No way to run an economy

No way to run an economy

Ann Pettifor: September 24, 2009

As world leaders meet in Pittsburgh and then Istanbul (for the World Bank and IMF meetings) expect much self-congratulation and back-slapping for having got the world through the post-Lehman crisis.

But behind the cacophony of self-praise, watch out for three alarms flashing red:

• The escalating foreclosure and rising mortgage delinquency rates in the US
• The dramatic contraction of credit in the US over the summer – putting paid to any hope of the US acting as the ‘engine’ of a global recovery
• That big accident waiting to happen to the European economies –Spain

With the help of a great new book – about to be published in the US - let’s take a look at why there is no room for complacency.

“No way to run an economy” (Pluto Press, 2009) is by a man whose research and analyses I have come to respect and rely upon - Graham Turner of GFC economics. While the book is full of solid facts and data – it is eminently readable for those prepared to unleash their inner wonk.

Turner lived and worked in Japan through the last twenty years of debt-deflation – and now looks at the US and European economies through the prism of that prolonged deflationary crisis. And it’s not a pretty sight.

He first takes a close look at the Bernanke/Geithner/Summers strategy for reflating the US economy. There are, or at least were, five planks to this strategy – lower interest rates, the Public Private Investment Program (remember that?); mortgage modification; fiscal expansion and ‘stress tests’.

While free money and fiscal expansion, Turner argues, may have helped the Dow move up – it’s not reflating the economy. On the contrary, debt-driven deflation is the order of the day - reflected in debt defaults, falling house prices, rising foreclosures and mortgage delinquencies. But stabilising the housing market is key to bank solvency, to generating employment and to kick-starting a full recovery.

All the signs are that despite their massive collective brain power the Bernanke/Geithner/ Summers strategy will not give President Obama and the Democratic Party the sound economic recovery needed to win over the electorate in 2010.

So self-congratulation should be put on hold for a while…..

What of the Europeans? They will be at Pittsburgh to boast of imminent recovery, and to contrast their economies with Anglo-American economies. They will imply that in Euroland policy-makers were more cautious about lending, and that their economies are therefore less prone to Anglo-American-style bubbles.

That might be plausible – if it were not for Spain, Ireland, Eastern Europe and the European Central Bank (ECB).

For if the Federal Reserve has blundered – and it has - the governor of the ECB is guilty of criminal inaction and continued complacency. Indeed at the height of the crisis – in July, 2008 - the ECB actually raised interest rates! Consider one of the most disastrous impacts of that massive strategic miscalculation: the growing debt-deflationary crises in Spain, Ireland and Eastern Europe.

Of these the crisis in Spain is the most alarming. Just as in the US, real interest rates are still high – despite recent, belated cuts by the ECB – and remain well above falling and negative prices and wages. According to Variant Perception the Spanish real estate crash is worse than widely believed; banks are hiding their losses, and while Forbes magazine might argue that “Spanish banks are in Top Form” – that may be because Forbes has not looked closely at their balance sheets. Spanish banks are hiding their losses, it is alleged - by sophisticated accounting tricks, by not marking loans to market (i.e. valuing them higher than the market would) and by lending to what Variant call ‘zombie companies’ – mostly in the construction sector.

Sound familiar? Could this be happening in other parts of the global financial forest?

Spain, like the US is experiencing deflation. Prices have been falling for three months in a row. At the same time – and just as in the US – unemployment is still rising - heading towards a socially and politically disruptive 25% .

It’s worse in much of the rest of the European periphery. Prices in Ireland are falling at an annual rate of 5.9% - the highest deflation rate in the world.

The big losers will not just be the poor and middle classes of these countries: deflation will have ‘broad ramifications across the European banking sector’.

Why? Because countries on the periphery are net debtors, and the rest of Europe – including France and Germany – are net creditors. When the debtors stop paying their creditors – then Germany, France and other members of the European Union will face huge losses. On top of that they will need to re-capitalise Spain and the periphery economies - costly to their taxpayers.

When that crisis comes, Mrs Merkel may well have survived a German election campaign. But other G-20 leaders will not be so lucky.

Their management of the global economy and their legitimacy will have been severely tested – this time by voters.