For the last year, I have been arguing that the Long Wave Boom means that the probability of the Financial Crisis, and subsequent recession, turning into a Depression, or even a more serious double-dip recession was low. I am in the process of a re-evaluation of that view. The reason is simple. As I suggested back in 2008, the problem of bank debt could turn into a problem of sovereign debt, as States were forced to come in behind those banks, some of which had Balance Sheets bigger than the economies in which they were situated. That sovereign debt crisis is not yet fully upon us, and sensible policies by States and Central Banks – essentially printing money to cover the debts, and not cratering economies and growth by fiscal tightening – could easily avoid it. But, then there is politics. One the one hand, there are political manoeuvres within the Eurozone, as different states attempt to gain advantage, and political parties seek to address the concerns of their voter base. At the same time, there is manoeuvring between European Capital and US Capital. European Capital is seeking to make the US and China do all the heavy lifting of increasing economic activity and trade, so that it can benefit from increased exports without committing its own funds to a global fiscal stimulus.
In the run up to the Falklands War, Maggie Thatcher and Galtieri both engaged in sabre rattling to garner political support within their respective nations. Both, after all, were facing severe criticism and opposition from their respective populations, at the time. Both were forced to continually ratchet up the rhetoric until eventually they were both backed into a corner, and were forced into a War that neither really wanted – there had been an agreement already reached between Britain, Argentina, the US and South Africa to divide up the Falklands in order to exploit potential resources – and out of which no one benefited. The situation in Europe today is similar, as Governments seek to present themselves as fiscally conservative, in an attempt to calm the nerves of the markets. In fact, their policies, in threatening the continuation of the recovery, have, in recent weeks, done the opposite. Markets are in a state of panic. In fact, as a consequence, renewed fears are emerging over the banking sector, and banks have once again begun to restrict lending to each other in a way similar to that leading up to the Financial Crisis at the end of 2008. Interbank rates are rising sharply again – which could actually mean that some of the smaller, regional banks like the Spanish Cajas actually are placed in jeopardy – and the US has had to re-open a $450 billion window again to European banks, because they were simply unable to get the dollars needed from each other to finance dollar trade.
I continue to believe that the Long Wave remains in place, and that, over the medium term, growth will resume as a result. In fact, a crisis now could result in even more robust growth later. However, even if, as again I believe to be the case, the permanent State acts to stifle the economic madness, of fiscal tightening, being attempted by various Governments, the policies that do get through, the measures already taken, may, even in themselves, be sufficient to cause a double-dip. On top of that, the fundamental problems I have referred to, in respect of developed Western economies – basically living standards are unsustainably high compared to those in developing economies like China, India etc. without a massive shift of Capital to higher Value production – and the disproportionalities arising from that creates its own dynamics that could cause severe problems. Some of those problems, of disproportion, are not just in the allocation of capital, but are intra-generational disproportions too, particularly in relation to housing wealth.
I quoted the other day the views of RBS in that regard - RBS warns Of Cliff-Edge. Today, the Independent has a lead story about the likelihood of a housing crash. How long Can The Housing Market Avoid A Crash. They point to a number of factors including the continued problems in getting mortgages, the difficulty some buyers have in raising necessary deposits, an increase in supply, and the difficulties households will have over the next four years as its forecast that wages will lag behind price rises. In fact, as I've repeatedly pointed out, the likelihood is that inflation will rise way above that being forecast – the real figure as opposed to the official figure being even higher still. The Independent quote the figure of 5.3% on RPI that is current today, and accept the official view that it will fall by year end, before pointing out that the VAT rise will send it up again in January. But, I do not believe that inflation will fall by year end. It has consistently moved against such predictions by the Bank of England over previous months, even when economic activity has been slow or even negative. There has been massive money printing that, in the past, has always resulted in inflation, two years down the road. Even with sluggish economic activity, inflation will rise, as that liquidity is soaked up by rising costs. The pound has fallen against the dollar in which oil, and many basic commodities continue to be priced, which means that the import cost of those items rises for Britain. On top of that, China has now sort of floated the RMB, and it is rising in value. China's costs have risen significantly, as the prices of raw materials and food have risen, on the world market – in large part because of Chinese and Asian demand. In addition, Chinese workers, with the support of the State, are demanding, and receiving, huge pay increases of between 30% and 50%, as the Chinese State seeks to shift the balance of its economy away from exports to the domestic market, and away from low value production towards higher value production. The consequence of that is that the masses of imported cheap Chinese goods, that have kept workers living costs down, in the West, for the last 10-20 years, are about to become MUCH more expensive, but without the potential for import substitution. Inflation is going way up. That was also the basis of the prediction I quoted the other day from Dennis Gartman that the price of Gold is going to go parabolic - Gold To Go Parabolic. It is that inflation will soar, paper currencies will get trashed, and there will be a flight to real money.
On top of the problems facing workers, from falling real wages, through inflation, we now know that the Tories policies, according to the Treasury, will lead to one and a quarter million extra people being unemployed, the majority of those from the private sector. Unemployment To Soar. In fact, if the Tories actually did manage to cut by £60 billion, the actual rise in unemployment would be more like two and a half million. Even the uncertainty arising from all this will have a negative effect on economic activity. No one is going to think about laying out large sums of money for a new house if they think they might lose their job, or their living standard is going to crater. No business is going to take on workers, or invest any large sums, if they think the economy is going to go down the tubes. That in itself will reduce effective demand in the economy, and lead to exactly those kinds of consequences. Already, we have seen some private companies hammered, as a result of the Tories announcements, even before orders from the Public Sector start being cancelled. Nor does it take account of the hundreds of thousands of actions that have the same economic consequences, like the Public Servant the other day who was interviewed having just bought his lunch, who said that in future he would have to resort to making sandwiches, thereby demolishing the businesses of tens of thousands of town centre shops, and their suppliers.
Under those conditions, the 5% fall in house prices mentioned by the Independent seems a gross underestimate, and the people it interviewed, who said they couldn't reduce the prices of their houses any further, are going to find they will have to do just that. Recently, economist Richard Koo was interviewed, from Japan, by Newsnight. He related how the Japanese Government had made the same mistake the Tories are making now, in 1997. They began a fiscal tightening when the economy was just starting to recover, and sent it into a renewed tailspin, from which it still has not recovered. On that occasion, property prices, in Japan – which had already fallen significantly during the early 90's – dropped by 80%! One of the disproportionalities that arose over the last 30 years was precisely this rise in asset prices – houses, and shares in particular – as the massive increases in liquidity, pumped into the economy, found their way into a series of asset price bubbles, whereas cheap imported goods from Asia, kept consumer price inflation low. In a “reversion to the mean”, that process is about to be reversed. Consumer price inflation will rise sharply, and as living standards are squeezed, the amount of disposable income, available for allocation to assets, will drop considerably. Whilst, rising profits for the rich may mean that the fall in share prices may be muted, and disguised by rising inflation, the one asset which the majority of workers spend their money on – housing – will tank. In 1990, house prices fell by 40%. Since then they have bubbled up again. It has created another of those disproportions, this time inflating the “wealth” of the older generation, who bought their houses decades ago, and immiserating young workers unable to afford the inflated prices. A fall in house prices of 50-80%, is quite possible if the economy enters a double-dip – a double dip, which, as Nouriel Roubina points out, governments are not now in a position to deal with, because they have used up most of their ammunition. That “reversion to the mean” would rebalance the intra-generational divide, and would begin to make housing affordable to young workers. The immediate effect would, however, be to give yet another downward twist to the economy.