PrintMay 20, 2011
The US is Running Out of Ammunition for the Coming Economic Crisis
Lately one of the primary topics discussed among my business associates in Europe is the question: How long before we [the U.S. and the world] confront a new financial crisis? In fact, an overview of the financial landscape indicates there are many potential triggers that could initiate a new catastrophe.
Normally a severe crisis, such as the one in 2008, takes a number of years to evolve into a prolonged recovery cycle. Economies have to recover and bank capital has to be rebuilt concurrent with debt workouts. These factors as a rule constrain risk appetite thus allowing for an orderly transition into growth and prosperity as well a gradual rebirth of optimism. However, in just a few short years the markets are already experiencing uncontrolled optimism, excessive leverage and overpriced assets -- the central factors inherent in any financial crisis.
As John Plender writing in the Financial Times points out:
Consider the state of the asset markets. Commodities remain overblown despite the setback that recently overtook silver and subsequently spread to other markets. Developed world debt look seriously overpriced in light of the slow response to spiraling fiscal deficits in the US and elsewhere. In equities, we have a new internet bubble with shares in the likes of Facebook, Linkedln and Renren trading on absurd multiples of revenue. As for credit markets, lending standards are falling and covenant-lite [granting borrowers credit with nearly no conditions] lending has staged a comeback.
This scenario has largely been created by the world central banks, most notably the Federal Reserve who have flooded the globe with cash while the world and particularly the United States is crippled with debt. Instead of tackling head-on the unsustainable debt and spending policies of governments both in America and Europe the powers to be simply chose to muddle through by increasing liquidity instead of forcing politically painful but necessary solutions to what is a solvency problem.
Further the government and the central banks, instead of allowing banking or financial institutions to fail on an orderly basis, chose which would survive and which would fail. Those chosen to survive were propped up by massive infusions of taxpayer subsidies or cash from the central banks.
In Europe this strategy as played out in the ongoing and never-ending saga of the insolvency of countries such as Greece, Portugal, Ireland, et al has only delayed the inevitable.
In the United States, the Obama administration, since its inauguration up to the present, still refuses to acknowledge that there is a fiscal crisis -- except to pay lip-service as part of its re-election strategy. The Federal Reserve thus was forced to take up the slack by its various quantitative easing programs (buying US Treasury debt thus effectively printing money). As a result, while Wall Street and the major banking institutions are doing quite well, the rest of the economy suffers and job creation stagnates.
In another very worrisome scenario and a consequence of these polices, there is an ever increasing concentration of retail, wholesale, and investment banking among a few, chosen but systemically important, financial institutions. This includes the highly volatile derivatives business. These institutions have been designated as "too big to fail" by the government and can thus operate as if they were fully insured and guaranteed by the taxpayers (which in reality they are).
There is talk of placing more of the derivative activity though central clearinghouses to absorb some of the systemic risk; however, there is always the issue of what happens if these global institutions fail. Who is to guarantee their solvency without unleashing a financial Armageddon?
It is impossible to say when another financial crisis would descend upon the world; however the most troubling aspect is that there is nearly nothing left in the way of ammunition in either monetary or fiscal policy with which to address another financial collapse. The central banks and national governments have exhausted their ability to use the remedies of the past to resolve the next nearly inevitable crisis.
For the people of the United States the situation may prove to be more dire, as the policies of this administration have destroyed any real chance of a genuine economic recovery before another financial crisis may hit. Thus the nation is further behind than it should be had pro-growth anti-government spending actions been put in place. In fact the country may be facing another recession. Yet the ideology based Obama administration is again pushing banks to offer sub-prime loans, one of the catalysts of the 2008 financial maelstrom.
The national debt will have been increased by nearly $4.3 Trillion from January 2008 to the end of this year. (Thirty-one percent of the total national debt in just three years for a country 222 years old.) Despite this spending, total employment has dropped by 6.4 million since May of 2008 (7.5 million including those no longer in the civilian labor force).
The most recent economic statistics do not hold out hope for any sustainable recovery despite the best efforts of the media and the Obama administration to paint a rosier picture. In April new housing starts were down 10.6% as the value of existing homes continues to decline. The consumer price index increased by 3.2% (annualized) in April thanks to food and gas prices, which show no signs of abating in the near future. On an annualized basis the US GDP grew only 1.75% in the first quarter of 2011 well below consensus estimates of 2.8 to 3.1%.
Unemployment shows no signs of improvement. Since January 2010 the average unemployment rate (per Gallup) has been 9.7%. In mid May it is 9.2%. The average underemployment rate over this period has been 19.5%. In mid May it is 19.1%. No one expects any significant improvement over the next 18 to 24 months.
The United States may well be faced with a recessionary trend coupled with a potential financial crisis with no remedy at hand because of its policies over the past two and a half years. As for the American people, who instinctively know all is not well, they must continue to reduce their personal debt burden, not assume new debt, and be prepared to ride out the storm if and when it breaks. The Republicans in Congress must ignore the hysteria and doom and gloom scenarios proffered by the media and the Democrats and dramatically reduce spending permanently before any increase in the debt ceiling.
The financial world will not collapse if the US does not raise its debt ceiling based on an artificial timetable; but there will be a major crisis of disastrous proportions down the road if spending, debt, and runaway government are not brought under control and the country cannot reimburse its bond holders with or without paying a usurious interest rate.
