Eight decades ago the stock market crash of 1929 sparked the Great Depression, an economic crisis without parallel-until now. The 1930s were dark times of economic contraction, only alleviated to a modest degree in the United States by the New Deal of President Franklin D. Roosevelt. It would take the massive public works project known as World War II to bring the Great Depression to a close in the United States. The postwar economic boom in the U.S. ultimately revived the economies of Western Europe and Japan.
Now that the world is engulfed in a global economic crisis of staggering ferocity, does it mean another Great Depression is underway, and will it match the 1930s in its incessant demand destruction? The very bad news is that the Global Economic Crisis will ultimately prove far more devastating that the Great Depression. That is my projection, and I base it on a number of assumptions that appear to be supported by rapidly emerging macroeconomic data.
The American consumer has been the driver of the global economic expansion that impacted the Eurozone, the BRIC countries (Brazil, Russia, India and China), Southeast Asia and Japan and emerging markets. The capacity of Americans to consume was not based on intrinsic productivity but rather on debt from overseas creditors, further lubricated by irrationally loose monetary policies enacted by the U.S. Federal Reserve. The American consumer has been leveraged to a level that is unsustainable, and that bubble has burst.
The first symptoms were manifested in the sub-prime mortgage meltdown. A complex architecture of financial engineering exported toxic securitized paper investments based on these non-performing sub-prime loans. The result has been the virtual destruction of the financial world as we knew it, with the extinction of many of the largest American investment houses, some of which had been in existence for more than a century, having weathered the Great Depression.
While the financial world and now sovereign governments are currently inundated with the consequences inflicted by the sub-prime meltdown, which have cost trillions of dollars, much worse is about to be set loose on the global house of financial cards. There are other asset bubbles that will be popping with lethal force.
While sub-prime mortgages continue to devastate the American housing market, near-prime and prime mortgages are about to get hammered, as the over-leveraged American consumer becomes financially debilitated by rapidly rising unemployment rates, restricted access to credit and collapsing value of their retirement funds and household equity. Car loan delinquencies and credit card defaults will also accelerate, while consumer spending in the United States plummets, leading to the next asset bubble: commercial real estate. Retail trade declines will bring about a horde of commercial bankruptcies and foreclosures, creating vast square footage of vacant offices and storefronts. Shopping malls will become deserted, leading to unpaid commercial mortgages that will rival the sub-prime disaster in intensity.
An American Government that is already consumed with mountains of debt may promise to bail out every American consumer and business, however this is just not possible in the real world. Yet, this is the course the incoming Obama administration seems determined to follow. And leading the charge will be Tim Geithner, Barack Obama’s nominee to succeed Hank Paulson as Treasury Secretary.
Paulson of the $700 billion TARP debacle, preceded by his numerous wrong assumptions about the direction of the U.S. and global economy, was clearly a disastrous Treasury Secretary for coping with the onset of the Global Economic Crisis. However, will Geithner be an improvement? A revelation just released raises disturbing doubts. It has now been disclosed that the man President-elect Obama wants to entrust the Treasury Department to, at a time of the gravest economic crisis, failed to pay $34,000 in back taxes. Failure to pay $34,000 in back taxes? This is the genius supposed to run the Treasury Department, which supervises the IRS, and strategize our way out the current global economic disaster? This leads to another signpost on the road to global economic catastrophe. When excellence in leadership is essential for coping with the Global Economic Crisis, throughout the world the political establishment is represented by mediocrities. Mister Thirty-Four-Thousand in back taxes is a metaphor for this failure by the global political elites to identify and select the most competent professionals to confront the world’s most chronic economic disaster.
When one aggregates the cumulative affects of the asset bubbles about to burst with incendiary destructiveness, factoring in mediocre decision makers, the case for a crisis as bad as the Great Depression is solidified. There remains another element that will make it much worse.
In the 1930s the world was not as financially interconnected as it is today. Globalization has massively increased the vulnerability of the world’s financial and economic system. To take one example, a corrupt stock or bond trader in Singapore or Paris can, by manipulating his computer, gamble away billions of dollars of his company’s assets, undiscovered until calamity has struck. Every day trillions of dollars is transacted at the speed of light, much of it unregulated, particularly with those mysterious entities known as hedge funds. The derivative products they have engineered have accrued to the stratospheric level of hundreds of trillions of dollars, unmonitored by any governmental authority. In essence, a vast global financial superstructure has been erected on a foundation of quicksand as fragile as the worst of the sub-prime securities. As the global economy sinks, hedge funds will begin to deleverage and liquidate, in effect multiplying the already catastrophic global economic downturn. The result: global economic Armageddon.
The Great Depression led to the most destructive war in the history of human civilization. Will the Global Economic Crisis so disrupt social stability and international relations that an even more terrible global conflict erupts? It may be that however calamitous the financial impact of the Global Economic Crisis becomes, it will be the inevitable geopolitical consequences that will exceed our worst nightmares.