Global Economic Crisis

An additional signpost on the road to a double dip recession for advanced economies came from the latest briefing note issued by the International Monetary Fund. According to the IMF, global economic growth is likely to shrink in the last quarter of 2010. In essence, this means that the supposed recovery, artificially stimulated by unprecedented levels of public debt, has in effect failed.

The contents of the IMF briefing note contains other indicators of growing concern about the future trajectory of the global economic crisis. There is a stern warning about unsustainable public deficits  in advanced economies that need to be reined in; imbalance in the level of exports versus imports in these same economies; growing risks of proliferation of sovereign debt crises similar to what Greece is currently experiencing.

Perhaps the most sober element in the IMF report is a warning about the ramifications of the worsening home repossession crisis in the United States. Since the U.S. housing market was ground zero for the 2008 global financial crisis, this would seem to indicate that the other shoe is still to drop on American real estate weaknesses and the further damage it may inflict on the global economy.

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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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First it was the supposed citadel of free market capitalism, the United States, insisting that its beleaguered taxpayers must bailout the private sector Wall Street firms and banks, despite the nation’s public finances being  deeply in the red. Now, in macabre replication, all the nations that comprise the European monetary union and employ the euro as their common currency must bailout Greece, now threatened with national insolvency . The concept of moral hazard is therefore confined to the trash heap of history, as it was already disposed of in the U.S.

When the European monetary union was instituted, member states had to guarantee that their annual fiscal deficits would not exceed 3% of GDP. There is also a no-bailout clause in the Eurozone agreement, the implication being that nations utilizing the euro would establish the gold standard for fiscal prudence. Well, we have all witnessed what happened to that supposed gold standard. Successive Greek governments lied about the country’s fiscal problems, and with the help of outside Wall Street “consulting,” constructed stratagems to make it appear that the Eurozone deficit stipulations were being adhered to, when in fact Athens was drowning in a sea of fiscal debt. Even today, it is not known for sure how bad the annual Greek government deficit is, but most recent estimates put it at 14% of GDP, a figure so far in excess of the 3% Eurozone stipulation that it  boggles the mind that European taxpayers are being told by their politicians and the IMF that they should trust the politicos in Athens when they proclaim that their new austerity measures will magically shrink the Greek deficit to the required 3% in only a few years-though the estimate of when that  event will occur keeps being pushed back. In addition, most financial observers concur that the savage austerity plans hatched in Athens and Brussels with the IMF and Eurozone, will condemn the Greek economy to a prolonged and severe recession, making a mockery of claims that future economic growth will eventually improve the Greek fiscal imbalance.

In reality, Greece is insolvent, a point that Professor Nouriel Roubini has recently elaborated on, with a warning that a bailout that does not recognize that the nation is bankrupt will waste an enormous amount of public money. Even more surreal, the very nations being asked to bailout Greece are themselves in deficit, in some cases having a national debt and yearly deficit to GDP ratio as bad as that which brought down Greece’s public finances. Several of the countries that will be contributing public money to prop up Greece are on everyone’s hit list of the next Eurozone nations to be the target of the  unfolding sovereign debt crisis and bond vigilantes. These include Portugal, Spain, Ireland and Italy. We may soon witness the absurdity of nations that are experiencing their own debt crisis but must borrow additional money to bailout Greece, only to soon be in the same predicament as Athens, joining Greece in begging the IMF and their fellow Europeans to grant them a bailout.

Throughout the unfolding Greek debt crisis, politicians in Europe have sought  to pretend that the problem was only one of jittery markets, and things would return to normal. Before pleading for a financial lifeline of $146 billion from the IMF and Eurozone, Greek Prime Minister Papandreou gave numerous assurances that his country would not need a bailout. Now we are being told that countries that are themselves suffering various levels of debt problems should add the massive costs of a Greek bailout to their sovereign credit cards, and somehow this will all work out.

I just don’t see the logic of asking a terminally ill patient to provide a blood transfusion to a corpse.

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During a panel discussion conducted by the Milken Institute on the Greek debt crisis, as well as in comments to the media, Professor Nouriel Roubini relayed a stark assessment on the situation. His assessment of the planned bailout of Greece by the International Monetary Fund and the Eurozone nations, especially (if reluctantly) Germany, was damning. The bailout will not work, Roubini emphasized, as the problem confronting Greece was not one of illiquidity but rather the far more dire circumstance of insolvency.

Roubini made several references to Argentina’s fiscal crisis at the turn of the current century, which culminated in default on the national debt because of egregious errors made by policymakers. The failure of policymakers in the Eurozone to recognize that Greece is insolvent and requires debt restructuring, rather than a bailout in the hope of calming markets, will make a bad situation far worse, and waste an enormous amount of public money.

“Greece is just the tip of the iceberg, or the canary in the coal mine for a much broader range of fiscal problems,” said Roubini. The disorderly debt default of Greece would spread contagion throughout other highly leveraged economies in the Eurozone, he warned.

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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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Economic and financial history seems to be repeating itself, in an utterly surreal example of hubris and mockery. When residential real estate prices in the U.S. began collapsing and the sub-prime mortgage market imploded, Federal Reserve Chairman Ben Bernanke and his then sidekick, Treasury Secretary Hank Paulson, boasted that their brilliant intervention had “contained” the crisis, preventing it from spreading into the broader American economy. Well, in hindsight, they were partially right. The sub-prime debacle did quite spread, or rather only spread, to the wider U.S. economy. It merely metastasized across the world, bringing about the global economic crisis. It now appears that the head of the International Monetary Fund is doing the same thing.

Dominique Strauss-Kahn, the scandal-prone managing director of the IMF (he had previously been involved in a highly publicized intimate tryst with a female employee at the IMF, triggering a legal investigation into his conduct) has just offered his pontification on the potential systemic risks connected with the ongoing Greek public debt and deficit crisis. He told the news agency Reuters that “there was no reason to expect that Spain and Portugal will need external financial support to get to grips with their public debt.” The IMF boss, in essence, claims that the Greek debt crisis will not spread to other regions of the Eurozone experiencing high levels of public debt to GDP.

His calming words will probably fool few investors. Obviously, Dominique Strauss-Kahn has engaged in PR spin, as his attempts at downplaying the growing public debt to GDP ratios throughout the Eurozone and in the UK, not to mention the United States, are absurd beyond all measure. More importantly, he has illustrated  in his own uniquely obtuse fashion that the IMF is an increasingly irrelevant institution as the mounting public debt levels ensure that a massive sovereign debt crisis is ahead of us all.

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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.

global economic crisis Dominique Strauss-Kahn, IMF, international monetary fund

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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