Three fundamental trends aggravating the crisis in the second half of 2010
Excerpt GEAB N°42 (February 16, 2010)
For LEAP/E2020, behind the « sophisticated » dissertations on the exit from the crisis and the end of the policies of support for the economy and the financial sector hides a very simple truth, but one which governments and central bankers are unable to express: they don’t know what to do? when to do it? how to do it? and if they should do it alone or with the other big global players? Indeed if the lack of preparation to the start of the crisis resulted from world leaders inability to imagine a crisis could happen, for many months now, it has been their inability to correctly judge the true situation of the world economy and the interaction of the large number of extraordinary measures taken everywhere on the planet which now condemns them to remain passive. Between now and the end of this semester, this lack of action will simply leave the place to mere reactions to social, economic and political events. All this will take place within a framework of complete disorder, reinforcing everyman-for-himself trends which have become clearer and clearer since the end of 2009.
This situation of intellectual paralysis explains why, for months now, from bankers’ meetings to G20 conferences, one only hears positive statements on the inevitable end of the emergency measures taken in 2008/2009, whilst still observing that these extraordinary measures remain in place. As always happens in these cases, the impetus for the decision will be caused by a reaction to a sudden event and not by strategic, pro-active, carefully calculated thinking. The refusal during 2009, to face up to the crucial question of the recasting of the international monetary system (1) creates a constantly shifting situation and the eventual systematic shattering of the community of interests between the big global players: disparate priorities between the Euro and Dollar zones, growing tensions between Beijing and Washington on the Yuan-Dollar exchange rate, etc… which, henceforth, encroach more and more upon the spheres of commerce and diplomacy.
In the light of this worrying international backdrop our team has chosen, in this GEAB issue, to anticipate the development of three trends which we think will contribute to a sudden worsening of the crisis in the second half of 2010, namely:
- the explosion of the bubble in public deficits and the corresponding increase in states failing to pay
- the fatal impact of the Western banking system between the increasing number of payment defaults and the wall of maturing debt
- the inevitable increase in interest rates
The explosion of the bubble in public deficits and the corresponding increase in states failing to pay
These three trends are closely correlated because, in the end, they are all are based on the same simple truth: the short term financing needs of the world’s banking system and Western states are now much, much larger than available savings. We are currently at the beginning of a huge wave of repayment and/or refinancing of loans made at the end of the pre-crisis period (2005/2007) that is, loans made during this period of complete financial irresponsibility, especially for schemes where profitability has collapsed due to the crisis or where the value attributed by the counterparties becomes increasingly fanciful. Simply put, it is time to pay the « bill » for all those (LBO (2), commercial real estate investors, loans to governments, states, barely solvent cities, etc.) who believed they could have a « free lunch » in the years 2005/2007. The circumstances of a lasting economic crisis creates the worst situation possible for any repayment or refinancing.
On the one hand the crisis has caused the collapse of average profitability of almost all economic activities (for those which have avoided bankruptcy), profitability now hovering around 2% to 5% rather than above the 10% expected for most financial transactions entered into in the 2005-2007 period.
On the other hand, the competition to access financing has become, as is always the case in times of crisis, a real grabbing match, with households, businesses, financiers (classic), as well as Governments (and local authorities) and banks themselves. As LEAP/E2020 anticipated over two years ago, with the crisis causing the disappearance of around 30 trillion in « ghost assets », 2010 will see the start of « the ball of the damned » where, in order to repay or refinance their debts, every household, business, authority, financial institution and country will be desperately looking for resources or profits that it no longer has (due to loss of employment, falling profits, lower tax receipts, or increasing costs related to the crisis) or even trying to obtain new credit terms at a time when there are limited offers of credit for a large number seeking it.
Effect of exclusion of the private sector due to the growth of United States’ public debt (in black: credit to industry; in dark grey: sum total of American banks’ balance sheets: in light grey: current US public debt) – Source: Wegelin Bank, 01/2010
One of the most glaring examples of this situation is, without doubt, the exclusion effect caused by US public financing huge needs: internally, businesses and households are marginalised in the face of the increasing need for credit by the American state; externally, those countries in the weakest financial condition will be excluded from accessing credit or indeed be obliged to pay huge additional financial charges, when they are unable simply considering to just ask for aid (3).
On this last point, 2010 will produce a surprising case of the increase in strength of the concept of sovereign debt at risk: it started with Iceland in 2008, then moved to Latvia (4), Ireland, California and Dubai in 2009, and now Greece. Portugal and Spain will easily get out of it because the Eurozone is currently testing its discovery of the method of supporting countries with credit difficulties with Greece’s case and because these two countries consist of foreseen and manageable risks by Euroland. Then, this wave will go to Japan, the United Kingdom and the United States: the three risks which the system in charge refuses to recognise and for which there is really no possible solution because it concerns the prop of the system and its two supports (5).
By reason of next May’s General Election, the United Kingdom’s case is currently under embargo by the international press who are using the Greek one as a diversion. However, as previously stated, the United Kingdom’s financial situation continues to deteriorate. For mainly electoral reasons the draft budget proposals, as well as the Bank of England’s decisions, are aimed at temporarily covering increasing problems: on the part of the government, there is a draft budget completely at odds with the need to cut expenditure substantially for at least five years to probably a decade of fundamental budgetary austerity; on the part of the central bank, they have announced a suspension of « quantitative easing », in other words « monetisation », knowing full well that no one is buying Gilts (British treasury bonds) any more other than the Bank of England. But all that, supported by a media campaign which describes a Eurozone in turmoil, allows the average British voter to believe that, thanks to their clairvoyance the Kingdom’s leaders have enabled their people to avoid the reefs on which continental countries are smashing to pieces (and hide, for example the fact that the British banking system is no longer rated by Standard and Poor’s amongst the safest in the world (6)). In British politics it is a topic which generally wins elections; in the real world, it is the guarantee of a major crisis just after the elections, during a « readjustment to reality ». Our team asks itself, as well, if the British government has the ability to maintain this facade up to the election itself. We recall (7) the inability of the Republican party, then the party in power in the United States, to prevent the Wall Street crisis exploding before the last presidential elections.
In the United States, where all possible scenarios exist in an election year, we also note a growing disconnect between pronouncements (and the statistics) and reality. If one takes the only indicator of US Treasury bond buying, one finds on the one hand a Federal government and the Fed explaining that they are selling like « hot cakes (8) » whilst the need to sell more doesn’t stop growing due to increasingly bigger deficits; and on the other (as previously stated), where the main buyer of US Treasury bonds over these last few years (China) has steadied its purchases and even undertaken the task of reducing its holdings (9). Knowing that American households have no savings and that deficits of all kinds weigh down the major countries of the planet which are therefore unable to substitute to Chinese purchases, only two solutions remain:
- Tim Geithner multiplies T-Bond sales just as Jesus multiplied the « loaves »
- Ben Bernanke, and the Fed, says the first thing that comes into his head and henceforth buys the bulk of US Treasury Bonds via the primary dealers and other financial participants using a variety of opaque routes (and offshore (10)) like the Cayman Islands, the Channel Islands, Hong Kong…
The LEAP/E2020 team rather favours the second premise and, thus, expects a rapid increase in tensions between Washington and Beijing in the coming months (11): it was, in effect, just what the United States had promises not to do to the Chinese, very concerned over the growing risk of their Dollar denominated assets losing value. Add to that the sale of arms to Taiwan, the meeting with the Dalai Lama, commercial spats and Iran, and we consider that the second half of 2010 will be favourable to the beginning of a settling of scores between Washington and Beijing, which will only aggravate the crisis.
As regards Japan, their geopolitical situation is being confirmed by the course of events: Tokyo works closer and closer with Beijing, which can only lead to a rapid weakening of the Dollar and Dollar denominated assets by reason of Japan’s key role in holding Dollar reserves. The areas of conflict with Washington are increasing: besides the issue of US military bases in Japan, the argument over the secret treaties binding Japan and the United States during the Cold War has now surfaced. In the business arena, Tokyo accuses Washington of using Toyota’s problems to cast doubt on the quality of all Japanese goods. But beyond Japanese-American relations, Japan is entering a very difficult economic and financial period because it is simultaneously the prey of problems and major doubts over its economic model of the last two decades and it must face up to the first major questions over the credit financing of its enormous public debt: even Tokyo is going to have to fight to finance its deficits, a completely new phenomenon for Japan.
To summarise the United States, the Eurozone, the United Kingdom, Japan and China are going to see their dreams of growth reduced to nil from the second half of 2010 onwards.
Progression of the number of American bank closures and cumulative losses (2007-2010) (in blue: closures; in red: losses in billions USD) – Source: Bank Imploder blog/FDIC
Notes:
(1) By replacing the present system, based on the US Dollar, by a system based on an international currency originating from a basket of major world currencies (see previous GEAB reports)
(2) For the United States alone, Moodys calculates that LBOs will have serious difficulty in refinancing almost 1.4 trillion USD. Source: CNBC, 02/02/2010
(3) Source: Bloomberg, 01/27/2010
(4) Because of the Baltic states, the Swedish banking system is still fragile. Source: Swedishwire, 01/19/2010
(5) Aon, a country risk specialist estimates that, currently, 18 countries are economically and financially at risk and considers sovereign debt problems to be particularly worrying in 2010. Source: Business Insurance, 01/27/2010
(6) Source: Reuters, 01/28/2010
(7) And with good reason, because our missed appreciation on this issue led us to totally miscalculate the 2008 presidential election results.
(8) The day they say otherwise, the Dollar will have lost 80% of its value.
(9) As anticipated by LEAP/E2020, China actually began divesting itself of the Dollar and Dollar denominated assets during 2009
(10) Or perhaps tries to get American money market funds to buy them because it is in deep discussions with their managers to « soak up » the liquidity which was on offer these last few months and because the primary dealers are no longer capable (or, more likely, unwilling?) to carry out the task. Source: Bloomberg, 02/11/2010
(11) Source: New York Times, 01/26/2010
Via: leap2020.eu
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