The International Monetary Fund (IMF) expects the savings mountain to rise yet
further next year as the governments of Europe, Britain, and the US tighten
belts, in unison, by up to 2pc of GDP.
This is double the intensity of the last big synchronized squeeze in 1980.
They will do so before the private sector is ready to grasp the baton, and
without stimulus from the trade surplus states (Germany, China, Japan) to
offset the contraction in demand.
Put another way, there is a chronic lack of consumption in the world. "This
probably comes as a surprise to most people, gorged on propaganda about
excessive debt and the need for retrenchment," said Charles Dumas from
Lombard Street Research.
The inevitable outcome of one-sided austerity polices in the Anglo-sphere and
Club Med is a self-feeding downward slide for the whole global system, a
variant of 1930s debt-deflation. "Excess savers refuse to acknowledge
that if world savings are demonstrably too high, healthy recovery depends on
the surplus countries saving less," he said.
Mr Dumas said China's "grotesque and destructive" policies of
over-investment (50pc of GDP) and under-consumption (36pc of GDP) are
unprecedented in history, but at least China's currency advantage is being
eroded by wage inflation.
His full wrath is reserved for the "fallacious and malignant policies"
of Angela Merkel and Wolfgang Schauble in Germany. They are enforcing a Gold
Standard outcome on the whole eurozone. "Suffused with
self-righteousness, they insist that the imbalances must be put right only
by deficit-country deflation."
The sheer scale of global imbalances is made clear in
a
paper by Stephen Cecchetti at the Bank for International Settlements.
His paper contains a chart showing that combined surplus/deficits reached 6pc
of world GDP in the boom, far beyond the extremes that led to the US losing
patience in 1985 and imposing the Plaza Accord. The gap narrowed post-Lehman
but is widening again.
Money flows are even more out of kilter. Cross-border liabilities have jumped
from $15 trillion to $100 trillion in fifteen years, or 150pc of global GDP.
This creates a very big risk.
"Gross financial flows can stop suddenly, or even reverse. They can
overwhelm weak or weakly regulated financial systems," said Mr
Cecchetti.
Well, yes, this is now happening. Did anybody think about this when they
unleashed globalisation with its elemental deformity, free trade without
free currencies?
The self-correction mechanism is jammed. China holds down the yuan against the
dollar through a dirty peg. Germany and its satellites hold down the D-mark
against Club Med covertly through the mechanism of EMU.
This outcome in Europe is not deliberate (I hope); it is not a German plot; it
is the unintended effect of a currency union created by ideologues against
Bundesbank advice, and which has calamitous implications for German foreign
policy and for Latin social stability.
My sympathies go to the hard-working citizens of Germany, Spain, Italy,
Portugal, and Ireland for being led into this impasse by foolish elites.
A global system biased towards export dumping has had unhappy effects on the
US, UK, and Club Med. These countries have faced a Morton’s Folk over recent
years: an implicit choice between job losses at home, or accepting credit
bubbles to mask the pain.
They chose bubbles. That was a mistake. This strategy of buying time cannot
safely be repeated because fiscal woes are already near "boiling point",
in the words of the BIS. “Drastic improvements will be necessary to prevent
debt ratios from exploding," it said.
Bank of England Governor Mervyn King called recently for a "grand bargain"
of the world's major powers to break the vicious circle and ensure that the
burden of adjustment does not fall on debtors alone.
"The need to act in the collective interest has yet to be recognised.
Unless it is, it will be only a matter of time before one or more countries
resort to protectionism. That could, as in the 1930s, lead to a disastrous
collapse in activity around the world," he said.
We are not there yet, but a global double-dip would take us to the edge. US
democracy cannot allow America’s precious stimulus to leak out to countries
that have bent their exchange rates, tax systems, and industrial structures
towards predatory export advantage. It cannot let broad (U6) unemployment
ratchet up to 20pc or more.
If the White House will not do it, Congress will. Capitol Hill is already
launching its latest bill to label China a currency violator, and open the
way for retaliatory sanctions.
"They get away with economic murder and thus far our country has just
said, 'Oh, we don't care. This legislation will send a huge shot across
China's bow,” said Senator Chuck Schumer.
The risk – or solution? – is that the US will opt for a variant of Imperial
Preference, the pro-growth bloc created behind tariff walls by the British
Empire with Scandinavia, Argentina and other like-minded states in 1932.
This experiment has been air-brushed out of history by free trade
hegemonists.
One can imagine how this might unfold. North America would clamp down on
dumping, at first gingerly, before escalating towards a cascade of
Smoot-Hawley tariffs and barriers. Mexico and Central America would join.
Brazil and Mercosur would find it irresistible because that is where the
demand would be, and BRIC solidarity would wither on the vine.
By then you would have the US recovering behind its wall, while surplus states
were recoiling from severe shock. Britain would face the moment of truth,
offered salvation in the `Pact of the Americas’ or slow asphyxiation by
trade ties to EMU’s deflation machine. Portugal and Spain would face the
same fateful choice. This is how the EU might end.
Ultimately, America would get its way. Korea and the Asian Tigers would come
knocking. The austerity brigade and mercantilists would be shut out until
they capitulated. The rules of world trade system would be redrawn.
The IMF's Christine Lagarde understands the risks intuitively. The global
economy is entering a "dangerous new phase", she warns. Leaders
must prepare for "bold and collective action to break the vicious cycle
of weak growth and weak balance sheets feeding negatively off each other".
Central banks must stand ready to "dive back into unconventional waters
as needed."
But how many infantry divisions does the IMF command, to paraphrase Stalin?
Power resides in the G20, where debtors and creditors have radically
contrasting views. The body cannot even start to offer a solution.
A US double-dip is not yet a foregone conclusion. America’s M3 money supply is
last growing decently again at 5.6pc, which would in normal circumstances
signal some recovery next year. The latest GDP and confidence data in the US
have not been as bad as feared.
Ajay Kapur from Deutsche Bank said investors have to decide whether the market
slump of recent weeks is a “panic like the LTCM sell-off in late-1998 that
proved to be a great buying opportunity, or the first leg in what could
eventually be a pervasive global recession. We believe it is the latter.”
He said the triple warnings from US leading indicators (ECRI, the Philly Fed’s
'Anxious Index', and the earnings revision index) all point to recession,
while China is “probably over-tightening” into a global slump.
In Europe, policy is still on deflationary settings, with Italy and Spain
having to tighten fiscal yet further to meet their budget targets. The
European Central Bank is overseeing a collapse in real M1 deposits in Italy
of around 6pc, annualized over the last six-months.
Michael Darda from MKM Partners said the ECB has made such a hash of monetary
policy that nominal GDP for the whole eurozone may even start to contract.
That is astonishing. If correct, there is no hope of averting a debt spiral in
Italy and Spain. Any such outcome will test the EU’s bail-out machinery to
destruction within months.
Mr King’s “disastrous collapse” is staring policy-makers in the face.
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