Global Economic Crisis

The U.S. Commerce Department has just released data showing that the American economy shrank by 0.1 percent in the  fourth quarter of 2012. This data is seen as a shocking development, particularly after the claimed growth in GDP of  3.1 percent in Q3 of 2012. The miserable data for Q4 of last year marks the first contraction in GDP of the U.S. economy since the last recession of 2008-2009.

The commentators are already trying to spin the Q4 data, attributing it to, among other things, reduction in inventories and reduced military spending by the Pentagon. However, spin aside, it is clear that nearly five years after the supposed end of the last recession, the U.S. economy is still on life support, depending on a trillion dollars every year in deficit spending to remain afloat, and create artificial “growth” in GDP.  Now, despite the massive borrowing binge by the U.S. government and its policymakers, even tepid growth cannot be assured. At best, the American economy is at stall speed, and with increased talk by politicians in Washington of fiscal consolidation and austerity, the worst may be yet to come.

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Despite the attempt by statisticians to bend and twist the employment numbers to create the illusion of robust job creation in the  United States, even those manipulated numbers could not conceal the bitter reality; the U.S. has effectively zero job creation, with 150,000-200,000 additional job-seekers coming into the labor market each month. Officially, the American unemployment rate rose to 9.2 percent, while more credible unofficial estimates  exceed 20 percent.

The structural mega-deficits have failed to increase employment in the United States, and now President Obama and Congress are deadlocked on the issue of raising the debt ceiling. The ugly truth is that America is effectively insolvent. It can only pay interest on its debts by accruing more debt. This cannot end well.

The National Association of Realtors released its most current report on pending home sales; it was utterly dismal. April witnessed  a contraction from March of 11 percent;  year-on-year pending house purchases fell by 26.5 percent. It must be recalled that a year ago the U.S. housing market was already in feeble shape.

These numbers confirm that America’s residential housing market remains in pathetic condition. This massive share of U.S. economic activity, the faltering of which triggered the ongoing global financial and economic crisis, remains in pathetic condition. With no recovery in sight-and it must be recalled that housing is typically the leading edge of a real economic recovery from a deep recession, there is no clear path towards healthy economic metrics. This sobering statistic, in conjunction with other tepid economic indicators, including a weak employment market, highlights the fragility of the U.S. economy. At this point, it is only massive government deficits, projected at more than $1.6 trillion for the current fiscal year, that has prevented a continued massive contraction in overall economic performance in America. And, as I have pointed out before, massive public debt is no viable strategy for creating long-term sustainable economic growth.

According to the Congressional Budget Office, the U.S. federal government’s spending in February exceeded revenues by $223 billion. This staggering number is the largest American monthly deficit in history, and actually exceeds the entire U.S. government deficit for all of 2007, just prior to the onset of the global financial and economic crisis.

 The  monthly deficit number released by the CBO, combined with projections for a record federal deficit for 2011, clearly shows that the United States is trapped  in a spiral of structural mega-deficits, which are unsustainable and will inevitably lead to a sovereign debt collapse for America. This is made more certain with the continuing proof that the American political establishment is totally useless in responding to this acute fiscal emergency.

Sooner and not later, market forces, in particular the bond vigilantes, will intercede where the politicians in Washington have failed. The result will not be pretty, for the U.S. and entire global economy.

According to the non-partisan Congressional Budget Office, the annual deficit of the United States federal government will reach $1.5 trillion in 2011, a record amount in nominal terms. More alarmingly, the CBO projection exceeds 10 percent of the U.S. GDP for the first time since the onset of the global financial and economic crisis in 2008.

Two things need to be pointed out. The CBO forecast is not a “worst case” scenario but a conservative projection, which may possibly be exceeded. Secondly, this staggering structural mega-deficit follows on the heels of several previous annual U.S. trillion dollar annual deficits, in parallel with similar ratios of government deficit to GDP in many other advanced economies.

The continuing flood of red ink is rapidly hastening a “come to Jesus” moment for many indebted economies, and a catastrophic sovereign debt crisis looks increasingly likely for the United States.

Thomas Hoenig, President of the Federal Reserve Bank of Kansas City, has issued a stark warning regarding the ballooning U.S. federal government annual deficit and cumulative national debt. Hoenig told  the Pew-Peterson Commission on Budget Reform that massive deficits being  projected by the Obama administration would endanger the Fed’s ability to fulfill its mandate of maintaining stable economic growth and price stability.

“Without pre-emptive action, the U.S. risks its next crisis,” stated Hoenig. What this senior Federal Reserve official is saying, on the public record, is that the current U.S. fiscal policies are unsustainable, and unless halted and reversed in short order, will precipitate a hyper-inflationary depression.

Paul Revere has spoken. But who is listening? Certainly not the economic policymakers in Washington DC, who believe only small countries like Greece can face national insolvency. Sooner then they can imagine, they will receive an education  which unfortunately will cost their countrymen dear.

In an earlier post, I reported on the statement Chinese premier Wen Jiabao made at a press conference regarding his anxiety over the security of his nation’s vast investments in U.S. securities due to Washington’s wild and crazy fiscal policies. Well, it appears that his nervousness regarding the United States economy is growing rather than receding.

Premier Wen is touring Africa, where China in investing sizeable amounts of cash in strategic acquisitions. While in Egypt, and again at a news conference, Wen made the following statement to the international press:

“I hope that as the largest economy in the world and an issuing country of a major reserve currency, the United States will effectively discharge its responsibilities. Most importantly, we hope the U.S. will keep its deficit at an appropriate size so that there will be basic stability in the exchange rate that is conducive to the stability and recovery of the world economy.”

With the value of the U.S. dollar continuing to plummet as gold prices rise, and America’s massive deficit spending continuing unabated, I wonder how China will react when the Obama administration decides on a new stimulus spending package, as will almost certainly be the case in early 2010. Perhaps Beijing may be reluctant to continue acting as Washington’s revolving credit card. But without China’s largesse, who then buys U.S. Treasuries, and most importantly, at what bond yield?  I believe that the days when Washington could fund its deficits at absurdly low interest rates may be about  to leave us for good.

In the New York Times the oracle of Omaha, billionaire investor Warrent Buffet, has written a powerful piece warning about the growing danger of America’s expanding debt to GDP ratio. While defending massive deficits in the short run as necessary to save the financial system from collapse and economy from imploding, Buffet warns that in the long term an answer must be found for America’s fiscal imbalance.

“Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress,” concludes Buffet in his piece.

If the fate of fiscal sanity lies with the same Congress that is spending money like a fleet of drunken sailors, what are the odds that America will avoid hyperinflation?

No one can accuse Obama of not recognizing that the U.S. faces a severe economic recession. Most of his administration’s initial activity has centered around crafting policy responses to the recession, primarily involving the unprecedented expenditure of borrowed money in an attempt to revive growth. However, the very character and essence of his administration’s economic policymaking reveals the lack of comprehension of how dire and unique the Global Economic Crisis is on the part of President Obama. At his core, Obama believes that the American economic system is basically sound, but slid into a severe recession because of irresponsible behavior on the part of some actors within the financial oligarchy. Hence, by restoring growth through deficit spending and enacting a new regulatory regime to restrict the destructive greed of some Wall Street tycoons and bankers, we can return to the happy economic days of yore. In effect, Obama is acting like a nostalgia buff, hoping that the correct policies will recapture the solid economic model of pre-George W. Bush America. Unfortunately, this view of America’s political economy is mythological. The U.S. economy was unhinged under the presidency of Bill Clinton as much as it has been under Bush, yet Obama has chosen Clintonites to serve in the most important economic policymaking positions in his administration. Cheerleaders for a failed model will not lead America to a new economic Jerusalem.

A major part of the problem Obama is facing is philosophical. He is following a conventional view of counter-cyclical economics; when a recession occurs, the sovereign can go into debt and use borrowed money to artificially increase demand and thus arrest the decline in growth. Once the recession is arrested, government fiscal policy can return to a more prudent policy of balanced budgets, as restored economic growth eliminates the need for the government to maintain demand. Sounds simple, as this has been enshrined as the recession-fighting bible created by economist Maynard Keynes. The only difference, the Obama administration would argue, is that this recession is much bigger than previous economic downturns, and therefore requires much more significant deficit spending. Otherwise, the Keynesian model remains unaltered.

This perspective by the Obama administration, in my view, is myopic. Like many contemporary politicians and economists, President Obama and his senior economic advisors have misread Maynard Keynes. Contrary to public perception, Keynes was no economic radical, but a centrist in dealing with the challenge of managing economic cycles within a capitalist system. Though Keynes did believe deficit spending was justified as a means to stimulate economies in deep recession, he also advocated budget surpluses during times of relative prosperity. In effect, Keynes believed in “rainy day” economics; in times of plenty you put away a little fiscal cushion that can then be spent during a recessionary period to enable the sovereign to maintain economic demand during a time of private sector contraction and declining tax revenues. This is actually a conservative philosophy that many farmers are familiar with.

In the United States, even during times of sustained economic growth, massive government deficits have been de rigeur during the past nine years, in the process doubling the national debt. There is no rainy day fund to speak of, so the staggering deficits that are now being enacted by the Obama administration are, in my judgement, fiscally unsustainable. Already, the projection for the current fiscal year’s deficit has risen by $200 billion to a stratospheric $1.8 trillion; my own estimate is that it will top $2 trillion. Looking into the future, the current Obama fiscal agenda foresees annual deficits of $1 trillion or more for several years into the future, gambling that the recession will be short-lived, with growth returning as early as the last quarter of 2009, leading to increased tax revenue and declining deficits.

But are we in a recession? The current downturn is already the most protracted and destructive since World War II. However, there is another ingredient that has been added into this toxic economic stew: globalization. We are in a Global Economic Crisis in which synchronized contractions across the world create multiple negative feedback loops that reinforce the underlying negative causation. The subprime collapse in the United States crippled banks in the U.K. and devastated Japan’s export machine; the Eurozone economic contraction is now impacting America’s export driven manufacturers. When China’s exports to America decline, commodity exporters and peripheral economies that supply value-added components to China’s export goods get whipsawed. This phenomenon is occurring at an accelerating pace, despite attempts by the Obama administration to portray minor statistical anomalies to the prevailing trend as “rays of hope” and “green shoots.” Reading tealeaves is no substitute for critical analysis.

The ongoing Global Economic Crisis has proven to be so severe, sustained and virulent that if it is not yet a global depression, it is embarked on that dangerous trajectory. However, another flaw in the Obama administration’s approach is its failure to recognize that a substantial part of the financial system is rotten to the core, and not merely a fundamentally sound system with a few bad applies populating it, who can be restrained by improved regulation. More importantly, the Obama economic team seems to have convinced themselves that “mind over matter” is the best palliative for the nation’s stricken banking system. When a sovereign’s private banks are essentially insolvent and not engaged in normal loan activities, this is another manifestation of an economic depression. Rather than admit the truth, the Obama administration cobbled together a make-believe series of bank stress tests, which supposedly show that America’s banking system, with a few minor problems, is essentially sound and fiscally healthy. This conclusion is an utter fraud, designed to artificially create a climate of economic confidence. It won’t work, and by delaying an honest approach towards the nation’s crippling level of bank insolvency, the policymakers are insuring that the final cost of the inevitable day of reckoning will be far more costly to the taxpayers.

The economist Hernando de Soto has captured the essence of the Global Economic Crisis as few others have. In his view, the Western world, and principally the United States, who have for so long railed against Third World inefficiency and corruption, have created the largest, most toxic shadow economy in the history of human civilization. More than one quadrillion dollars in unregulated financial derivatives paper, according to de Soto, has destroyed inter-bank and financial counterparty trust to such an extent, credit flows have largely frozen despite unprecedented levels of taxpayer-funded borrowing to bailout the global financial system. Nothing short of an honest accounting of the true value of the toxic assets underlying these colossal derivatives products, which equal twenty times the entire world’s GDP, can put the global economy on the road to recovery. Until these unregulated “unknown unknowns” become fully transparent, all other government interventions, including Obama’s massive borrowing binge, are doomed to failure. Sadly, as the bogus bank stress tests reveal, President Barack Obama and his Clinton-era economic advisors have financial transparency as the least important objective on their agenda.

It seems that President Obama, despite his obvious leadership gifts and towering intellect, has chosen to place his faith in a team of advisors who are tied to the Wall Street oligarchy by an umbilical chord than cannot be severed. In a sense, Obama is following the path of the last Soviet leader, Mikhail Gorbachev, who also sincerely wished to resolve his country’s economic problems, but believed that the system was fundamentally sound and only required a modicum of reform to correct its distortions. Only after the collapse of the USSR did Gorbachev conclude that the system itself was unsustainable. Now it appears to this observer that President Obama may be fated to travel the same path as Gorbachev, and like him end up as a valiant failure.

Not only did the statisticians of the U.S. government miss the true rate of economic descent in Q4 by a country mile; they were completely dislocated from the true rate of economic disintegration afflicting all strata of U.S. econometrics. Take for example exports, which supposedly showed some growth in the preliminary estimate, but are now shown in actuality to have been in decline. Ditto for inventory expansion. If anything, the corrected Q4 numbers tell us that the American economy is in free fall, and neither the public nor private sector analysts can give us a reliable appreciation of how severe the economic decline is in the United States in anything approaching a timely manner. In contrast, the Japanese government at least has been able to track its own economic implosion with much more accurate and timely numbers.

I point out the wide gap in the preliminary Q4 number and the corrected results because it is a reminder to be weary of the likely attempts by both government and Wall Street to downplay the American economic contraction while hyping the projected upside. The Obama administration has just unveiled a budget that projects a stratospheric deficit of $1.75 trillion dollars, a number equivalent to roughly 12% of the GDP. In their budget projections, Obama’s economic advisors are projecting a total GDP contraction in all of 2009 of just a little over one percent. Based on the revised Q4 contraction of negative 6.2%, how can the Obama administration believe the American economy will rebound in the middle of 2009 and sustain a modest decline in annual GDP? The answer is that President Obama’s economic team needs a GDP decline limited to just above 1% to keep the administration’s promise of cutting the gargantuan deficit in half by the end of its first term in office, at least on paper.

Political expediency may dictate how those in Washington deal with economic projections, however the Global Economic Crisis is not a respecter of political requirements. The U.S. is in a severe recession, and likely entering an economic depression. Any belief that the United States will halve its deficit while continuing with its accelerated public spending is pure fantasy.

As with the revised Q4 number on GDP, the unvarnished data that is yet to emerge throughout the course of 2009 will end up being far worse than is being currently forecast.