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Dark Window Debt Default

Interest-Rates / Global Debt Crisis Aug 05, 2011 - 11:58 AM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleThe US debt crisis, with its see-through debt ceiling and dark invisible floor, so far below, has very serious rivals in Europe. Relative to GDP, the USA's sovereign debt is either less extreme, comparable to, or not far ahead of sovereign debt load in not-so-small Italy, France, Germany, UK and Spain. Apart from Germany, the other four members of Europe's Big-5 are very close to recession, even using their own official and doctored economic data. But needless to say, these are not normal times and hope, or at least illusion is more important than ever, to keep the party going one more day.

By 4 August, the outgoing director of the ECB, J-C Trichet, a rare French decider with high-level financial and monetary power but without a trailing scandal, came close to describing the current European debt crisis as no longer a simple money and finance crisis, but a political call for action.  The Fed’s Ben Bernanke openly talks about "catastrophe" if politicians fail to control their passions, which in no way prevented Italy's Silvio Berlusconi, also on 4 August, passionately telling the Milan stock exchange he owned four traded companies and was as confident as their prospects, as his own political prospects. The Milan MIB showed one of the biggest waves of panic selling in Europe, 4 August.

The political action needed from our deciders, we could guess, is neither passionate but effective and above all real. They have to map a fragile tightrope across Doom Valley for not-so-steady walkers doing the walk, and unsure talkers doing the talk. Political action has to be real.

What we get is talk. This talk can be found almost anyplace in what the guardians of politically correct are telling us about the crisis in mainstream media. One example is the continuing, near-incredible rate of money supply growth in EU countries, Japan and the USA, with US money supply growth well above 12 percent annual, as of June and accelerating hard. This is OK, we are told. The far lower single-digit growth rate for M3, including longer term savings deposits is supposedly yet more reassuring, but in fact it shows what every recession tells us: people are forced to spend their savings when the economy turns down and the jobless queues, and soup kitchens beckon. With savings growth low, the chance of the present and mid-term context delivering the perpetual fond hope - a bounce in the housing market - is as low as Obama climbing in the opinion polls.

 The fond hope is the OECD economy can cure itself in time-honoured fashion. This is shifted to the enticing but dark window of playing with money parities and standards. These seem to offer quick fixes - because solving the accumulated economic, infrastructure, social and cultural problems of the "late consumer society" in OECD countries is a Superman task, concerns the real economy and society, and needs very real effort.

A supposed "monetary cure", unreal as it is, will be the focus of predictably frenetic, passionate and unproductive talks run by politicians in Washington, Berlin, Tokyo, Rome, London, and Madrid.

Some guardians of good thinking will tell us that monetary quick fixes, like a 25% deval of the dollar (against what ?) might be imaginable. Other quick fixes would of course be more subtle and insidious, for example forcing banks and insurers to buy bad sovereign debt, and using new IMF-type international bad debt agencies to mutualize the risks, with the basic goal of pushing the state debt crisis back into the supposedly more comforting arena of "only a banking and insurance sector crisis".

Above all, the new great fear is triggering the Big One. This is the 1929-1931 sequence, when the already (in real terms) inoperative fixed exchange system called the Gold Standard finally and openly fell apart, lighting the fuze on the bomb which exploded both US and European banking systems.

Essentially we have semi-fixed exchange rates, without a gold standard, today. We are already post-gold standard. Exchange rate changes, except of the extreme type will do nothing to solve the crisis.

Our keep-it-going hopefuls in their weekly columns tell us that even with another 1929 stock market rout - and we had the most recent in 2008-2009, only 2 years ago - the right political action, avoiding political blunders, will stop recession from turning into Great Depression. If in fact we backdated our current crisis to 2009, and said that stock exchange recovery to 2011 has been mostly fake, with semi-real numbers chased out by blatantly false data, we can argue that we are already well into the 1931 scenario, that we are told is being avoided.

We have a rather clear and sombre proof of that, simply with stock market crash-performance through 4 and 5 August: a rot, today, only needs relatively small falls of index numbers, much less than in 2008. The reason is that apparent recovery since 2009 has been an illusion.

The comfort view, of 1931, is that real damage came from beggar-thy-neighbour at state level. Private sector crises, as ever in banking, insurance and related crossover sectors from the virtual to the real economy, percolated upstream in 1931 to become State crises. France and Germany were edging towards war again, and used banking and insurance chips to score political hits. Frightened markets tested the weak links of the Gold Standard and found the whole chain was made of weak links. What was even then a globalizing economy, in the late 1920s and early 1930s, made a de facto retreat to national autarchy and self-reliance - and to fascism.

In fact we have the same operating today, at a much larger scale, and the same failed political uptake at national level for real policy shifts towards autarky. The political blunders of 1930s politicians surely included their "no exit strategy" from global economy disaster, with inevitably worst-possible results.

 Obama's laughably inept handling of the US debt crisis has serious rivals in Europe and Japan. Anything you can do - badly - we can do even worse. Basically Obama and his European and Japanese lookalikes have the no-choice of setting either a ferocious austerity fiscal freeze, or raising their debt ceilings, to avoid default. Either choice can easily lead to default. In the present US case, Washington would have had to slash spending at around 11 percent of GDP if the debt ceiling had been treated as real. This type of spending cut is basically impossible, underlining the truly unprecedented situation we have today - vastly more complicated and worse than 1931.

Brave words can be trotted out, for precedents of economic growth recovering, if not rebounding after fiscal contractions, the rare examples including the UK after 1932 and in 1993, but the scale of cuts needed to close US, most European, and Japanese deficits is of an entirely different order. And the reason is stark and simple: in country after country, the economy is vastly over-leveraged.  Solving this problem includes physically de-leveraging the economy, by regionalizing and localizing it. When this is achieved, we have greater national self-reliance, or autarky.

The likely rising threat of Obama buying a little time and 'pushing down' the Fed debt crisis, to the State level, triggering serial defaults by states and then municipal borrowers, is very similar but in reverse order to what is happening in the Eurozone-17 group of countries. The sequence, here, was the debt crisis first affected smaller entities and defined economic sectors in smaller countries, but is now rapidly and dangerously percolating upwards, all ways.

This underlines why and how the threat of national default is larger in Europe, but the global crisis is more serious in the USA. In the immediate short-term, sovereign debt disaster is probably an outside risk in America but is the odds-on bet in Europe. The most recent EU talkshow summit and shaky deal is much too little and too late to stop the spiralling crisis of confidence. With no surprise at all, Spanish and Italian bond yields are back to pre-summit danger levels, and can fly out of control any moment unless European politicians massively bolster and extend federal-type institutions, which national voters do not want.

The European Central Bank can refuse to act, eroding its credibility every day, and the European FSF bad debt bail-out fund will not be able to do it until national parliaments enable this "latent" or semi-virtual entity. But exactly as we find with US Federal and State debts, the fantastic growth of immediate financing needs underscores that we are essentially post-1931.

The 440 bn euro FSF, whenever it can start operating, is undersized. Probable needs are at least 2000 bn euro to forestall a twin crisis in Italy and Spain, which by its fatal magnetic power will surely drag in France and Belgium. In turn, this will place the European debt crisis hot potato back in German hands. For Germany the question is very simple: will it do whatever it takes to uphold European monetary union in its current form, or will it not? The second question is: has it got the wherewithal to do it ?

All three pillars of the global economy - USA, Europe, Japan - have failed to resolve their debt crises.  All of them in fact include the same cycling of debt from the banking and corporate sector to state debt crises, always growing and less treatable. Much worse, there is no resolution. The two bail out packages for Greece are a stark example: despite having been pushed into default, Greece’s debt will rise in pure automatic fashion by a further 5 percent of GDP (to at least 160pc of GDP) next year. In turn, this will make it certain Greece will need a third rescue.

What we have therefore is the first sovereign default in Western Europe since World War 2, with no resolution of Greece's financial and economic crisis. This is the worst of all worlds.

The Obama debt ceiling show, which played out in recent weeks, promises - in fact threatens -  us with a Super Greece. High debt burdens and large budget deficits are now "classic" or "structural", which is another stark difference from the 1931 situation.  The US cannot insulate itself from the consequences of Europe’s elemental blunders in "one size fits all" money policy, but is ensuring its own deepening crisis through putting the pedal down on Fed money supply in an economic context of slowing growth, itself due to America's crippling inability - shared by Europe and Japan - of acting to remodel and relaunch its whole economic superstructure.

The dark window beckons: in the 1930s, following the 1931 watershed,  national autarky and self-reliance was seen, later on and in retrospect, as only bad and only able to favor fascism.

This is a classic of throwing the baby with the bathwater: the solutions to our current crisis most certainly include pushing down fiscal and financial responsibility from national levels, to state, regional and municipal level.  In turn this creates real opportunities for economic restructuring at local levels, bolstering local democracy, and generating a bulwark against fascistic trends. The economy can "go local" but not if local initiatives and actions are swallowed by national debt and, even worse, by international debt. At the local economy level, new moneys and payment systems are vastly easier to introduce and support, than at higher levels.

To be sure this is an unprecedented context - not like 1931. The most sinister comparison is that politicians unable to face entirely new challenges will take the fatal and traditional political default of playing the extremist card, and lurching into war and conflict. Their real choices should be decentralizingnd regionalizing their economies, downsizing from national to municipal level, creating new local moneys, and attacking the debt crisis from ground-up.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2011 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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