The descent into global C-H-A-O-S

It’s Monday and time for another helping of doom and gloom from Albert Edwards.

This week SocGen’s ‘strategiste global’ is in particularly bearish mood, arguing that all of the ingredients are now available for a meal of global chaos.

Bon Appétit.

First, fry some ideologically-driven policymakers for slashing fiscal deficits at a time of sky-high unemployment and inequality:

I have every sympathy with economists who say that governments are insolvent. My colleague Dylan Grice showed recently that, once unfunded liabilities are included, it is obvious that most governments are already insolvent, with debt to GDP ratios closer to 500% of GDP than the official estimates for most G7 countries (see chart below and link). It is simply too late. We’re stuffed either way and cannot escape the consequences of years of private and public sector debt debauchery, much as we might pretend otherwise.

Yet government insolvency does not prevent me from being persuaded by Richard Koo’s book about the lessons from Japan’s balance-sheet recession. The crux of his analysis is that governments have no option but to stimulate aggressively all the while the private sector is de-leveraging. And any attempt at fiscal cuts simply results in renewed recession and a further loss of confidence, thus making it even harder and more costly to sustain any subsequent recovery and hence as Koo shows the budget deficit ends up even bigger. This is exactly the outcome I expect in the UK, especially.

Then add some Chinese currency manipulation:

Our Chief Economist, Michala Marcussen, thinks that the Chinese, in starting to buy Japanese assets, have pushed up the yen and effectively forced the BoJ to intervene. She writes, “China may thus be the big winner from Japan’s intervention; winning on three levels (1) diversifying reserves (albeit still only a small amount) and reducing its exposure to the US dollar, (2) escaping the title of currency manipulator, and (3) placing Japan in the hot seat ahead of the G20, thus detracting attention away from itself.

I would contend that China is now playing a very, very dangerous game. With the US trade deficit deteriorating again (see top right-hand chart above), and – much to my surprise – the Chinese trade surplus widening, patience is rapidly running out in the US with China’s currency policies. I believe we are now nearer to an outbreak of trade war than at any time since the 1930s. Any downturn in the global economy back into recession would almost certainly guarantee such a result, as the political pressure to do something mounts.

A touch of inequality to season:

Many commentators, including myself, believe it is no accident that before this crisis inequality in the US and the UK reached extreme levels. Many believe there is a causal relationship from extreme levels of inequality to the crisis. How? Central bankers, by pursuing policies that allowed the middle classes to borrow against rising asset prices, kept them consuming despite the stagnation of their incomes and hence disguised the effect of government policies that allowed the rich to acquire virtually all of the gains in GDP growth.

And in the process of “robbing” the middle classes and now still attempting to keep asset prices artificially high, they are also robbing our children of the ability to buy a house at an affordable price. Yet central bankers still see QE as key to maintaining the illusion of prosperity and stoking consumer spending! I will write more about the role of high levels of inequality in causing the recent crisis in a future paper (James Montier has passed me some interesting papers). But with youth unemployment rocketing in recent years (can you believe it is 40% in Spain), policymakers had better start manning the barricades for the backlash. For as my mother used to say “the devil makes work for idle hands”.

Stir well and cook for 30 minutes.

Garnish and serve with a side of grain and a nice bottle of pessimism:

For one idea of what might drive the poor to breaking point in the coming years, read my colleague Dylan Grice’s excellent report on the likelihood that we will see a structural spike in higher grain prices from these already high levels – link! For he notes that the grain markets today are at a very similar level of tightness to the oil market in the early 1970’s when the US turned into a substantial oil importer. This made the market very vulnerable to a supply shock (such as the 1973 Arab embargo), in a way that it wasn’t in 1967. China is in that same situation today for grains (see chart below). If the devil makes work for idle hands, history is full of examples of what happens when those same hands are owned by the poor and hungry.

Voilà.

The perfect recipe for descent into global C-H-A-OS.

Follow that, Delia.

Related Links:
China, 1789 and potash – FT Alphaville
These are the voyages of the starship QE2 – FT Alphaville
Everyone’s an Albert these days – FT Alphaville