weak consumer demand. The United States is dependent on the American consumer for at least 70% of GDP output. Overleveraged and underemployed consumers dampen growth prospects and  retard government tax revenues. While public finances remain weak, policymakers will likely maintain stimulus spending programs, which translates into structural mega-deficits. The Congressional Budget Office is currently projecting a $9 trillion deficit over the next decade; based on the CBO’s past record, this is likely a lowball estimate.

In my look at the probable economic trajectory for the U.S. and other major economies over the next five years, I had to confront the strong possibility that amid America’s growing fiscal imbalance, there exists a serious danger of future shocks to the global financial system, which may possibly rival the implosion of the investment banks which occurred in 2008. During the next two years, $2 trillion in commercial real estate loans will come due. These were loans initiated when commercial properties were at their peak valuation, and largely securitized, as was the case with subprime loans that triggered the financial crisis in 2008. Should a commercial real estate implosion replicate the carnage that the banking system experienced in 2008, how will sovereign governments, the United States in particular, find the money to finance another financial system bailout? My conclusion is that it will not be mathematically possible for the U.S. and other governments to sustain a future rescue of the banking system. In essence, sovereign  governments will become overwhelmed with public debt, reaching a point of fiscal collapse. The result will be sovereign insolvency, leading to a synchronized global depression.

In his farewell address to the nation in January 1961, President Dwight D. Eisenhower warned his countrymen about the long-term consequences of soaring public debt. Mortgaging the assets of future generations, Eisenhower believed, could transform today’s democracy into tomorrow’s “insolvent phantom.” In the midst of our current economic crisis, it would be wise to pay heed to the sage advice that President Eisenhower offered nearly half a century ago.

When media reports surfaced last week claiming that the prophet of doom of the Global Economic Crisis, NYU economics professor Nouriel Roubini, had  “improved” upon his previously gloomy economic forecast and predicted the recession would end by the close of 2009, a stock market rally was ignited. It seems it does not take much to facilitate a bear market sucker’s rally on Wall Street at this time of global economic distress, including false rumours. To his credit, Roubini swiftly set the record straight with the following comment on his blog:

“It has been widely reported today that I have stated that the recession will be over ‘this year’ and that I have ‘improved’ my economic outlook. Despite those reports – however – my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.”

Nouriel Roubini has consistently stated that he expected the current recession-by far the worst America has experienced since World War II- to terminate by the close of the year. This has been his longstanding forecast. Thus, when he repeated this consistent prediction of his, the media went wild with excitement, discarding the continuity of his forecast and presenting his belief that by the close of 2009 the recession would end as a surprise revelation. With business journalism like this, no wonder the Dow Jones is searching new highs even as employment numbers continue to plummet.

What is noteworthy about Roubini’s most recent insights on the economic situation are their increasingly gloomy tone related to the mid-term and long-term prospects for the American economy. This is largely predicated on the growing fiscal imbalance in connection with the public indebtedness of the United States. Though a supporter of the vast deficit-driven stimulus programs and expensive bailouts of the financial sector owing to his belief that to negate these policy responses would have resulted in the collapse of the global financial system and the free fall contraction of the U.S. economy, Roubini is not unmindful of the their consequences. In that sense, he parts company from other advocates of deficit-creating economic stimulus packages, including Paul Krugman, who prefer to discard the danger of the vastly-expanding debt of the federal government.

In addition to his concern about the ramifications of unprecedented levels of budget deficits, Roubini is also worried that the end of the recession he has long forecasted will now be only temporary, to be followed by a double dip recession during the latter half of 2010, interrupted by anaemic growth of less than 1%.

The forces contributing to what, at best, will be a weak recovery in 2010 are linked to the uniformly negative statistics on employment which, according to Professor Roubini, have a direct impact on an economy as highly dependent on consumer spending as America’s. According to Roubini, commenting on the latest employment numbers,  “these raw figures on job losses, bad as they are, actually understate the weakness in world labor markets. If you include partially employed workers and discouraged workers who left the U.S. labor force, for example, the unemployment rate is already 16.5 per cent. Monetary and fiscal stimulus in most countries has done little to slow down the rate of job losses. As a result, total labor income — the product of jobs times hours worked times average hourly wages — has fallen dramatically.”

In his recent observations on declining labor income and its relationship to the continuing financial and economic crisis, Roubini identifies how this factor will exacerbate several interlocking indices. Consumer loan defaults across the board-mortgages, students loans, credit card debt-will continue to increase, adding to the level of toxicity of assets on the balance sheets of banks, and extending the credit crunch. Government revenues will decline while the need to fund unemployment benefits and other social expenditures will grow, further increasing budgetary deficits. Professor Roubini summarizes the growing contradictions in utilizing fiscal and monetary policy responses as the primary sovereign means of countering the worst global economic disaster since the Great Depression as follows:
“The higher the unemployment rate goes, the wider budget deficits will become, as automatic stabilisers reduce revenue and increase spending (for example, on unemployment benefits). Thus, an already unsustainable U.S. fiscal path, with budget deficits above 10 per cent of GDP and public debt expected to double as a share of GDP by 2014, becomes even worse. This leads to a policy dilemma: rising unemployment rates are forcing politicians in the U.S. and other countries to consider additional fiscal stimulus programs to boost sagging demand and falling employment. But, despite persistent deflationary pressure through 2010, rising budget deficits, high financial-sector bailout costs, continued monetisation of deficits, and eventually unsustainable levels of public debt will ultimately lead to higher expected inflation — and thus to higher interest rates, which would stifle the recovery of private demand.”
This leads to what economists refer to as a “W” or double dip recession. In other words, the very policy responses politicians and their advocates claim are vital to restoring the economy may, by the end of 2010, become the principal enabler of forces that will unleash round two of the Global Economic Crisis.

Nouriel Roubini had warned for years that the subprime mortgage sector would bring about financial and economic calamity, and take down much of the investment banking industry. Today we would all be wise to listen carefully to Professor Roubini’s warnings on the growing danger of a double dip recession and the long-term implications of a fiscal roadmap being pursued by our politicians that, in Roubini’s prescient words, is “unsustainable.” Given his track record, we can only discard the truth of which Roubini speaks at our peril.