Global Economic Crisis

The International Monetary Fund has issued its latest quarterly report, and in effect it talks out of both sides of its mouth. It gives the supposedly happy news that the IMF experts have revised upwards their forecast on global growth, now estimated at 4.6%. However, in contrast with this dose of economic optimism, the IMF report also issues a sombre warning about the perpetuation of the European debt crisis and its impact on the overall global economy.
 
According to the IMF’s director of monetary and capital markets department, governments in Europe must take “credible and decisive action,” if confidence in European banking and financial institutions is to be restored. In the face of this understated yet clear warning, the IMF’s boast that the danger of a double dip recession is “very unlikely” strikes this observer as being utterly preposterous and nonsensical.

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Ever since the monetary spigots and fiscal deficit pump primers were set on overload in the wake of the global recession that erupted following the Wall Street calamities of 2008, many economists have warned about the danger of a double dip recession. In other words,  the underlying weakness of the advanced economies most impacted by the recession  is so severe, an anaemic recovery may be shortly followed by a quick return to economic contraction. This is in fact what is increasingly likely to occur.

After incurring a flood tide of debt to cover the losses of the private banking sector, many advanced economies doubled down their bets by unleashing another torrent of debt for economic stimulus activity. The Keynesian policymakers assumed that the massive dose of public debt would quickly restore economic growth, thus ending the global economic crisis.

What has in fact  happened is that unprecedented levels of massive growth in the public debt has, at best, bought a feeble, anaemic and jobless “recovery,” with many economists calling for additional deficits for more stimulus spending. However, the bond markets have begun to react to the increasingly unsustainable levels of public debt. Thus, in short order we saw the Greek debt crisis evolve into the European debt crisis. Sovereigns that once boasted of their deficit spending are now in a panic, desperately trying to find ways of shrinking their structural deficits. The UK is joining with major Eurozone countries such as Germany in warning their citizens that austere times lie ahead, as governments reverse direction and begin to cut spending. These sombre voices are being echoed by the International Monetary Fund (IMF) and G20, as those officials, largely American, who are still calling for more deficit spending are now being drowned out by increasingly desperate European sovereigns, who have caught the scent of public default and national insolvency, and the apocalyptic economic repercussions that would ensue.

Now, what happens to a weak and artificial recovery from the worst economic recession since World War II when the fiscal deficits which alone underpin this so-called recovery are sharply curtailed? The answer is clear except to the politicians; double dip recession lies ahead, which will likely transform the global economic crisis into a full-blown synchronized depression.

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We all exist in an interconnected global economy, meaning a major financial crisis in one country is virtually impossible to contain before it has metastasized abroad. The financial implosion that began with the collapse of Lehman Brothers in September 2008 was an object lesson in this aggregation of global financial fragility, as credit markets worldwide froze solid. We are now seeing a similar though far more dangerous phenomenon unfold, this time involving sovereign debt in Europe as opposed to private investment banks on Wall Street. The United States is far from immune to the long-term consequences of the Eurozone’s public debt and currency crisis.

We all recall the state of petrified panic that engulfed key political actors in major economies throughout the world as LIBOR and Ted spreads soared to the heavens in the fall of 2008. Policymakers made the fateful decision to dump the impediment of moral hazard, bailout Wall Street at taxpayers’ expense, and to transfer private toxic debt into public debt. This policy measure was further exacerbated by massive increases in deficit-driven stimulus spending to offset the economic contraction that resulted from this same credit crisis.

Ever since, policymakers have engaged in an orgy of self-congratulation, praising themselves for “saving the world” from another great depression. However, not so clever. The massive increase in public debt in virtually every advanced economy has now given rise to the next phase of the global economic crisis. We are in the midst of the initial stages of a full-blown sovereign debt crisis that potentially may inflict far more havoc on the global financial system than the turmoil that erupted less than two years ago.

A few months ago, the Eurozone politicians claimed that there existed a sovereign debt crisis only in Greece, that it was contained and would not even require an actual bailout, only the possibility of aid if it was needed, the implication being that this reassurance would be sufficient to calm the bond markets without any Eurozone rescue money actually flowing to Athens. Then, as the situation deteriorated further, we were assured that only a few tens of billions of Euros would put Greece back on its feet. When the markets weren’t fooled, the increasingly frantic Eurozone politicos offered a vastly higher level of bailout cash for Greece, translating into more than $140 billion. However, even that princely sum didn’t stop the spreads on Greek public debt from expanding, while Spain, Portugal and Italy came under increasingly harsh scrutiny from the bond vigilantes.  The result is a joint Eurozone and IMF bailout package for all the so-called PIIGS nations in the Eurozone (Portugal, Ireland, Italy, Greece and Spain) totalling a cool $1 trillion.

The unprecedented scope of the Eurozone  bailout package in its latest form (bereft of a plausible explanation as to how this money would actually be raised),  saved the euro from further deterioration for all of 24 hours. The embattled currency has now resumed its descent into fiscal oblivion, as global markets correctly question how other European nations that are themselves faced with massive structural deficits and ballooning public debts can bailout the PIIGS. There is a growing consensus that Europe is confronting a mounting  and insoluble sovereign debt crisis. In the short run, the U.S. is the beneficiary, as a flight to safety sentiment channels investors towards Treasuries as a safe haven. However, the economic consequences of the crisis in the Eurozone, combined with the public debt crisis in the UK that the new government is committed to resolving through severe budget cuts, will inevitably imperil the U.S. economy’s fragile recovery from the Great Recession, at a time when America itself is faced with structural mega-deficits far into the future.

The International Monetary Fund has now weighed in with its own expression of concern on the looming danger of a sovereign debt crisis impacting all major economies. The IMF’s recent fiscal monitor projects that by 2015, the proportion of public debt to GDP will reach 110% in the U.S., 250% in Japan and 91% in the UK, with comparable figures for most other large economies in Europe.  These numbers do not even recognize unfunded contingent liabilities, which in the United States would add another 400-600% to the debt to GDP ratio.

What began in Greece and now grips the entire Eurozone economy will inevitably impact the United States. When Washington is compelled by the bond market to finally confront the full force of a sovereign debt crisis, it may prove as impotent in the face of global market forces as is the Eurozone. Furthermore, when that day arrives, unlike the Wall Street bailout of 2008, there will be no taxpayers in some far-off magical land that will be able to bailout Uncle Sam.

We are indeed living through interesting times.

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With the markets giving the proverbial “thumbs down” to the deficit-financed Eurozone/IMF bailout of insolvent Greece, the value of the once might euro in relation to a basket of key currencies is sinking at warp speed. It is quite clear that the Eurozone bailout is a panicked-induced  attempt to save the euro from its own contradictions. However, it is a futile attempt that is doomed to failure, in my view.

A monetary union  involving 16 vastly different economies with asymmetrical fiscal policies is nonsensical in the extreme. A common currency may have made sense for a limited number of major European economies, however the current matrix is unsustainable, despite the willingness of European politicians to bankrupt their citizens in a fool’s errand attempt to save what is doomed.

Greece is now convulsed in social unrest, an entirely predictable outcome that is bound to get more serious as the full severity of the IMF and Eurozone austerity measures take full affect on the Greek workers and taxpayers. Supposedly this is all being done to prevent a contagion from infecting other European economies with high deficit to GDP ratios. The painful reality is that the pandemic is already beyond the borders of Greece. It will ultimately savage every nation-state existing in a neo-Keynesian fantasy of  infinitely-expanding sovereign debt. This includes not only the Eurozone, but also the UK, Japan and ultimately the United States.

Greece is a window into the next phase of the global economic crisis. The euro may very well be an early casualty of what is unfolding into the deepest systemic crisis of modern capitalism since the Great Depression of the 1930s.

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For more than a year, I have been warning in my blog of the acute risk to the global economy stemming from out of control public spending in major and advanced economies. My new book , “Global Economic Forecast 2010-2015: Recession Into Depression,” amplifies my warning  with data  and trend analysis. The bottom line in my forecast: the current level of public debt and deficits in large economies, in particular the United States and United Kingdom, is unsustainable, and will inevitably lead to a profound sovereign debt implosion, sparking a synchronized global depression (my book is available on Amazon.com, can be downloaded as an Amazon kindle, or can be purchased directly from this website, http://www.globaleconomiccrisis.com). Now, a growing chorus of authoritative figures in the world of economics and finance are echoing my warnings.

As reported in Bloomberg, the International Monetary Fund’s first deputy managing director, John Lipsky, speaking at the China Development Forum in Beijing, said “this surge in government debt is occurring at a time when pressure from rising health and pension spending is building up,” leading to major economies being confronted with “acute” fiscal challenges. The IMF official warned that even if these countries exit from their so-called economic stimulus measures, this won’t even come close to confronting their growing public debt gap.

Lipsky’s remarks follow on the heels of another bleak warning that emerged from the co-chief investment officer at Pimco,  Mohamed El-Erian, which I reviewed in a previous post.  He spoke frankly of the danger that sovereigns will attempt to inflate away their excess public debt, or even default.

When  individuals of the rank of  Mohamed El-Erian and John Lipsky discuss openly, on the public record, the alarming growth of public indebtedness, then only an ostrich can conclude that there exists no sovereign debt crisis.

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The G20 will be convening this month to no doubt boast about their cooperative efforts to reign in the global financial and economic crisis. The reality is that, at the price of saddling future generations with an immense debt burden, they have temporarily stabilized the financial system. But at what price?

While government deficits are artificially showing quarterly GDP growth or stability after the free fall in Q1 of 2009, consumer spending is contracting due to massive unemployment and stagnation or reduction in real wages.

The head of the IMF, Dominique Strauss-Kahn, recently told the French newspaper LeMonde, “Who will replace the U.S. consumer to power global growth? We have left the financial crisis, but we are still in the economic crisis. ”

The IMF head is correct about the economic crisis. As for the financial crisis, it will be back, with vengeance.

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A few weeks before these antics a more sober assessment of America’s banking health was delivered at the National Press Club in Washington by Dr. Martin D. Weiss, the head of Weiss Research, a global investment research firm. Previously, Weiss had accurately forecast the demise of Bear Stearns and the implosion of the U.S. investment-banking sector. However, at the National Press Club he offered a more chilling prediction: 1,568 U.S. banks and thrifts risk failure. Included in that number are several of the largest American banks, including J.P. Morgan Chase, Goldman Sachs, Citigroup, Wells Fargo, Sun Trust Bank and HSBC Bank USA. The numbers and depth of the banking problem highlighted by Dr. Weiss are far larger and much more ominous than has been portrayed by the Federal Reserve, Treasury Department and FDIC. He backed up his dire analysis with documentation and precise mathematical modeling. For example, he refers to the government’s justification for a hideously expensive taxpayer bailout of AIG, based on the firm’s exposure to the fragile investment vehicles known as Credit Default Swaps, or CDS. The policymakers maintain that AIG’s $2 trillion in CDS exposure represented an unacceptable systemic risk, meaning AIG was “too big to fail.” However, Weiss points out that Citigroup alone holds a portfolio of $2.9 trillion in Credit Default Swaps, while J.P. Morgan Chase possesses a staggering $9.2 trillion of these toxic instruments, about five times the exposure that led AIG to demand that the government rescue it, or see the global financial system implode.

The essential point Dr. Weiss made at his press conference is that the degree of exposure U.S. banks have to a variety of toxic assets is beyond what the U.S. government and, by extension, the American taxpayer is financially capable of rescuing. Continued bailouts of insolvent banking institutions will not repair a broken financial order, but may very well cripple the overall economy.

Earlier, NYU economics professor Nouriel Roubini had already gone on record as declaring that much of the U.S. banking sector was functionally insolvent, and that bailing out zombie financial institutions would only replicate the Japanese “lost decade” of the 1990s, when Tokyo’s preference for keeping alive insolvent banks instead of closing them down led to a prolonged L-shaped recession. Roubini and other critics of both Bush and Obama administration policies on bank bailouts have looked to the Swedish model for resolving a profound banking crisis, which involved temporary short-term nationalization, closing down insolvent banks, while those banks that can be salvaged are cleaned up of their toxic assets, recapitalized and then sold back to the private sector. “You have to take them over and you have to split them up into three or four national banks, rather than having a humongous monster that is too big to fail,” Nouriel Roubini has argued.

According to the International Monetary Fund, the global financial and economic crisis has already created more than $4 trillion in credit losses due to toxic assets. If nothing else, the IMF estimate on the scale of the economic and financial disaster thus far should compel the Washington political establishment to face the painful yet necessary truths regarding America’s precarious situation. However, it appears that fantasy is preferred over reality within the corridors of power.

The procrastination of policymakers in Washington in facing dark reality, and preference to avoid any public takeover of troubled banking institutions while simultaneously subsidizing these financial dead men walking with almost unlimited taxpayer funds, at the same time maintaining the fiction, as Timothy Geithner has just done, that all is basically fine with the “vast majority” of U.S. banks, is to insure the inevitability of a systemic banking collapse in the United States. The conglomeration of reckless, greed-induced banking practices by the oligarchs of finance and inept, reality-denying policymakers is sending much of the American banking sector on a Wagnerian death ride into a financial apocalypse. Many of the U.S. banks are in fact doomed to fail, and no contrived stress test or Geithner speech can alter that outcome. And that isn’t even the worst part. For when mass banking failures occur in the United States and overseas, a global economic depression will be an irreversible outcome.

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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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It was only back in January that the IMF had estimated that toxic assets tied to the United States stood at $2.2 billion, while NYU professor of economics Nouriel Roubini provided a more sobering analysis that placed a figure of $3.6 trillion regarding toxic garbage sitting on global balance sheets, half that figure being directly tied to U.S. financial institutions. The revised IMF numbers, in my view, tell us two things: 1. The erosion in asset values across the world is accelerating and 2. No

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There is not even a glimmer of optimism in the IMF forecast, except in the sense that some regions will contract at slower levels than others. Japan is projected to decline by 5.8 %, with lower but still shattering levels of economic contraction in the United States, the United Kingdom and Eurozone. Emerging markets, especially Eastern Europe, are assessed as being particularly vulnerable to the turbulence being unleashed by the Global Economic Crisis. “The risks are largest for emerging countries that rely on cross-border flows to finance current account deficits,” concludes the IMF in reference to the impact the global financial crisis and credit crunch have had on the debt-dependant economies of Eastern Europe.

Reading between the lines of the IMF forecast, it is clear that the contraction ratios would be even more severe, but are in effect being masked to a certain degree by so-called economic stimulus programs. In effect, future tax money is being borrowed to artificially create employment in the near term. However, the IMF report alludes to the challenges to be faced in 2010, when less stimulus spending is projected, especially in Europe. This is already a source of contention between the United States, which is currently projecting a deficit of 12% of her GDP, and the European Union where, in comparison, a much lower ratio is being allocated within the Eurozone. The UK, however, is forecast by the IMF to have attained a fiscal deficit in 2010 that will comprise 11% of her GDP, nearly the same percentage as is the case with the US federal budget.

With deficits soaring and projections of global economic contraction multiplying, the U.S. Federal Reserve has made its own unique contribution to the toxic brew being stirred in the midst of our worldwide economic catastrophe. As I have previously warned in my earlier blog comments regarding Ben Bernanke and quantitative easing, the Fed has now officially announced that it will fire up the printing presses and conjure out of thin air $1.2 trillion of freshly minted fiat currency, which it will utilize for purchasing Treasury bonds and mortgage-backed securities. This is an act of desperation, devoid of any long-term strategic framework. In a panic to achieve a short-term reversal of economic fortunes in the U.S., the all-powerful Federal Reserve has embarked upon an experiment in quantitative easing and government debt-monetization that will inevitably unleash the dangerous prospect of hyperinflation. Defenders of the Fed’s reckless gamble with America’s fiscal and monetary health will argue that currently deflation is a much greater danger than hyperinflation. This is accurate only in a very short-term time horizon. If anything, the Global Economic Crisis has shown how powerful financial and economic currents can be turned around on a dime. Last summer, the price of oil skyrocketed, reaching levels of nearly $150 per barrel, with serious financial analysts projecting a much higher price in the near future. Within a matter of weeks, the world witnessed a radical reversal in the price of oil and other commodities. I mention this as a warning that disastrous policy measures being enacted by the Fed can transform deflation into hyperinflation much more rapidly than can presently be envisioned.

Between news bulletins concerning the IMF and World Bank reports that are forecasting the most severe global economic contraction in 60 years, and the $1.2 trillion in make-believe money being manufactured by the Fed, it is inexplicable why major stock markets are undergoing a rally of sorts. Could this be the calm before the storm?

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