In this extract from his new book, Countdown to Catastrophe, Spear’s economics editor Stephen Hill offers his vision of the course the financial crisis has left to run
WE MUST RETURN to that question: ‘Have the central bankers lost control?’ As they think — hope would be a better word — that the banking crisis has at least been stabilised; that deflation has been defeated; that there is no sign of inflation; that unemployment is slowing; that growth has resumed as the pull of the BRICs, especially China and India, lead the recovery; that interest rates will remain low for the foreseeable future; and that in 2011 they can begin to unwind all the bail-out loans, ease off on the QE and stimulus packages and gently raise interest rates at the first sign of inflation returning.
At that point they will all clap each other on the back for having saved the world economy. Such an outcome is devoutly to be wished, but all that would happen is that the casino banks would be off and running and ready to do it all over again, racking up more bonuses and indebtedness. Unless…
Well, every aspect of this positive scenario is even questionable, beginning with the first assumption: banking crises last for 4.3 years on a historic average and this crisis is only halfway through and far from over. In November 2009, Dominic Strauss-Kahn of the IMF reckoned that the global banking losses were $3.5 trillion, more in Europe than America, of which only half had been admitted to, let alone provided for.
And that is after many G20 governments have unburdened these banks in the private sector and have transferred a great level of their indebtedness into the public sector, to the point where Moody’s estimates total sovereign debt at $15.3 trillion, and rising to well over $22.5 trillion over the next five years, or even double this. Never has the world seen anything like these total debt levels.
The G7 are still experiencing reduction of the money supply as bank credit continues to contract and as banks continue to deleverage their balance sheets and this process will necessarily continue for the next two years at least. Interest rates are low and will probably stay that way for a time, but the cost of actual borrowing will remain high.
Next, deflation is still stalking the world, led by Japan, and asset values are still in decline, apart from stock markets that have gotten ahead of themselves as QE has seeped into the stock exchanges. Another rumble from the ongoing banking crisis will surely see them tumble once again.
In the US, the Fed, the FDIC and the Office of the Comptroller of the Currency have communicated to auditors that implementation of FASB 157 (mark-to-market) has been suspended and that interest payments on NPLs, or Non-performing Loans, can be extrapolated into the future with no resultant provisioning of capital, a policy now known as ‘Pretend to Extend’.
And real unemployment is rising everywhere except in the BRICs, but the arithmetic behind the idea that the Chinese and Indian consumer will haul the West out of the mire doesn’t even begin to add up.
SINCE THE FORMATION of the Bank of England in 1697, the pound sterling, along with the mighty dollar, are the only two major world currencies that have never collapsed and been replaced. In 2010–11, however, there is realistically no spare monetary capacity for any further bank bail-outs for the UK, which is looking anyway at a ratings downgrade and possibly the attentions of the IMF, as the UK’s fiscal deficit projection for 2010 at 13.3 per cent is the highest in the OECD Group.
The US and EU are of a size to go further with QE, and size in this crisis counts as we have seen, but the ramifications will be there for them down the cul-de-sac. If the embers of the banking crisis flare up again, further substantial bail-outs will trigger the devaluation of fiat currencies and the debts expressed in them.
A currency or sovereign debt crisis would force higher interest rates and pitch the Anglo-sphere economy towards a double-dip W-recession, or even depression. When the indebtedness of the UK, as global interest rates rise, and the increasing interest payments are perceived to be creating a compound debt spiral, where the level of rising debt is eating its own head off with compounding interest charges, then Irving Fisher’s debt-deflation model will take over.
Capital flees and the currency effectively collapses, destroying savings, pensions and asset values, including house values, in real terms, while gold soars, clutching on to the Swiss franc and Norwegian krone, as the only fiat currencies with resilient inherent value, as their total budgets are in positive surplus.
The next currency facing something of a similar plight would be the euro, but it would have a very different effect than in the US or UK: it is more likely that Greece, whose debt rating was cut in December 2009 by Fitch from A- to BBB+ with negative watch, while Athens rioted, will be forced out of the eurozone as it is past the tipping point of wage-cuts or of a compounding debt-deflation spiral, and back on to the drachma.
This is probably to be followed by Ireland back on to the punt after a riot or two in Dublin, and possibly followed by Spain on to the peseta while they march again through Zaragoza, while Southern Italy languishes as usual as it anguishes about a return to the lira, all of which positive probabilities were prefigured by the pound’s expulsion from the ERM on ‘White Wednesday’ in September 1992, courtesy of George Soros.
The East European currency pegs to the euro might snap as well, particularly in Latvia, Romania and Hungary. The central core of the ‘Original Six’ will hold firm around the Franco-German axis, however, but this will make the euro even stronger and the exits and de-couplings from the fringes of the eurozone ever more likely. Global Crunch will yet question the extent and speed with which the job-destroying deflationary euro was rolled out across the plains of Europe, but the effect on worldwide confidence could exponentially feed the possibility of a global sovereign debt crisis.
THE FLAW AT the heart of the eurozone is already being mercilessly exposed: Germany’s instinctive fear of inflation is pitted against Club Med’s fear of minus-growth unemployment. The Germans are not about to lose that one, so it will inevitably be ‘Bye, bye eurozone’ as Club Med once again becomes an affordable holiday-zone for the rest of us and Europe Continental rediscovers that it can build the whole of an Airbus. Hallelujah!
In whichever scenario comes to pass, we are facing the possibility of the economic equivalent of Gladwell’s tipping point and Irving Fisher’s debt-deflation model taking hold on a broad front, but nobody knows the maths for the starting-point, as it would be triggered by ‘events, dear boy, events’. At any time between January 2010 and 2019, in the new Short Cycle, the total indebtedness of the G7 world could implode and re-ignite the banking crisis.
And lying underneath this unlit bonfire of unimaginable indebtedness is the $600 trillion heap of unregulated derivatives, of which no one has any definitive assessment of the potential for systemic or counter-party risk, or even where the concentration of these new risks might lie.
If just one ‘Too-Big-To-Fail’ bank becomes illiquid, the central bankers are already in the Macbeth predicament where they would have little choice in this derivative-correlated world but to continue to support the system further, racking up even more debt until the unknown tipping point would render any further creation of fiat money self-defeating, and paper money and the economy would crash into hyper-inflation and Great Depression 2.
And if and when the catastrophe does come in this new Short Cycle, there will come the critical moment for right decisions by Creative Persons to turn the ensuing crisis to immediate advantage and rid the system of dysfunctional governmental and economic structures, worthless currencies, failed banks, doubtful debts, devalued assets and the trappings and practices of Degenerate Persons.
Catastrophe will surely come with our current macro-economic structures, based on Thatcherism with its implicit faultline, which encourages the relentless greed and lesser instincts of Degenerate Persons, those businessmen and bankers who are so infected by the thought of their gains and bonuses that they run, followed in chase by the hapless regulators, like the Gadarene swine of old as they all hurtle over the cliff-tops and drown in the shallows below.
Unless Creative Persons change these macro-economic structures and the incidence of taxation as a matter of rational analysis and conscious choice, or even as a moral and right choice forced upon us by catastrophe, and so return to balanced prosperity for all in the new Long Cycle, by striking the natural and sustainable balance between Adam Smith’s dual principles of labour and property, ‘hands and lands’.
Countdown to Catastrophe is available for £20 + P&P by emailing email@example.com