Global Economic Crisis

The credit default swaps on Dubai’s debt immediately climbed by 90 basis points, as investors staggered at the prospect of a major sovereign debt default. Other Persian Gulf emirates may also be at risk. However, the Gulf is only one region that is seriously exposed to the prospect of sovereign debt default. Much of Eastern Europe is financially under water. Ultimately, however, the worst case scenario by far is debt default by the United States federal government. With the U.S. government projecting structural mega-deficits for at least the next decade, can it be safely assumed that Washington will not follow in the path of Dubai?

Global Economic Forecast 2010-2015: Recession…(Paperback)

by Sheldon Filger

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The economic metrics are truly surreal. The Dow Jones and other equity indices are soaring to the skies, while Wall Street boasts about its executive bonuses, which are at record levels. Amid the obvious creation of a new asset bubble, courtesy of the U.S. Federal Reserve and other central banks, coinciding with a return to megalomaniacal arrogance by the titans of finance, the real economy continues to plummet, despite claims that many economies have retuned to positive GDP growth. But with unemployment at record levels and continuing to grow, it is clear to many that the so-called economic recovery is based on a facade of fragility. It may take only one major international crisis to collapse the global financial house of cards.

In case you have not noticed, Iran is going full steam ahead with its opaque and ambitious nuclear program. Israel has continued to hint that time is running our for a peaceful resolution  of the controversy over the Iranian nuclear program, which it suspects is a covert atomic weapons program, aimed ultimately at them. However, the rhetoric from Israel has been toned down somewhat of late. That, in my opinion, is not a good sign. While the Israelis were loudly engaging in military manoeuvres suggestive of preparations for an attack on Iran, it was clear that this was a psychological game, aimed at putting pressure on Tehran and the international community. It is when the Israelis become quiet over what their military is preparing for that the world may be about to experience a surprise Israeli attack on the Iranian nuclear facilities. This would clearly spark a regional conflict, which will likely involve the United States, which now has military forces deployed on two different frontiers with Iran.

A regional conflict in the Middle East, beginning with a military exchange between Iran and Israel, could be the kiss of death for the global economy. Imagine another interminable conflict in that volatile region, with the major chokepoint for oil exports from the Persian Gulf to the primary industrial economies, the Strait of Hormuz, being interdicted by Iranian missiles. Oil prices would soar beyond their historic highs, sending the current false economic recovery into an authentic global depression.

The world may be just a single regional war short of a full-throated economic meltdown, and that fearsome war may be coming to a theatre near you, sooner than anyone can imagine.

Among the many dangerous challenges facing U.S. economic policymakers is China’s growing unease with the profligate monetary looseness of the U.S. Federal Reserve. Witness the comment made by the Chairman of China’s Banking Regulatory Commission, Liu Mingkang, which coincided with President Barack Obama`s state visit to the People’s Republic of China. Here is what he had to say:

“The continuous depreciation in the dollar, and the U.S. government’s indication that, in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation. U.S. monetary policy has seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy.”

Clearly, Chinese decision makers are increasingly viewing America’s monetary polices as utterly reckless. Given that China is now the largest holder of U.S. Treasuries, it would be unreasonably optimistic to expect Beijing to continue purchasing U.S. sovereign debt indefinitely, and at historically low rates of interest. What happens when the Chinese authorities begin moving away from the dollar? In my view, nothing good for the U.S. economy, especially as it sinks ever deeper into debilitating debt.

I have previously predicted that the Obama administration will almost certainly push for a second stimulus package prior to the 2010 mid-term congressional elections. The upcoming White House  jobs summit, scheduled for December, is probably a set-up to create the PR context for promulgating a new instalment of the previous Economic Recovery Act.

In a recent op ed piece, NYU economist Nouriel Roubini warned that unless “bold action” (meaning more stimulus spending ) is taken, “the damage will be extensive and severe unless bold policy action is undertaken now.” He rightly fears that a continuing growth in the unemployment rate, which he believes will top out at 11% according to U3 measurements, will likely send the U.S. economy back into another recession, the feared “double dip” or W recessionary curve.

Of course, Roubini is correct. But as he himself has previously pointed out, the growing deficits and national debt of the United States in itself is a growing danger to the nation’s long-term economic future. With a staggering national debt, I do not believe the U.S. can absorb the additional debt load required to fund another stimulus package. Irrespective of fiscal realities, however, political expediency will undoubtedly triumph. Which means a new stimulus bill will be approved by Congress in 2010, a few hundred thousand temporary jobs may be created, but when the next banking crisis arises (and it will) a fiscal disaster will confront the U.S. economy, more than wiping out any small gains in employment that will result from allocating several hundred billion dollars of borrowed money for President Barack Obama’s version 2 of stimulus spending.

Economic mythology is now being confronted by political reality. The so-called jobs summit has an air of desperation about it, as the Democrats begin to contemplate the loss of Congress in the 2010 mid-term elections. The next step will probably be a second Obama economic stimulus program, which may temporarily bring about a slight improvement in employment numbers, but at the cost of a further deterioration of America’s already bleak public fiscal posture. This will further weaken the dollar, which undoubtedly will bear political consequences in the 2010 mid-term elections. Obama may be in for a bitter surprise in the second half of his presidential term.

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.

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.

The U.S. Labor Department came out with the latest official jobless figures, showing that unemployment has now reached double digit territory: 10.2%. However, shortly after  this grim milestone was revealed, The New York Times had a front page headline that proclaimed the actual unemployment rate was 17.5%, meaning one in six American workers was either unemployed or forced to take a lower-paying part-time job due to the unavailability of a suitable fulltime position.

Since 1961, the Bureau of Labor Statistics has excluded discouraged workers from the official unemployment count, disseminated as U3. The more inclusive U6 unemployment figure, published in The New York Times, stands at 17.5%. However, there are other estimates that indicate true unemployment in the United States stands in excess of 20%.

More important than the competing unemployment figures in the change in  total labor income, equivalent to the gross number of hours worked multiplied by the mean average hourly wage. Over the past year, hours worked in the United States has declined by 7%, simultaneously with wages being frozen or reduced. In an economy dependent on the American consumer for more than 70% of GDP, these statistics do not augur well for a sustained economic recovery in the U.S., despite the official boasting of “green shoots” on the horizon.

The zombie automotive behemoth that is General Motors would have been long buried but for the  intervention of the U.S. government and massive infusions of cash, borrowed by the overleveraged American taxpayer. Supposedly, in exchange for taxpayer support, GM was supposed to downsize and focus and a few core U.S. brands. Part of this restructuring was the elimination of foreign brands, the largest being European-based Opel. After months of negotiations, a consortium led by the Canadian automotive parts firm Magna International Inc., also involving a Russian bank, with significant financial support from the German government, was on the verge of buying Opel from GM. The legal papers were ready to be signed, but now GM’s management and board of directors have had an about face.

The surprise decision, made at the last moment, to scuttle the carefully crafted deal worked out by Magna, was based, so says GM, on a more positive outlook for their business. Hours after the decision was made, GM also announced it was axing 10,000 Opel employees, sending the workers of the firm’s German factories on strike.

What we have here is an impulsive, instinctive example of flawed corporate decision-making, choosing to discard the months of international negotiations for a sale that would have taken Opel off of GM’s back and balance sheet. Instead, we have a clique that wants  to hold on to the fantasy that GM remains the world’s largest automaker. As for the U.S. taxpayers who will be the ultimate losers, the “new” General Motors couldn’t care a wink.

In the Financial Times Professor Roubini wrote a thoughtful and frightening piece on the implications of the U.S. dollar’s sinking value and its increasing role in the global carry trade. Given Nouriel Roubini’s track record  in offering a timely warning on the collapse of the subprime mortgage  bubble, his latest red flag should be looked at very closely.

In essence, the loose monetary policies of the Fed have  poured a tidal wave of liquidity into the world, in the form of U.S. dollars being offered at effectively zero interest rates while simultaneously being devalued. This explains the explosive role the American dollar is exercising on the carry trade. As Roubini points out, speculators can borrow cheap dollars at effectively negative interest rates, and plough this cheap currency into higher yielding assets available in foreign exchange. What Professor Roubini describes as the “mother of all carry trades” is building a global speculative bubble of vast proportions, and in a manner that is utterly unsustainable.

Roubini closes his sober article in the Financial Times with the following chilling warning:

“This unravelling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.”

* Global Economic Forecast 2010-2015: Recession Into Depression, now available. More information at:

http://www.createspace.com/3403422