Global Economic Crisis

In February 2009, my blog referred to a story that appeared in The Daily Telegraph, a leading UK newspaper, headlined, “European bank bail-out could push EU into crisis.” The essence of the story was that The Daily Telegraph was shown a top secret document, leaked from the European Commission, the executive body that oversees the 27 nation European Union, which warned that the EU’s banking system was contaminated by an ocean of toxic assets. Though the story was ignored by the rest of mainstream media, for the most part, I think it is timely to look again at this secret EU document in the light of the current European debt crisis and growing rumours regarding the insolvency of many leading banks across the continent.

The confidential 17 page European Commission document warned that the European banking system could be holding as much as 18.6 trillion euros in toxic assets. Furthermore, in the wake of the European bank bailout that followed the collapse of Lehman Brothers, the document warned that the cost of a second Eurozone and UK bank bailout would exceed the financial capacity of the European Union. In other words, if Europe’s banking system enters a meltdown in the face of the sovereign debt crisis now plaguing European economies, the EU will be powerless to stop the implosion of the European banking and financial system.

Reviewing what the European Commission warned about more than a year ago, it appears that the document’s authors had an impressively prescient ability to forecast the current European sovereign debt and fiscal crisis. In stark terms, the EU document warned that, “It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems…Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance.”

With Greece essentially insolvent, Spain in the grips of its own sovereign debt crisis and the UK and Italy teetering on the edge, not to mention Ireland, Portugal and Eastern Europe, it seems to me that the worst case scenario hinted at in the leaked document more than a year ago is no longer a speculative possibility, but unfortunately a chillingly realistic forecast of what may very soon be the next great global banking crisis.

In 2009 the United States experienced its worst year for bank closures since 1992. It now looks like 2010 will be an even more critical year for U.S. banks, with the FDIC on pace to exceed the 2009 record of 140 banks closed. With three more banks shut down by the FDIC after the Friday news cycle slowed for the weekend ( the customary bank shut down procedure for the FDIC), the total number of bank failures for 2010 already stands at 86.

Why are so many U.S. banks being closed after the U.S. Treasury Department’s vaunted bank stress test last spring declared America’s financial institutions to be healthy and well capitalized? Because, as I stated in my blog comment at the time, the so-called banking stress tests were a complete charade. In reality, much of America’s banking and financial system is virtually insolvent, and about to face an implosion in commercial real estate valuations polluting its balance sheets, along with the asset erosion that will be worsened by the pending double dip recession.

The global economic and financial crisis is far from over. The next phase in the deteriorating banking crisis in America, the UK and Eurozone points to a global recession morphing into a worldwide depression.

The U.S. Census Bureau has released the new home sales figures for May, and to say they were dismal would be an extreme understatement. May is the first month reflecting new home sales since the expiration of the Obama administration’s tax credit for first time home buyers, so a decline was expected by economists. However, what was not expected was the collapse of the new home housing market in the United States, which is what the data just released indicated.

In May new home sales in the U.S.A. declined by 32.7 %, which reflects a seasonally adjusted rate of 300,000 home sale per year, a level not witnessed in America since the 1960s. Add in the also dismal used home sales in the U.S. and there you have Fed Chairman Bernanke’s  “green shoots” of economic recovery from the global economic and financial crisis.

Double dip recession, anybody?

As expected, George Osborne, Chancellor of the Exchequer in the new British coalition government, unveiled an emergency budget aimed at tacking the UK’s massive structural fiscal deficit. It is being described as the toughest UK budget since the age of austerity that followed in the immediate postwar period after the Second World War. It features a rise in the VAT to 20%, increased income and capital gains taxes, public service wage freezes and across the board programmatic budget cuts. The question that stands is this: will it work?

In my view, as explained in my book (Global Economic Forecast 2010-2015: Recession Into Depression) the United Kingdom, as with many other advanced economies, is in a fiscal and demographic trap. It’s national debt has skyrocketed to almost 70% of GDP; even with the Osborne budget cuts, continuing deficits will send this ratio towards 100% of GDP in the near future. With an aging population, meagre real economic growth at best and an economy that, like a heroin addict, has become dependent on its fiscal deficit fix, the UK economy is in such a trap.

Cut public spending dramatically, warn the critics, and the British economy will enter a double dip recession, and they are right. A renewed economic contraction will diminish tax revenue, largely defeating the purpose  of budget cuts and increased levels of taxation. However, continuing the neo-Keynesian debt folly is even more calamitous, for it will inevitably lead to a total fiscal collapse of the UK.

The real lesson is that the wild spending spree engaged in by policymakers in response to the global economic and financial crisis was flawed, and should have been curtailed before public debt to GDP ratios exploded to unsustainable levels. It is now too late to avoid severe economic pain. The only option left is determining which path will incur the least suffering on society.

It is the epitome of all ironies. A supposedly workers Marxist/Communist political entity, the Peoples Republic of China, is in reality capitalism’s ultimate creation: an authoritarian  workshop for multinational corporations, that keeps wages at  the lowest possible levels, while making strikes and plant shutdowns by workers strictly illegal. This enforced low-wage corporate model is the basis behind China’s export boom and economic ascendancy. However, despite government pressure, cracks are beginning to appear in the façade.

Strikes are breaking out throughout China. The factory of the world is in revolt, with workers unrest growing like wildfire. Most recently, plants that produce parts for the Japanese automakers Honda and Toyota have been hit by labor shutdowns. In virtually every case that has become publicly exposed, the employers have been forced to provide large pay rises as the price of ending the strike. Illegal or not, the strike has emerged as a potent and popular labor weapon across the shop floors of the factory of the world.

There are profound economic and political ramifications related to China’s growing labor unrest. Inflation is increasing in China amid asset bubbles fed by Beijing’s loose fiscal and monetary policies. The Chinese workers are becoming increasingly militant in reacting to the widening gap between rich and poor in this supposedly classless communist nation. What is at risk is the very essence of what has thus far enabled China to compete on the world stage and emerge as the primary global exporter. Also at risk is the ability of the central government to profit from a low wage economy, in the process building up huge cash reserves. In large part, these reserves are what has enabled the Chinese sovereign fund to invest in U.S. Treasuries.

This is potentially a huge story, bigger than many currently appreciate, given that the Chinese authorities have probably suppressed the news concerning most strikes and workers demonstrations in China.  What we have learned about the strikes at Honda and Toyota plants in China is merely the tip of the iceberg of labor discontent in China, a factor that may in time create severe obstacles for the Chinese and global economy.

The U.S. Commerce Department released figures for housing starts for May 2010, and they were far worse than projected by economists. They plunged 10%, representing a seasonally adjusted annual rate of 593,000 housing starts, versus  659,000 for April. The decline in single family dwelling starts was 17%, the worst contraction since 1991.

The minor uplift in housing starts over the past several months was due entirely to government funded tax credits, paid for with borrowed money. With these short-term gimmicks now being phased out, the organic weakness in the American housing market can no longer be obscured. It must be recalled that the trigger for the current global economic crisis was the collapse of the sub-prime residential housing market in the United States. With worsening public deficits forcing governments to phase out artificial props for a fractured housing industry, we are now seeing adjustable rate, near prime and prime mortgages going into default, not only in the U.S. but throughout the world. This will all serve to undermine what has thus far passed for an anaemic recovery from the worst economic downturn since the Great Depression of the 1930s.

With a public debt to GDP ratio of about 200%, Japan is the most indebted major economy in the world. If this were the public debt ratio of the United States or the UK, both nations would be experiencing a catastrophic sovereign debt crisis. If this was the public debt correlation in Greece, Athens would already be insolvent and for sale. But until now, Tokyo had the luxury of incurring increasingly heavy debt loads, owing to a nation of patriotic savers willing to loan the government money at absurdly low interest rates. But no longer.

Japan’s workers are being squeezed, and have less income to save. The demographic time bomb, with an aging and decreasing population, means that a point will soon approach when Tokyo must sell the bulk of its bonds in the international sovereign debt marketplace, in competition with America, the UK and Eurozone. Needless to say, the interest rates Japan will have to borrow at will be vastly higher than at present.

Japan’s latest  Prime Minster, in a revolving door of national leaders that plague the country, is Naoto Kan. He recently stated that, “Our country’s outstanding public debt is huge. Our public finances have been the worst of any developed country.”

Kan added that Japan risked becoming the next Greece. Some observers claim that he was exaggerating Japan’s fiscal and debt problems in order to depreciate the value of the yen. However, I don’t think the new Japanese  prime minister was overstating the Japanese debt crisis. He was merely being prophetic. I will only add that Japan’s debt problem is more than a national crisis; it threatens the entire global fiscal architecture. Throw Japan’s massive debt requirements into the global sovereign bond market and yields for all the other indebted nations will spike through the proverbial roof.

In an interview with CNBC, the bestselling author of  “The Black Swan,” Nassim Taleb, described the current economic environment as being significantly deteriorated from 2008, when Lehman Brothers went bankrupt. In his gloomy assessment of the global economic crisis, Taleb said, “We had less debt cumulatively (two years ago), and more people employed. Today, we have more risk in the system, and a smaller tax base.”

According to Nassim Taleb, the core economic and financial problem afflicting major economies is a saturation of debt, both public and private. The current Eurozone and UK debt crisis is a manifestation of the age of austerity that lies before us. The United States and UK share the debt crisis afflicting Eurozone economies, however policymakers are still addicted to deficits even in the current critical economic environment. Taleb warned that a debt crisis could not be countered by taking on even more debt, a policy response he compared with giving more alcoholic beverage to an alcoholic.

Nassim Taleb also pointed out that toxic assets on bank balance sheets were as severe a problem now as two years ago. While acknowledging that governments have used taxpayer money to take some toxic assets off bank balance sheets, he pointed out that further degradation of remaining bank assets due to deteriorating economic metrics meant that banks were as fragile today as they were in 2008.

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.

Contrary to the expectation of pundits and economists, May’s employment numbers released by the U.S. Labor Department are an unmitigated disaster. At first glance, though, the uninformed would think that the vast deficit funding on economic stimulus by the Obama administration was working. Supposedly, “employers” added  431,000 jobs, and the overall U3 unemployment rate dropped to 9.7%. However, the so-called “employers” consisted almost entirely of the U.S. federal government, which added  411,000 temporary census jobs in May. These jobs, which will disappear in a few weeks, are responsible for about 95% of the claimed job creation in May in the United States.

In May, according to the government’s own data, private sector job creation was statistically insignificant. I personally believe, based on past patterns, that  the U.S. government statisticians consistently over-report private sector employment in most of the initial monthly tabulations.

One other factor should be noted. The drop in unemployment from 9.9% to 9.7% was due not to vast job growth in the U.S. economy, but rather due to the fact that 322,000 unemployed workers were eliminated from the officially counted workforce. In fact, when one counts this category of so-called discourage workers, in addition to part time workers unable to find preferred full-time employment, the more inclusive U6 unemployment rate is close to 20%, or one in every five U.S. workers.

With continuing high rates of unemployment, it is clear that there will be no consumer-led economic recovery in major advanced economies. This means that massive government deficit spending is the only means of propping up national economies. However, with the global economic crisis rapidly mutating  into a virulent sovereign debt crisis, the option of public pump-priming clearly has its days numbered.