Global Economic Crisis

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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Despite all the rhetorical flourishes and grandstanding engaged in by that once august body, the U.S. Senate, when it came time for the rubber to meet the road, they voted overwhelmingly to reappoint Ben Bernanke to a second term as chairman of the Federal Reserve. Let us be clear as to what those 70 senators voted for, in deciding to support President Obama’s preference that Bernanke remain at the helm of the Fed. Failure on a monumental scale has been conspicuously rewarded.

While Bernanke’s predecessor has been rightly condemned for his loose monetary polices and dogmatic conviction that unregulated market fundamentalism is always correct, the current Fed chairman has demonstrated continuity with those now discredited policies, along with a numbing myopia in failing to see a train wreck coming, despite ample warning.

In October 2005 Ben Bernanke appeared before Congress, only days before being nominated to succeed  Alan Greenspan.  Growing concern had already emerged regarding the unsustainability of what was obviously a massive housing asset bubble,  in large part facilitated by  the Fed’s easy monetary policies, fully supported by Bernanke. When questioned on the perception that the residential housing market was a growing danger to the nation’s economic health, the supposedly brilliant and perceptive Ben Bernanke stated that the escalation in U.S. housing  prices did not constitute an asset bubble, and was in fact based on sound economic fundamentals.

Sound economic fundamentals?

In an earlier post, I described Bernanke’s statement to Congress in 2005 as the worst economic prediction in recorded history. Yet this same flawed individual has now been  anointed by the U.S. Senate to have another go at deconstructing the U.S. economy.  A proven failure  now has another four years as head of the world’s most powerful central bank, with executive powers that in may respects exceed those of the president’s, with virtually no meaningful legislative oversight.

The justification for reappointing Ben Bernanke rests on a flimsy pretext. He supposedly saved the world from a global financial meltdown after the collapse of Lehman Brothers in the fall of 2008. This ignores his conspicuous role as a principle architect of the global financial and economic crisis. In effect, he is glorified for indebting  generations of Americans yet unborn for covering the costs of his colossal errors in judgement. Furthermore, the Senate has failed to take cognizance that the very debt load they salute Bernanke for creating  as part of his “heroic” rescue mission has laid the seeds for a far more dangerous  phase of the global economic crisis. The risk of a paralyzing sovereign debt crisis is growing, raising the threat of national insolvency. The current fiscal crisis in Greece, and the economic purgatory being experienced by the people of Iceland, are clear warning signs on the economic horizon of what lies in wait for the American people. Maintaining Bernanke as Fed chairman magnifies the risk that a sovereign debt explosion will occur, creating a whole new level of economic devastation across the United States.

The lopsided vote by the U.S. Senate in favour of reappointing Ben Bernanke was  a clear triumph for the disaster-prone Ben Bernanke. As for the American people, this result is nothing less than a total, unmitigated defeat.

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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.

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The speculation after the November presidential election was that Barack Obama originally wanted  Bill Clinton’s former Treasury Secretary, Larry Summers, to serve in the same capacity in his administration. When criticism arose within his own party due to Summers’ strong ties to Wall Street, Obama selected  Timothy Geithner as Treasury Secretary and appointed  Larry Summers to serve as Director of the National Economic Council. In essence, Summers is serving as the principal economic advisor to President Barack Obama. In that role, Summers was undoubtedly one of the principal architects of the Obama administration’s so-called Economic Recovery Act, the $787 billion deficit-driven stimulus package that was supposed to put the brakes on the free fall in employment numbers in the United States.

Increasingly, many critics, not all of them Republican, have raised serious doubts as to the efficacy of the Obama stimulus plan. However, the Obama team is not about  passivity and turning the other cheek in the  face of public doubts. They are pushing back, and taking the lead in connection with the stimulus plan has been Larry Summers.

Appearing before the Peterson Institute for International Economics, Larry Summers wanted to make the case that the Recovery Act was, in fact, working. One would expect a man with as brilliant an intellect as Mr. Summers is alleged to possess to offer convincing analysis based on solid macroeconomic data. However, if that was your expectation, you are out of luck. This is what President Obama’s lead economic advisor had to offer as irrefutable “proof” that the administration’s Recovery Act was functioning according to plan: the number of people conducting Google searches for the term “economic depression,” which had increased last fall in the wake of the demise of Lehman Brothers, was now “back to normal.”

Is Larry Summers serious? This is the strategic data point that the key actor within Obama’s team of economic advisors is fixated on? Google searches are now the leading indicator and most persuasive metric of what’s happening to the real economy? Well, Mr. Summers, last fall, when you noticed  a spike in Google searches related to an economic depression, I established a new website on the crisis, GlobalEconomicCrisis. Com.  During the first few weeks that the website existed, there was hardly any traffic. Now, months afterwards, the site receives hundreds of thousands of hits per month.  Is that indicative of economic trends? Of course not. But neither is Larry Summers’ “observation.”

A far more relevant indicator of what is occurring with the real economy is the unemployment rate. Contrary to the declarations of the Obama administration that passage of the Recovery Act would stem the tide of job layoffs and stabilize the official unemployment rate at 8%, this sobering statistic has now increased to 9.5%, excluding the long-term unemployed and underemployed unable to find full-time jobs. All indications are that this number will exceed double-digits by the end of the year.

The attempt by Larry Summers to utilize nonsensical data in defence of the core economic policy of the Obama administration in addressing the most severe economic contraction in American history since the Great Depression not only fails to reassure an increasingly uncertain public; it increases scepticism regarding the suitability of Larry Summers to serve as the White House point-person on the economy. Those who had pre-existing doubts regarding Summers due to his role in dismantling the  Glass- Steagall Act ( which eliminated the  longstanding separation between investment and retail banks, leading to the subprime implosion that sparked the current economic crisis) will see them reinforced by the bizarre rationalizations he is now  increasingly resorting to in defence of the Obama administration’s economic policies.

Perhaps we should not be surprised by the convoluted logic Summers invokes in support of  his view of reality. After all, a major factor in his fall from the presidency of Harvard University was his “explanation” for why females were grossly under-represented in tenured academic positions in the sciences and engineering: “the different availability of aptitude at the high end,” according to Summers.

Starting with Alan Greenspan as long-serving Fed chairman, and continuing with the likes of Rubin, Paulson, Bernanke, Geithner and now Summers, the public has been subjected to propaganda from the political establishment that presents those who have been selected to design our economic architecture as being brilliant beyond all measure. If we have learned anything over the past year, it is that these supposed geniuses of macroeconomic policy are in fact highly fallible. If nothing else, Larry Summers’ perplexing descent into meaningless trivialities suggests that this key economic policymaker is as detached from reality as most of his recent predecessors. Rather than being reassured by his reference to Google searches that bright rays of sunshine are about to dissipate the dark economic clouds hovering over the nation, I see Larry Summers’ ascendancy  in the economic policymaking hierarchy of the Obama administration as the harbinger of a long recessionary winter which still lies ahead.

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Now we are in 2009, with the subprime mortgage securities debacle having been the underlying cause of the state of insolvency afflicting America’s largest banks. The U.S. government, including Congress, Treasury and the Fed, have injected or issued backstop guarantees to the tune of $13 trillion, in a frantic effort aimed at keeping these zombie financial institutions artificially alive. Yet, in this truly global economic and financial crisis, events in other parts of the world may render mute and futile all the trillions of dollars the U.S. is borrowing to save the American and global financial system. As in 1931, it may well be the Austrian banking sector that is the final nail in the coffin of the current globalized financial order.

With the fall of communism, former East Bloc European states were encouraged to borrow heavily by their Western brethren, with Austrian banks leading the way. Governments in Eastern Europe borrowed massively to finance the modernization of their industries, with the goal of providing lower-cost industrial goods and commodities to consumers throughout Western Europe. In addition, consumers in Eastern Europe were encouraged to borrow money in Euro currency at low interest rates for homes and consumer durables. When the Global Economic Crisis hit Europe, demand destruction afflicted the highly leveraged new industrial plants in Eastern Europe. In addition, the consumers who unwisely borrowed money from Western banks in Euros were devastated by the collapse of their home currencies. A new housing crisis has arisen in lands as diverse as Hungary, Bulgaria and Romania.

The non-performing assets on the balance sheets of European banks are enormous, and have affected many countries throughout the Eurozone. However, in terms of percentage of toxic assets to GDP, no European state is in as precarious a state as Austria. More than $250 billion in bad assets are poisoning the balance sheets of Austrian banks, a sum equal to more than 62% of the nation’s GDP. By way of comparison, if the admittedly shaky U.S. banks held toxic assets in the same ratio to GDP, this would equal $8.7 trillion dollars in bad assets. If America’s banking disaster was on the same scale as Austria’s, it would require a dozen TARP programs to cover the holes on the balance sheets.

Is another Credit-Anstalt catastrophe in the works? The macroeconomic data emerging from Europe looks increasingly gloomy. In addition, the European Union is proving to be both disunited and uncoordinated in facing up to mounting evidence of a financial avalanche that may bury the Union and everything else with it, including the common currency. Policymakers throughout Europe are arguing over Eastern European stabilization funds, protectionism versus “free trade,” and other issues, both real and distractions, while the financial underpinning of the entire European economic system is ablaze.

Just as Iceland was the first nation to become nationally insolvent due to bank failures stemming from the Global Economic Crisis, Austria may be fated to endure a similar disastrous outcome. Should Austria’s banks fail as spectacularly as did the Credit-Anstalt back in 1931, the impact on the world’s financial and economic order will be at least as catastrophic and likely much worse. It is indeed timely for Paul Krugman to state the obvious regarding the looming Austrian banking crisis, irrespective of the indignation pouring out of Vienna.

Will 2009 prove to be 1931 redux? The indicators favor the pessimists far more than the optimists. Nobel Prize winning economist Paul Krugman has issued a sober warning, which hopefully will not be drowned out by the hyperbole of reality-denying European politicians.

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Right now, frightening proportions of the banks of the major economies are either insolvent, close to insolvent or in otherwise poor condition. Though the major economies have already poured trillions of dollars of largely borrowed money into shoring up the balance sheets of failing banks, it has been a case of good money after bad. There may simply not be enough money available in the world to “fix” all the banks, which are rotting with the disease of toxic assets. Yet, without some form of effective, coordinated policy response on a strategic level to the financial component of this global crisis, all the other conversations ongoing in Rome with these illustrious finance ministers represents nothing more than side-talk on the decks of the Titanic.

U.S. Treasury Secretary Timothy Geithner and his G7 colleagues are pontificating about their robust stimulus deficit spending and pledges to avoid protectionism, while paying lip service to the catastrophic disintegration of much of the global financial architecture. As outlined on this blog in prior posts, almost the entire United States banking sector is insolvent; ditto for the United Kingdom. I have also drawn reference in another post to a leaked secret document from the European Commission, which seems to suggest that a large proportion of the Eurozone Banks are also infected with toxic assets to such a degree, they are also threatened with insolvency.

The financial cancer is spreading through the enfeebled limbs and arteries of the global credit and banking system. Time is running out for an effective and comprehensive solution. Yet, in imitation of Emperor Nero, the G7 finance ministers prefer to exercise their fiddles, accompanied by the lyrical singing of meaningless rhetoric, as the financial and economic world around them burns with agonizing ferocity.

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For More Information on “Global Economic Forecast 2010-2015” please go to the homepage of our website, http://www.globaleconomiccrisis.com

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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.

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According to Roubini, his latest calculations indicate that U.S. banks face potential losses from the credit crisis in the region of $3.6 trillion, a figure that is both stratospheric and apocalyptic, reaching a level previously beyond the worst nightmares of major financial analysts. Professor Roubini points out that with only $1.4 trillion in total capitalization, this means if his projection is accurate, the entire U.S. banking sector is insolvent. This is the equivalent of economic and financial Armageddon.

Last October, Treasury Secretary Paulson warned Congress that without an immediate injection of $700 billion into the financial system (all of it borrowed money) the entire global credit system faced imminent collapse. It appears that this money, designated TARP, has been used almost entirely by banks and financial institutions to shore up their rapidly eroding balance sheets. What Roubini’s numbers suggest is that the TARP is nowhere near enough money to recapitalize a banking sector that appears to be collectively insolvent.

Is the solution more TARPs? Putting aside the issue of moral hazard, we must comprehend that this is an economic and financial crisis that is global, not national. That means if the United States decides to bail out its banks through the largess of the taxpayers, it will either have to borrow the money, print it, or raise taxes to a level that will be draconian.

As the U.S. is reliant on foreigners to finance its fiscal and current account deficits, it will have to compete with many other countries also seeking deficit financing to salvage their own insolvent banks, the UK being a conspicuous example. Even with higher interest rates, it is unlikely that there is enough credit available to cover the total cost of bailing out the U.S. banking industry (it must also be factored in that the Obama administration plans on borrowing one trillion dollars for an economic stimulus program, not directly related to salvaging the banks). Printing the money and monetizing debt will lead to crippling inflation and the inevitable destruction in the value of the U.S. dollar. Finally, the level of increased taxation required to pay for full recapitalization of the American banks without resort to credit markets would be so severe, it is probably both politically and fiscally unsustainable.

With the numerical analysis of Nouriel Roubini adding a quantitative reality to the impending meltdown of the global banking sector in general and U.S. banks in particular, it appears that a bankers hell is in store for us all. In a perverse paradox, instead of banks lending to people, it will be the people called upon to save what can be salvaged from an insolvent banking system, even at the cost of economic ruin that may endure for generations.

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Entitled appropriately “Living on a Prayer,” the report concludes that UK banks are “technically insolvent.” The Brown government’s expenditure of nearly $400 billion to prop up British banks impacted by the Global Economic Crisis has almost entirely failed to curtail the affects of the credit crunch.

In a stealthy meeting at 10 Downing Street involving Prime Minister Brown, Financial Services Authority chairman Lord Turner and Bank of England governor Mervyn King, the implications of the “Living on a Prayer” report were digested. The purpose of this panicky pow-wow was apparently to conjure up some desperate last-ditch solution. According to media reports in the UK, Brown will probably throw another $150 billion in taxpayers money at the UK’s insolvent banks, desperately hoping that more deficit spending and mortgaging of the future will somehow repair the mistakes made by the “masters of the universe” whose casino capitalism is responsible for  incinerating the balance sheets of British banks.

The problem with Gordon Brown’s characteristic response, as with the TARP and Fed money gusher in the United States, is that we are dealing with a Global Economic Crisis, which means that there is not enough real money on the planet to plug up the collective insolvency of all the world’s major banks and credit institutions. Living on a prayer, indeed!

For More Information on “Global Economic Forecast 2010-2015” please go to the homepage of our website, http://www.globaleconomiccrisis.com 

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