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Global Recession Or Low Carbon

Economics / Recession 2008 - 2010 Sep 04, 2009 - 03:05 PM GMT

By: Andrew_McKillop

Economics

Diamond Rated - Best Financial Markets Analysis ArticleKeynesian Boom and Bust - Like we know, the recent and continuing massive spending spree by nearly all G20 governmentsand their central banks, described as "fighting recession", is also called Keynesian. To be sure, this process of handing over or "injecting" perhaps $ 4 000 billion since around October 2008 (using IMF data), mostly into the bank, insurance and finance sector in OECD countries, is Keynesian in one sense. National debts and government budget deficits have been increased, often radically. Several east European members of the EU27, and most famously Iceland, as well as Ireland, Pakistan, the UK and USA, and some other countries have seen foreign and/or national debt grow so fast their public finances are now structurally unsound. If economic growth does not return soon, and continue for at least a year or two, the unthinkable prospect of central bank failure will return, in several of these countries. We can note that the approximate $ 4 trillion of 'Keynesian bailouts' in the OECD countries, since late 2008, is equivalent to roughly 6.5% of world total GDP in 2008, also using IMF data.


Moving on to the question of 'derivatives overhang' in the global financial and trading system, the outstanding nominal amounts in play are almost limitless, perhaps $ 50 000 trillion, in other words so large they are like national debts but even more so, and can never be redeemed or eliminated. Any talk of 'moralizing capitalism', or modernizing, reforming and regulating it - which will be given headline treatment at the coming Pittsburgh G20 meeting - has little sense due to the accumulated and stupendous amounts of financial instruments that have been "injected" into the global finance system over recent years. This has produced a form of "value" similar to central bank inscriptions of debt, transformed into money at the flick of a physical or electronic pen. Only economic growth permits this 'perpetual debt' from becoming completely impossible to service.

One important point is that the current 'classic Keynesian' spending, to fight recession, is unlike most previous national deficit-financed plans or programs to restore economic growth because final consumers are deliberately, and almost entirely excluded. One exception is 'cash for clunkers', in an attempt to save the car industry, in many OECD countries. The accent is supposedly placed on 'productive investments', and within this the fight against climate change is a highly favored sector for Keynesian largesse. Since 2007-2008, the conceptual framework of the 'Green Economy' has been constantly expanded away from its climate mitigation core or origin. This has enabled spending ambitions, and plans, to be constantly raised.

What is clear is that effects of the recent and present, massive spending to fight recession and restore economic growth, with a few possible exceptions in some countries, have been weak, hesitant and ambiguous to date. Nevertheless, the Pittsburgh G20 summit will surely feature self-congratulation by heads of state and their finance and economic ministers that 'the worst of the recession is over'. Nothing assures this public hope in a Happy Ending, as many 'doomster analysts' such as Nouriel Roubini and Marc Faber repeat.

There are several reasons why the current Keynesian excess is so unsure and unreliable in its impacts, and might produce the completely contrarian result of plunging the world economy into, or back into freefall recession, or perhaps even more mysteriously produce no result at all. These in part derive from the sheer scale of deficit-financed spending on the hope that economic growth will return quite soon, last a year or so at minimum, and inch'allah longer. They also originate in the scale of finance sector engineering, almost unlimited creation of debt and interest rate derivatives, their essential 'blind bet' trading process and strategy, and the constant drift and disconnection of the 'real economy' from the finance, bank, insurance and related sectors. Many other reasons also exist, including long-term climate, environment and resource pressures raising raw materials and energy costs, and also include economic policy and political changes since the 1970s and 1980s, as well as the emergence of the 'global economy'.

Liberalism and Crisis

Concerning economic policy and political change, we can note that until the crisis struck in 2008, almost any political decider in most OECD countries, and in some Emerging Economies, studiedly refrained from interfering with or intervening in the economy. This, as per 'Austrian school' notions, was a kind of self-regulating black box filled with Adam Smith's invisible hands to work the levers and buttons. Nothing could be further from hands-on Keynesian big spending, as many 'Austrian school' defenders loudly remark, deploring the now massive and naked government intervention in almost any and all markets. In the real world of today, intervention has never been so high and will increase further, most recently with plans to radically increase the fight against climate change. Surprisingly, 'Austrian school' economists rarely remarked the chaotic and massive production of financial derivatives, to feed the financial casinos of the world with gaming chips used in supposedly 'structured' games that could only lose, that is zero sum.

Keynesian-type deficit spending as a way to fight recession was first proposed, by Keynes, in the 1930s crisis of capitalism, but never applied at the time. One little remarked reason for this was Keynes himself, and the strange and ambiguous ways he explained his proposals. Any honest reading of Keynes' works, by different readers, always produces different and usually contradictory conclusions as to what his works might be recommending. Another point, or a defence of Keynes is that the idea of deficit spending did not become official policy and mainstream economic practice in his lifetime, preventing him from 'tuning up' his ideas, changing them, or whatever. To be sure, arguments can be made that 'the Bretton Woods world' was Keynesian. It can be argued the creation of the IMF and IBRD, state economic interventionism and macro management, and sometimes micro management of local and regional economies or sectors inside them, were and are all 'Keynesian inspired'.

The important point is that Keynesianism never worked in the 1930s, and has never been applied under 1930s-style crisis conditions - noting that the IMF has many times described the current recession as 'the worst since 1945'. Since Keynesian-type remedies have never been tried under real world, extreme global crisis conditions, why should the present and massive, deficit-financed attempts at restoring economic growth succeed ? The jury has to be out to lunch on this question. This is the first testing of 'Keynesian type' global economic management, or intervention, that has been attempted under real crisis conditions.

Another very important point is that current big government deficit spending is un-Keynesian in the sense that there is no real pretence in any country that final consumers will be specially enticed into spending more, given higher wages and salaries, and generate jobs by doing so. Investment in productive capacities and infrastructures is officially targeted, hoped for and encouraged, with the 'classic Keynesian' aim of generating jobs, later on. On the ground, direct results of supposedly 'Keynesian spending' in the car industry is relatively weak, apart from a slight recovery in employment and activity in some car factories, in some countries. Thus the loudly proclaimed ambitions to fight climate change and also generate a 'Global green recovery', mainly through big spending on new energy sources, is handy ammunition for imagining new employment will soon be generated.

One immediate, almost amusing incoherence is that partial and weak car factory job recovery is achieved by handing government cash to buyers of new and classic, oil-fuelled cars, who each day see media reports on electric and hybrid cars coming by 2011, which will entirely relegate oil fuelled cars to the wastebin of history, with a related resale value. Perhaps not surprisingly, the market has been unable to generate such flexible thinking, so this aspect of the fight against climate change - electric cars replacing oil fuelled cars - will need more deficit spending when or if the 'electric car future' can be marshalled into place.

Through 2009 to date, entities such as the IPCC, G8 and G20 meetings, the Davos Forum and others have rivalled each other in estimating and forecasting spending needs to fight climate change. These estimates are often around, or above $ 500 billion a year for the period 2010-2020. As already noted, this spending will be new and additional, over and above the approximate $ 4 trillion 'Keynesian injection' of the past year. It is therefore sure and certain the 'liberal hour' or flirt with Austrian school notions of black box economic management have completely disappeared from the mindset of G20 leaderships. Unparalleled amounts of borrowed and printed cash will be utilised, making it more than only possible that an Austrian-style and ultra classic crisis of capitalism, like that of the 1930s, breaks out in the near-term future.

Green Shoots or Overshoot ?

Over the past 4 months or so the war of words has raged on whether the end of the recession can be declared. Green shoot anticipation, itself, has perhaps changed the nature and type of recession we are experiencing, as equity and commodity traders have enthusiastically recycled chunks of theKeynesian largesse they have directly or indirectly received. Market trading volumes and open interest, for example, have increased quite rapidly over the last 4 - 6 months, and this newfound volume, which is not the same thing as newfound confidence, can easily "unwind", given the right "signals". In any case and until very recently, market operators were rejecting the warnings of pessimists or doomsters such as Marc Faber and Nouriel Roubini, but like warnings of the wolf inside the sheep pen, one day it might really be there, if we wait long enough.

Keynes had a celebrated one-liner about the short-term versus the long-term, to underline that only the short-term matters. As Keynes did not say, in the long-run both the wolf and the sheep will be dead, so why worry about huge budget deficits and national debts? However, as Faber, Roubini and other pessimists always remark, the basic unresolved questions hanging over the world economy, but particularly the OECD economies, concern its ability to recover from unprecedented public, corporate and private debt.

If the debt mountain is not reduced and goes on growing, the 'Austrian school' warns, the full meltdown of the US dollar with gold at or beyond $ 2000 per ounce should be rather logical, as 'flight to quality' goes metallic, or ballistic. Monetary weakness of the dollar, and oil prices can be compared for example by charting the Philadelphia XAU Gold-Silver index against the Amex XOI oil price index. This only shows that gold/oil price ratios of around 20 are absolutely normal, over the last 35 years, implying that $ 100 per barrel would be perfectly compatible with gold at $ 2000 per ounce. In theory yes, but gold prices even at $ 1000 per ounce will already sound warning bells, or sirens, while $ 2000 an ounce will signal that global hyperinflation is probably coming, and all shreds of remaining credibility for the US dollar and US government have been lost. Likewise, oil prices staying for any time at more than $ 150 a barrel will do the same.

At extremes, there is no remaining flexibility in the global economic and monetary system, and at these times waves of change overwhelm and replace previous models, structures or cycles. Since only the short-term matters, dixit Keynes, massive deficit spending should produce results in the short-term. In turn, given the recent and present spending, and the present impossibility of declaring the birth of recovery, the almost bizarre lethargy, hesitancy and unpredictability of the "real economy" is even more striking and disquieting. This itself should sound warning bells in the world's chancelleries, as the expression goes, but there is no official trace of this except mutterings, from some central bankers that national hyper debt must be reduced, of course in the longer-term

Genetic Damage ?

One possible explanation of the massive loss of honey bee populations in many countries features genetic damage due to GM crops, and a possible analogy for the plight of the world economy can include initial damage due to financial engineering through the last 15-20 years, followed by Keynesian excess since 2008. Meeting at Jackson Hole in late August 2009, central bankers from several countries agreed the world credit system gives a dangerously more solid impression of death than the recession, that is banks will not lend. All kinds of explanations can be given for this, starting with simple fear on the part of bank directors and deciders. Yet green shoots of certain types, have appeared and disappeared in several OECD countries in the past few months.

The key buzzword of 'sustainability' however most surely does not fit these will o' the wisp or gene mutant green shoots, as shown by even a cursory glance at data on the world housebuilding and construction, airplane, shipbuilding, ocean freight and car industries. Concerning the last and as noted as above, consumers and users can ask the simple question of whether they are buying a product that will soon be completely redundant and outdated, due to the climate change-linked, and supposed rapid arrival of mass produced electric cars. Incertitude is most surely the mother of caution, or at least hesitancy. Volatility in the financial markets, another example of incertitude, is traditionally much greater than volatility in its underlying driver, the real economy, but today we now have extremely high volatility in both. It is tempting to say that a crisis generated in, or induced by the finance sector and its "tradable instrument creating" capabilities, is now mirrored and replicated by the real economy. Volatility and unpredictability have radically increased.

To date however, few if any observers ask the obvious questions. It may be that the recession has already mutated, in part due to anticipation of its end, the ways it has been fought, and the mutations, including state intervention and financial engineering experienced or suffered by the global economy over the last 15-20 years. More simply we can ask if the present recession is (or was) a 'Keynesian recession', in first place, when it started in 2007 or 2008 ? Was it possible to have a 1930s-style crisis in 2008 ?

One reason these questions are little heard is they open a Pandora's Box. What can we say, for example, about the reality and substance of the now-you-see-it and now you dont 'Asian decoupled locomotive', imagining that a decoupled locomotive could or might pull a train of wagons. The basic question, here, is simple: Is the recession global ? This is the official or at least IMF theory, but posing the question brings along a much more dangerous subject: is there a global economy ?

Comparing Like With Like

One thing is sure: the world economy is vastly different from the 1930s economy treated by Keynes. Comforting claims are made by pessimists as well as optimists that economic trends are more or less similar, more or less negative or positive in any country, both inside the OECD and the Emerging Economies. Convergence in the 'Global Economy' has been proclaimed as a dominant economic, social and cultural theme for 20 years or more.

This claimed geographical and regional uniformity makes exactly the same quick mental leap used by economic analysts in the OECD countries. The stated or unstated assumption is that stock and primary product markets run together and reflect the same basic 'upstream' changes in the same or similar real economy, rather than more simply, and more honestly only reflecting crests and slumps in exuberant, and less exuberant day trading sentiment, where convergence is simpler to achieve, but has no specific need to remain in place. Real world evidence opposing the notion of convergence and uniformity is massive. The immediate short-term, market conclusion from this is also evident: the real economy is hard to read and volatile, it might still be contracting, finance markets need to backtrack.

This completely contradicts all apparent logic: the quantity of public money thrown at the bank and finance sector since late 2008 should have generated an extreme or massive rebound in that sector, with at least some significant trickle down to the real economy. This trickle down mechanism, or implied mechanism is now the pressure point, but the evidence and data is so incoherent and contrary that the only honest reading is that emerging markets are probably even further disconnected from their real economies, than OECD markets. Both we can note, are 'mutating' or evolving, but not necessarily in the same direction. One result is simple: markets have never been so opaque or lacking in 'visibility' as at present.

The signals were already fuzzy, but since late 2008 financial noise, vibration and friction has taken over. Electronic, atomic or thermodynamic analogies abound. The entropic effect of massive Keynesian 'injections' in the already heavily mutated finance and bank sector could help explain the apparently bizarre lack of clear result or action produced, making it now harder than ever to sound out the real economy, as Roubini and Faber, and many others sometimes underline

Due to no previous Keynesian attempt at restoring growth ever taking place, we cannot know what post-crisis 'Keynesian sustained growth' might include, other than various kinds of productive and other infrastructures. The rate of recovery is also open to question, despite simple logic suggesting a rapid recovery. As today's big deficit spenders often claim, the recession slope was almost vertical in late 2008 and early 2009, so why shouldnt the rebound be symmetrical and equally fast ?

Going a little further with this rationale and adding a few frills of Keynesian type magic, that in the 1930s he called 'multipliers', the gargantuan and unprecedented amounts of public cash used in a variety of ways to fight recession could generate a fantastic peak of growth. Some observers running this idea through their PCs claim we could soon see a remake of the Volcker boom of 1983-84, when this Fed chairman finally cut US interest rates to single digit rates after extreme double digit highs, and 'unleashed growth'. This growth attained a very surely unrepeatable 7% annual rate for 5 quarters, in the US economy.

Conversely, high interest rates are today almost impossible to imagine in any future scenario. How could any OECD central banker cut rates like Volcker did, by 5% or 7% or more over a year, today? What OECD central banker, today, could imagine or dare to imagine raising interest rates to say 10% anytime in the next 3 to 5 years forward? Despite this reality barrier, warnings came from Bernanke at Jackson Hole, in August 2009, that the rebound could or might be very inflationary, and fiscal tightening could soon be needed.
There is only one, but very important missing detail: the rebound has to come, first.

Carbon Certitude

G20 leadership determination in moving the global economy to low carbon is only rising, in fact taking on the trappings of crusader zeal. The coming Copenhagen climate summit in December will see ever tighter carbon emission limits being set across the economy and across the world, a possible international carbon tax or trade tariff, and further, large financial and economic aid to Cleantech in both OECD and emerging economies. As with IMF estimates and forecasts of anti-recession spending and engagements, which range from imaginative to flexible but are always large, future low carbon spending by the G20 will be large but numbers are unsure.

Underlying all this is certitude. Even if they dont know what is happening to their real economies, G20 leaders and their science advisers are sure and certain that world climate is changing for theworse, remedial action is urgent, and spending must be large. The closely linked stalking horse ofPeak Oil does not openly figure in the rationale and reasoning offered for ever-rising, increasingly massive spending, and muscular legislation to force energy transition away from the fossil fuels, but surely adds yet more impetus to what will be huge long-term intervention in the economy.

Ironically or not, G20 led climate change mitigation effort is already the focus of rising wails from the Austrian school, which has thrown in the towel on railing about the Keynesian largesse of 'recession mitigation' deficit spending, perhaps because of its almost unbelievable size.
Focusing on smaller sums, perhaps soon rising to $ 500 billion a year (according to the 2009 Davos Forum) and used by G20 governments to speed energy transition through 2010-2020, the Austrian school rightly underlines the distortions this will create. As a rough guide, if this spending attained $ 500 bn ayear, this would be about 25% to 33% above total annual spending by the world's oil and gasindustry in recent years. More important: would it be possible to ramp up to this level of spendingon alternate energy and fighting climate change, so soon?

How this spending will be financed makes appeal to Keynesian miracles. Some G20 leaders,borrowing from Lord Stern's creative accounting, already have one-liners prepared for pressconference grillings, of the type that big spending now will create beneficial climate and environment multiplier impacts by about 2030-2050. Also, to be sure, they promise shorter-term low carbon multipliers for the car industry, in the shape of electric cars, and large net gains, over a certain but flexible time horizon, in the employment market through shifting away from oil, and to a lesser extent away from coal or gas.

The Cycle Amplifies

Forecasting when or if the recession will end is almost impossible: we can only be sure of incertitude. The crisis itself was at least in part a massive evolution and change of the economy, with unknown future impacts in different geographic regions, as well as sectors (like the car industry and energy industry). This mutation was then joined by a heavy dose of cosmic radiation in the shape of supposedly 'Keynesian' deficit spending, in unprecedented amounts. This will now be joined by massive spending on the fight against climate change.

The simplest read-out from this is increased uncertainty, faster global economic change, and rising volatility for any market, anywhere. Markets, as well as economic sectors could or might quite rapidly de-converge or re-segment. If we added the ongoing anti-recession spending to the climate change mitigation spending that is now starting, and looked at the extreme sluggish pace of recovery, or apparent recovery, then in pure theory we should have double digit inflation within weeks or months !

This could happen, but not in traditional ways, again due to global economy mutation. Where national and reserve currencies cannot exhibit double-digit (or triple digit) inflation, or can be prevented from doing so, market values of other 'tradable instruments' can take the strain. In other words a global financial market reset of the type that has already happened once this year. To be sure, the reset of nominal values can only be down.

In turn, this will allow market volatility to be brought under control, ushering a new economic cycle. In the present context, due to the constant onrush of conflicting and contrarian signals, market operators can only show more than usual excesses of fear and hope. As we know, any period of high volatility generates or gives way to another cycle. The only problem is judging what shape and form the new cycle will have, and which way it is tilted.

Testing this hypothesis will be easy in the coming Quarter. Until and unless there is really concrete evidence of real economy growth and recovery, no smooth and clear cycle can emerge, probably for at least one, or several quarters ahead. This whipsaw profile can continue well into 2010, easily and alternately absorbing and reinforcing switchbacks of sentiment driven by climate changespending, Keynesian spending, oil and gold price peaks and crashes, the US dollar's feats ofvolatility, the Euro's feats of volatility, the agonies and extasies of the car industry, runs on central banks in several countries not necessarily restricted to small and unimportant countries, and so on.

No doubt converging with the worst flights of pessimism from Faber or Roubini, we can be sure that little prevents a reset of world finance markets.As noted, the reset could only be down, and could be by 33% or more, perhaps a lot more. From this new base, however, the long-term cycle can grow high and with decreasing volatility.

How the correction is made will be of course be traditional. An October crisis driven by externalchange, linked in various ways with the global economic and finance crisis, and generated in the political, policy, social, geopolitical, climate or environmental domains. If the process started soon, this October 2009 but slowly at first, it might extend 3 quarters or more, but will obviously last a shorter period of time if the correction is massive and rapid.

By Andrew McKillop

gsoassociates.com

Project Director, GSO Consulting Associates

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission

© 2009 Copyright Andrew McKillop - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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