When Will This New Depression End?
The following comments, written specifically for the Spanish language edition of The New Depression, were written in early March 2013, sixteen months after the original manuscript was completed at the end of October 2011.
In The New Depression, I wrote that the fate of the global economy depended on whether credit would once again begin to expand quickly enough to drive economic growth. It hasn’t. During the fourth quarter of 2012, the combined GDP of the 34 member states of the Organization of Economic Co-operation and Development (OECD) shrank by 0.6%. This has only occurred in 12 other quarters during the last 50 years.
In the United States, total credit has expanded by only 3.2% (or by $1.7 trillion) since the first quarter of 2009 (the pre-contraction peak). During the 14 quarters between then and now, private sector debt in the US contracted by $2.7 trillion (or by 5.8%); but the debt of the federal government expanded by $4.5 trillion (or by 65%). That expansion of government debt prevented the global economy from collapsing into a new great depression; but the government did not spend in a way that would lay the foundations for sustainable growth. Rather than investing, it continued to spend on consumption and war.
Worse still, the United States has now begun to implement fiscal austerity through higher taxes and decreased government spending, an approach guaranteed to further weaken the economy and exacerbate unemployment. The US budget deficits were $1.3 trillion and $1.1 trillion in 2011 and 2012, respectively (considerably more than the Congressional Budget Office was projecting when this book first went to print). Now, however, the CBO forecasts a reduction in the deficit to $845 billion in 2013 and to $616 billion in 2014. Tragically, the US is not alone in doing the wrong thing at the wrong time. The European Union and the United Kingdom are also inflicting unnecessary damage on their economies through ill-timed government austerity.
Monetary policy alone is keeping the global economy afloat. The European Central Bank (ECB) adopted aggressive measures – and just in time – in December 2011. The European banking system – and, therefore the global banking system – was then verging on systemic collapse. Rumors of the imminent failure of large European banks were rife. Equity investors were near panic. The S&P index was rapidly moving down toward 1100. ECB President, Jean-Claude Trichet, had vowed that his institution would not resort to large-scale money creation as the Fed had done. Luckily, his successor, Mario Draghi, taking office on November 1, 2011, abandoned that position and, in an extraordinary reversal, made roughly Euro 1 trillion of new liquidity available as loans to European banks at very low interest rates for three years. That program, known as Long-Term Refinancing Operation (LTRO), occurred in two stages, in December 2011 and in February 2012. As a direct result, panic was averted, financial sector stability was restored and stock prices shot higher all around the world, which, in turn, created a wealth effect that supported consumption and global economic output.
When that stock market rally began to grow tired in the middle of the year, the US Federal Reserve let it be known that it might soon launch yet another round of Quantitative Easing. Stock prices took the hint and moved higher still. In September, the Fed launched QE 3 with the creation of $40 billion of new money each month. In December, the Fed doubled the dosage to $85 billion a month – an amount which, if annualized, amounts to more than $1 trillion a year.
The results have been just as the Fed had hoped. The S&P index is now flirting with new all time highs and is more than 33% above where it stood just before LTRO was launched. Even US property prices now appear to have bottomed and to have begun to move higher. The net effect is that household net worth in the US has risen to $65 trillion, up $14 trillion from its crisis low point of $51 trillion and only $2 trillion below the all time high it reached in 2007. This rebound in net worth has helped underpin the economy by encouraging consumption. Despite all this, there is still very little core inflation in the United States. The Consumer Price Index ex-food and energy rose only 1.9% in December 2012.
The duration of the earlier rounds of Quantitative Easing was delineated from the outset. This time, however, the Fed announced that this round will continue until it works, by which they mean until the unemployment rate in the US drops substantially (from 7.9% currently). In consequence, some commentators have begun to refer to this round as “QE infinity”. With austerity beginning to bite, unemployment in the US is more likely to rise than to fall during 2013. Therefore, there is no obvious end in sight for Quantitative Easing. Furthermore, the Bank of England and, most recently, the Bank of Japan are also aggressively expanding their balance sheets by creating fiat money.
So, while fiscal austerity threatens to sink the global economy, monetary policy is doing all that it can to keep it above the waves. This aggressive money creation should continue to support asset prices. The danger is that it may also drive food prices much higher, too. If drought conditions in the United States persist, reduced crop production combined with robust money creation could create a very dire environment for the world’s poor. If so, hunger-inspired uprisings could once again undermine geopolitical stability in the developing world.
Meanwhile, in the economically advanced nations, a political backlash against fiscal austerity seems to already be underway. In December 2012, Japanese voters elected Shinzo Abe as Prime Minister on the back of his promise to stimulate Japan’s moribund economy with aggressive fiscal and monetary measures – despite the fact that the ratio of Japanese government debt to GDP is already 240%. Then, in late February 2013, Italian voters rejected a continuation of austerity in their country by strongly supporting the anti-establishment, anti-austerity 5-Star Movement in parliamentary elections. These election results in Japan and Italy suggest that a Democracy will not long tolerate austerity. The Conservative Party in the UK and the Republican Party in the United States should take note. They may be next to suffer from the public’s refusal to tolerate austerity during a depression.
The outlook for 2013 and 2014 is deeply disturbing. Unless the United States enters a new war, credit in that country will not expand enough to drive economic growth – there or elsewhere around the world. Super-aggressive monetary policy may prevent the bottom from dropping out from under the global economy, but it threatens to produce another spike in food prices which would inflict suffering on the two billion people on earth who live on less than $2 a day. Meanwhile, the political atmosphere in the developed world could easily become much nastier. Political gridlock in Washington seems set to make a bad economic environment there much worse. And, in Europe, with unemployment at 11.9% and rising (and with youth unemployment at 24%), the situation is potentially explosive.
Let us hope that reason prevails and that the public rejection of austerity that has begun in Japan and Italy quickly takes hold throughout the rest of the OECD countries. This is the time for governments to invest in the future. The governments of the United States, the UK, and Germany can all borrow money for ten years at interest rates below 2%. Japan’s government can borrow at less than 70 basis points. This is the time for them to do so aggressively. This is the time for governments to borrow and invest in transformative 21st century technologies on a scale sufficiently large to restructure their economies and put their people back to work.
Only then will this new depression end.