Will there be a global economic disaster?

August 31, 2008

The US economy grew at around 3,3 percent in the second quarter, according to BEA, but there are a lot of sensible people who believe that the deflator used to calculate the number was, in short, bogus. Same doubts are expressed about the discrepancy between establishment and household survey data on unemployment, and there’s also a lack of trust in the government’s published CPI and PCE numbers.


Outright deceat is perhaps less common then artful methodology in calculating the rosy data, but whatever the numbers say, it’s more or less certain that we’re entering, and will remain in, one of the darkest periods in the history of the world economy. And the United States is the epicenter of today’s crisis.


Still, US growth, whatever amount there was of it, was supported by rising demand, and continuing dynamism in developing nations. Though there’re countless problems in the Western world, Asia and the Middle East have a lot of liquidity to splash around, and they are the saviours of the financial system.


There is, however, every reason to believe that this picture of health is illusory, and that the bubble that in the western world developed in the financial and services sectors had its counterpart in the manufacturing and construction activity that boomed in places such as Shanghai, and Shenzhen. And it must be remembered that China, as a closed society, is much more prone to corruption- related ills, so if US cooks the books, so to speak, then there should be even more doubt about the integrity of the data from some of these developing nations.


There’s no reason to believe that the eastern bubble will outlive the western one, especially while Asian nations do what they can to prevent the spiralling of inflation. Past experience, and present analysis shows us that they will fail, but the end result of that failure will not mitigate the negative impact on growth.


There was for a long while a debate on whether there is a savings glut in the east, or a lack of saving in the West, that led to the abnormal situation of the US consumer. But it takes two to tango, and I don’t see how one of these would be possible without the existence of the other. The same profligacy that created the mortgage bubble in the West has created the investment bubble in the East. The more factories mushroom in China and Vietnam and Thailand, the more the US consumer must spend, and the more he spends, the more the Chinese and the Japanese will finance him by lending.


And how does this all become possible? Surely, at some point, the circular nature of the scheme should be obvious to financial participants, and lead to an unraveling fairly quickly.


But markets function on incentive, and with interest rates as low as they are in the world, – and they still are very low – there was and still is very little incentive to break the momentum of the bubbles. The failure of central banks to see that asset prices are just as valid a channel for masking inflation as are bogus statistics is likely to plunge the world into a period of economic turmoil the full consequences of which will only be understood and realised towards end of the next decade.


Nowadays what happens is that once a bubble in one area bursts, and the excessive liquidity can no longer use that channel to create false wealth, with the speed of lightning the now idle capital finds something else to direct itself to, without worrying too much about fundamentals.


Once the global stock market bubble of the nineties burst, excess liquidity quickly created the global real estate bubble, A short time after that burst, we had the commodity bubble. And while it’s not yet that clear that we have seen the end of this last bubble, there’s no question that it will end. And when it ends, and if there’s no other place to bubble up, so to speak, economic activity is likely to shrink dramatically. 


Since economical events of this size rarely culminate without some impact on other aspects of social life, we should expect some kind of geopolitical event to provide the breaking point. The Iran nuclear issue has the potential to create mayhem, but at least it will be the sword to cut the Gordian Knot – once all the illusions about a brief and light crisis are dispelled, we can begin recognising the reality and taking the necessary measures to repair the damage that was done.


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