Which Crisis?

People are beginning to think that the worst of the crisis is behind us. But which crisis are they referring to? If they mean the financial crisis, they may be right. In fact, I would be surprised if the apocalyptic events of last fall did not mark a high point, of sorts.

However, there's plenty more trouble to come. From where I sit, the next big unraveling is playing out in the real economy. As the truth hits home that there is no recovery and those in charge have used up all their bullets, businesses and individuals that have been hanging on in hope will throw in the towel.

Once that happens, unemployment will ratchet up well into the double digits, bankruptcies, foreclosures and evictions will explode, those who have not yet adjusted their spending habits will make a dramatic about-face, and tax revenues will evaporate, driving many state and local governments to the brink.

In "Lehman Is a Footnote in the Great East-West Globalisation Crisis," The Telegraph's Ambrose Evans-Pritchard offers more insights on the crisis that is actually in the making.

You can see why markets and governments both like to blame Lehman Brothers for the "Great Contraction". Such wishful thinking shields investors from the nasty reality that deeper forces are at work: it absolves officialdom from its own destructive role in fixing the price of credit too low for 20 years, luring us into debt.

As my colleague Jeremy Warner puts it, Lehman no more caused the economic convulsions of the last year than the assassination of an Austrian prince caused the First World War. There was the little matter of a rising Germany then, and a rising China now. Both scrambled the international system, albeit in different ways.

The 48 hours that killed Lehman and AIG – and would have killed Merrill, Morgan Stanley, and Goldman Sachs within a week if Washington had not stepped in – merely brought to a head the inevitable exhaustion of a global order in which the West chokes debt, and the East chokes on export capacity.

As of last week, the ABX index of sub-prime mortgage debt showed that AAA-rated securities from early 2007 were trading at 28 cents on the dollar – AA was at 4 cents, near all-time lows. No one can say that $2 trillion (£1.2 trillion) of sub-prime and Alt-A debt is still trading at panic levels, exaggerating losses. The dust has settled. What we can see is that creditors will never recoup their money.

The housing crash has tipped 15m US home owners into negative equity. A third of sub-prime mortgages are in default. Some 7.8pc of all loans backed by the Federal Housing Administration are in foreclosure or 90 days in arrears. This is why the US Treasury had to seize Fannie Mae and Freddie Mac, the $5.3 trillion pillars of US housing. It is not a liquidity crisis. It is a bankruptcy crisis.

Foreclosures reached 358,000 in August alone. More Americans are being evicted each month than during the entire Depression year of 1932. This is not to pick on America. Variants of the bubble occurred across the Anglosphere, Scandinavia, Holland, Club Med, and east Europe. Defaults will hit with a lag in Europe, but hit they will. The IMF expects global banks to lose $2.5 trillion by next year. So far they have confessed to $1 trillion.

We know why the bubble occurred. Call its Greenspanism. Central banks rescued assets each time there was a hiccup, but let booms run unchecked. They pulled "real" rates ever lower, creating addiction to monetary stimulus. Larger doses were required with each cycle, until we hit zero, and it is still not enough. Debt burdens rose to records across the OECD.

Couldn't they see that this was cheating: stealing from the future? No, they were seduced by "inflation targeting" – watch goods, ignore assets – just as cheap imports from China rendered the doctrine obsolete. It always takes ideology to consummate massive error.

Asia in turn caused a global bond bubble by accumulating $5 trillion in reserves (a side effect of holding down currencies to gain export share). Long-term rates collapsed too. The global credit bubble was complete.

The Great Game can continue only as long as deficit countries – currently, US (-$628bn), Spain (-$109bn), Italy (-$62bn), France (-$58bn), Britain (-$53bn), Greece (-$42bn), and east Europe – are willing to bankrupt themselves buying Asian goods. Obviously, this is absurd.

America's baby boomers have lost 45pc of their net worth. US pay fell 4.8pc in June year-on-year as hours were slashed. US consumer credit has contracted for six months in a row, falling by record $21.6bn in July. The US savings rate has risen from near zero to around 5pc.

"Who will replace the US consumer to power global growth?" asked IMF chief Dominique Strauss-Kahn in Friday's Le Monde. "We have left the financial crisis, but we are still in the economic crisis. "

There is gaping whole in world demand. It is being filled by governments, all nearing the limit of fiscal stimulus. Some have exceeded it: Spain is to raise taxes by 1.5pc of GDP, and Japan's Democrats are retreating from spending pledges. China is trying to plug the gap, belatedly, by ramping up credit 70pc this year, but it will take a cultural revolution to induce the Chinese to spend. The liquidity is leaking into stocks, metals, and property.

Yes, markets are sizzling, but industrial production is still down 23pc in Japan, 17pc in the eurozone, 13pc in the US and 11pc in Russia. We have a global glut of manufacturing plant. This is why companies will have to slash staff. Don't be deceived: profits can look good at first when firms cut into the bone. It is no strategy for an economy.

We can all agree (except Germany, hiding bank losses) that the G20 in Pittsburgh should tighten ratios for lenders. But will we hear a word about the capital and trade imbalances of late 20th Century globalisation that caused this crisis? Probably not. It is easier to ignore the elephant in the room.

Eventually, the phase now underway will reach some sort of climax. At that point, I believe, things are really going to get scary.

Comments

[Market Sniper]

Well done, Mike! Question that I have is approximately when, if ever, the realities on Main Street will be reflected on Wall Street? I guess that is the real $64,000 (maybe $64 Trillion?) question.

[Alexandra]

You ain't seen nothing yet. This is how the death of a way of live (the capitalist way of life) looks like. It will take globalisation with it but can we save democracy? That is really what we should be concerned about.
Stomp the corporations into the ground.

[Patrik]

Hello! What do you think about LaRouches solution? They consider the debt illegal and that the only way out is for the largest nations to join in a new credit system.

http://larouchepac.com/lpactv?nid=11734

[Subhankar]

"A gaping 'whole' in world demand", Mike? A Freudian slip?

Stock markets are supposed to discount the good news and the bad in advance. Economic cycles and market cycles rarely converge. The fact that a 1929 like collapse has been averted - whether by nationalizing financial institutions, or by printing dollars - is good enough reason for punters to buy.

[Marion Shaw]

Subhankar: I don't know much about international finance, but I do know a lot
about history. A young, brash, upcoming journalist named Henry Luce, who founded
an upstart, young magazine called Time in the mid 1920's, noted that after the
crash, the bankers seemed to own three fourths of the industrial sector of the
United States. The grandsons of those bankers are still on the boards and
rosters of the major corporations today; rolling in and out of contracting
government positions like a smooth game of musical chairs. It took a world war
to solidify their positions, and a few wars after that, but history does not
mince the truth, and once the people's business is nationalized , any reasonably
informed person knows what comes next.

[roger]

Credit to spend and credit to invest in production
are two different things. Greenspan acerbated the
problem ,but he did not create it. US consumers
bought foreign products on credit with borrowed money,
THIS IS CALLED POWERING GLOBAL GROWTH ??
We have a glut of manufacturing plants ( yes true )
so then its a matter of distribution, ho no that would
be socialism ( dirty word ).Capital & trade imbalance,
now there,s a bone to pick on.Seems to me,most economist
who are part of the Establishment are still in LALA
LOLO LULU land

[nevket240]

Alexandra.
I do not know where you live but I will guarantee it is not a Democracy. 100% Guarantee.
The United Soviet Socialist States of America have never been a democracy. Since 1913 the USSSA has been ruled by Monetary Tyranny.
Stomp on the Corporations Alex?? Why not elect Representatives who are decent people rather than corrupt scum instead??
regards

when the people fear their government you have tyranny.
when the government fear the people you have democracy.

[Sackerson]

Hi, Michael. Looks like we're both playing "Are we here?" - my thesis is we're in the mid-Seventies: on the threshold of a stockmarket boom that becomes so undermined by inflation that in real terms it's a collapse (http://theylaughedatnoah.blogspot.com/2009/09/2020-hindsight-and-coming-stock.html) Suggest people both sides the Atlantic look at inflation-indexed government savings bonds, but after doing that? Land? Is that the real reason why Buffett and Soros bought into railways a while back?

[Subhankar]

@Marion: I'm no exert in finance or economy - just a stock market investor. The ultra-conservative and bureaucratic nationalized banks have been one of the main reasons for the stunted growth of the Indian economy. The same banks also saved the country from the global economic collapse precipitated by the likes of Lehman Brothers, Citi, AIG et al, by not allowing the kind of financial jugglery that leads to asset bubbles.

[Marion Shaw]

Subhankar: As I understand what happened, it wasn't the banks that saved
anything: it was the fiat money, printed by the US Federal Reserve, and
ultimately tied to the American taxpayer that saved the so called banks,
which some feel are right back to their old tricks. I do understand that
stocks have to ultimately be tied to production, profit or something, otherwise
the buyer ends up holding what amounts to a chest full of Confederate dollars
that died on April 9, 1865 when the great Robert. E. Lee surrendered the
ill fated and doomed cause of the South. Having been born in Charleston, the
heart of the confederacy, that today, might still be regarded as a traitor's
view. The problems in countries like India is exactly where the US is headed
towards; not from. That is only a personal opinion.

[e_goldstein]

"The 48 hours that killed Lehman and AIG – and would have killed Merrill, Morgan Stanley, and Goldman Sachs within a week if Washington had not stepped in..."

wow, what a wonderful world it would be.

[Gary]

Recession, cession whats the depression.
Putten up with chimpy and BS causes
Recession, cession whats the depression

I mean the white chimp that never was the president
reap it suckers