Economists talk shop

The shape of the world economy

Is a global economic crash such as the one that occurred in 1929 possible?

The world today  -  Is a global economic crash possible?

Warren Buffet once said    -   "It's only when the tide goes out that you learn who's been swimming naked". 

Is it possible that the global tide of financial inbalances today will at some point fall like dominoes and expose governments and ordinary citizens that are financially over-exposed to indeed be naked?

In this corner we have America   -   the undisputed world superpower

The American dollar is the global monetary standard against which all financial transactions are measured. America is also militarily overextended, finds itself on an economic decline and is funding it's internal economy and external foreign trade shopping feast through foreign debt and monetary debasement as it works it's printing presses around the clock. In short the big bully is stealing from the nerds.

America's housing market has seen unprecedented growth which has been funded through ever increasing housing debt. The ominous signs of a bubble are beginning to show as sub-prime loans (loans made to financially stressed buyers) are starting to fail and liquidate. The dollar is hugely over-valued as foreign governments particularly China and Japan export their money to America to finance and stimulate American shopping for Chinese and Japanese toys, thus keeping their trade partners fully employed.

American federal debt stands at $9trn (it was $16bn in 1929) it is no longer self sufficient in energy and imports over 60% of its needs. It has a monstrous trade deficit and needs to borrow over $2,5bn a day from foreign sources to balance it's books. The good ship Titanic is showing signs of strain.

In the other corner across the ocean, far, far away we have China  -  The undisputed consumer manufacturing champion of the world

China today is a lot like America of the 1920s. Its trade surplus is the stuff that legends are made of and economist hail her as the eighth wonder of the world.

China has a credit boom far greater than America had just prior to the collapse of the stock exchange, built on the same principles of inflationary money creation by the Central bank which is growing at an annual rate of about 10%  (probably much higher). Its money supply in 2001 was 12trn yuan and by 2004 it had grown to 23trn yuan.

The Chinese property market has experienced a growth that is incomprehensible to western minds as it moves millions of people into new cities. The stock exchange is on a run to the moon at a pace that makes the American stock exchange of 1929 look like a dwarf. Credit is on the increase and everyone and his dog is in the stock market.

Just like the America of the 1920s, China exports its trade surplus to America and other parts of the world to finance the purchase of Chinese goods and to feed the dragon of consumption. In other words, there is no reciprocal trade and China is in effect buying from itself in the belief that it is supporting the export market and keeping employment levels high. It cannot see the possibility of financial failure from America.

The Chinese Reserve bank further pegs its currency to the American dollar, thus artificially undervaluing its currency as it floats against the dollar. In short, the manner in which China conducts it's economic affairs is a mirror image of what America was doing in the 1920s. A collapse of the American dollar will lead to a default on the repayment of its mammoth debt to China, a collapse of the Chinese economy and a global depression far worse than that of the 1930s.

A collapse of the Shanghai stock exchange will cause a financial Tsunami that will lead to the collapse of stock exchanges around the world.

We further need to consider the fact that China, as a global power, carries a tremendous amount of political baggage. It has not forgotten the 19^th century loss in the opium wars to foreigners or the occupation of Hong Kong by the British until 1997. Then there was the Tian Men Square humiliation of 1989 when Chinese youth paraded a replica of the Statue of Liberty for the whole world to see. China has also formed a political alliance with Russia and Iran over future supplies of oil, which could precipitate a world war in the Middle East  -  the guns are loaded and ready.

Other global financial problems  -

As if trade wars and currency devaluations by all exporting countries was not enough, we also have a global crude oil supply problem, peak oil and global warming.

Now add a derivative market problem that did not exist in the 1920s. According to the Bank of International Settlement data there are $370trn derivatives sitting on a wall just waiting for somebody to give them a push. Today every time a derivative trade goes bad the losses run into billions of dollars. A recent mal-investment on a derivatives bet in South Africa cost the trader R200m. A derivative collapse is on the cards and nobody knows the exact damage it will cause.

Japan is just one step away from the "funny farm" as it peddles its currency across the globe at ½ % interest  -  the yen carry trade. It has flooded financial world markets with unprecedented quantities of counterfeit money that is invested in stock exchanges around the world in the form of hot money which is giving rise to stock valuations that are unsustainable and will ultimately collapse.

Virtually every country, including South Africa has climbed on to the bandwagon of money creation that leads to excessive liquidity, growing credit, bad investments and high levels of inflation that could one day soon lead to hyper-inflation across the globe.

Global economies today appear to be strong, in fact stronger than at any time in history. Central banks are supremely confident that they can avert any global monetary crisis - this time it really, really is different  -  Financial systems are far more sophisticated. However, historically we have seen that just as the praises are sung and the tower of Babel is almost complete, tragedy strikes.

Benjamin Franklin once said   -    "Experience runs an expensive school, but fools will learn in no other".

Ben Bernanke, chairman of the American Federal Reserve bank and his predecessor Alan Greenspan have often calmed the markets on any talk of a global market collapse.

In fact Bernanke tell us in his own words why we do not have to fear any form of financial collapse:

"Like gold, US dollars have value only to the extent that they are strictly limited in supply. But the US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of dollars in circulation, or even credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is the equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."  

So in other words, you can always stimulate consumers to purchase goods and thus keep the wheels of industry and trade in motion by simply giving (ie, lending) the consumer money. And there we have it folks, I tidy solution from a truly gifted economist. 

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