Global Economic Crisis

According to the United Kingdom’s Office for National Statistics, the British economy contracted by 0.5 percent in Q4 of 2010. The ONS data came as a deep shock to the British economic and political establishment.  Expectations were that the UK economy would continue a pattern of weak growth during the last three  months of last year. By any stretch of the imagination, this is not good economic news.

The UK’s prime minister, David Cameron, already has his spin-masters working overtime. The official explanation is that “the weather” caused the contraction in Q4. However, even if the weather is taken out of the picture and the ONS data adjusted accordingly, the Q4 result would still show no growth. Undoubtedly, the UK coalition government is hoping that the ONS will eventually “revise” the Q4 number upwards. However, no matter how the politicians spin the news, the UK economic crisis remains intractable.

What is especially distressing about the ONS number is that the draconian spending cuts that have been formulated by Cameron’s government had not yet kicked in during the period in which Q4 economic statistics were being tabulated. With the British economy seemingly on the verge of a double-dip recession, the sharp cuts in public spending will prove to be a powerful pro-cyclical policy measure. The likely result is a renewed recession, resulting in a drop in tax receipts for the British government, ultimately defeating the stated purpose of the sharp fiscal cuts. In essence, the UK economy is caught in a dangerous fiscal trap, which the most recent ONS data for Q4 clearly illuminates in all its dark reality.

The massive structural deficit that has overwhelmed California’s legislators is only the most extreme manifestation of a rapidly metastasizing fiscal cancer that is threatening almost all of America’s fifty states with financial insolvency. Illinois and  New York also are in  a fiscal black hole of significant size, however, many small states are in a similar financial jam. The causes are  both recent and longstanding; a convergence of the Great Recession that continues to erode state coffers, and the sustained failure to adequately fund pension programs promised to public employees. The growing danger of  collective state insolvencies is no longer a secret that can be swept under the rug. Witness the front page headline that appeared only days ago in The New York Times, ” State Bankruptcy Option Is Sought.”

As reported in the Times, “ policymakers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.” And not just the underfunded state pensions. Bankruptcy, not currently a legal option for state government (though a viable and at times utilized option for counties and municipalities) would allow the virtually insolvent states to inflict a haircut on bondholders. Yet, that option, though on the surface an enticing possibility for desperate state governors and legislators, is a double edged sword. Given how dependent state governments are on the bond market to finance their operations, any hint that bankruptcy might be actively explored by policymakers on the federal level could dry up access to credit for state governments, or at the least drive up yields to a level that guarantees an earlier day of disastrous fiscal reckoning for the states.

In an e-mail exuding panicky agitation,  Bill Lockyer, who serves as California’s Treasurer, stated in response to the New York Times headline story that, “to the folks in Congress cooking this baloney: Don’t bother. States didn’t ask for it. We don’t want it. We don’t need it.”

However, it appears that a growing number of policymakers and politicians on Capitol Hill believe the states do need it. In part, some of the effort stems from Republicans, including possible 2012 presidential hopeful Newt Gingrich.  They believe that creating a legal path to state bankruptcy will punish the labor unions, viewed by the GOP as incorrigibly pro-Democratic. However, there is more to this scenario than party politics.

The fiscal conundrum confronting America’s states is so massive, it is virtually insoluble. States have fiscal restrictions that do not face the federal government; a requirement for a balanced budget, combined with restrictions on taxation, as is the case with California, and no state version of the Federal Reserve to print money or buy up state bonds. The situation is so bad, it threatens to unleash a second financial crisis that would derail even the meager economic recovery the Obama administration claims is underway. This leaves open the possibility of the states coming to Washington for a bailout, presenting the ultimate examples of being “too big to fail.” However, the states are also too big to bail out, which may be the primary driver of the behind-the-scenes exploration by policymakers for a possible structured bankruptcy by the states

What has failed to materialize thus far in these discussion, however, is an even more daunting fiscal challenge facing the federal government. If in fact a scenario was devised that enabled the most financially challenged states to declare bankruptcy and cleanse their balance sheets of obligations to public workers and investors, how much confidence would the bond market retain in the credit worthiness of the U.S. federal government? What is being discussed behind closed doors now in connection with an unsustainable debt burden of the states may be but an interlude before a full-blown sovereign debt crisis strikes directly at Washington, leading to even more apocalyptic reflections by policymakers.

Two years after the onset of the global financial crisis, sparked largely by the collapse of the American residential home market, primarily proprieties financed with sub-prime mortgages, the aftershocks continue. The latest data concludes that 2010 witnessed one million home foreclosures in the United States, a record high. While the tail end of 2010 did witness a deceleration in foreclosure filings, this seeminlgly positive news is misleading. The slowdown was caused by revelations that banks had resorted to improper documentation in persuing home foreclosures. This has led to a temporary reduction in such filings, however this merely means that there will likely be an acceleration in the foreclosure rate during 2011.

The continuing and growing foreclosure disaster in America contradicts all the other supposedly positive economic data pointed to by policymakers and their spin-masters ( that is, if you think the Federal Reserve engaging in a second round of quantitative easing is “positive” news). Despite the massive stimulus-derived public budget deficits and Fed money-printing, the weak housing sector in the U.S. will likely continue to be a wet blanket that suffocates the marginal economic growth being conjured into existence through unprecedented levels of public debt expansion. Clearly, the housing crisis that begat the global financial and economic crisis is far from over.

The savage shooting incident in Arizona over the weekend, in which six people were murdered and many others injured, including a U.S. congresswoman, has brought forth all sorts of political commentary and PR spin in the American media. I don’t wish to add to the partisan debate going on in America over the Tuscon shooting. Instead, I want to point out that the perception of political stability in the U.S. has been the primary factor in enabling Washington to borrow unlimited amounts of credit to finance its profligate budget deficits. It is also a vital factor in enabling the American dollar to hold its value relative to other currencies, despite very weak economic fundamentals.

If the assassination attempt targeting an American politician at a campaign meeting in Tucson, Arizona is the start of a wave of politically motivated violence throughout the United States, that veneer of perceived political stability will evaporate, leaving in its wake a floodtide of investors and bondholders stampeding for the exists. The Arizona shooting incident may, on top of its political significance,  also be a harbinger of economic and financial aftershocks that could prove a final nail on the coffin of America’s so far unhindered ability to borrow money on the global sovereign debt market.  Those who know the American political scene well realize how polarized the U.S. currently is. That, and the easy access to firearms has always made the potential for politically motivated violence a serious possibility. After this weekend’s tragic melee in Arizona, America’s creditors and purchasers of Treasuries can no longer assume  that America’s political stability will prove impervious to a worsening trend of political polarization.