2011 April 09 Saturday
Yet Another Financial Crisis In 2011?

For some years now I've been predicting economic conditions for the US and other industrialized countries will be somewhere between bad and worse for the 2010s. Developments of recent months unfortunately provide plenty of evidence for my expectation. Simon Derrick of BoNY Mellon sees lots of storm clouds building on the horizon.

2011 is beginning to look very like 2008 before the collapse of Lehman Brothers—except the numbers involved are much bigger this time around, according to Simon Derrick, the chief currency strategist at Bank of New York Mellon.

In Derrick's view the eurozone debt crisis, China's currency manipulations, and the oil price spike all work against continued economic growth.

Well-known currency strategist Simon Derrick is concerned that the global recession of 2007-2009 could come back with a vengeance. Analyzing where ‘real money’ comes and goes on a daily basis at the Bank of New York Mellon, Derrick fears that the eurozone debt crisis, crude oil above $100 a barrel and China’s managed currency spell doom for the global economy

Oil in April 2011 is at similar prices as oil in April 2008. In 2008 the US and world economy was already heading into a recession. Now the US economy and other Western economies are slowly (by historical standards for economic recoveries) coming out of a recession. Why? One really big reason: the global economy is now so big that global economic growth pushes up commodities prices. Economic growth bumps up against resource limitations.

Donald Luskin argues the economy can absorb even higher prices before falling back into recession. I hope so. I hope the economy can absorb enough of an oil price increase that Peak Oil Recession #2 does not start until 2012 or 2013. But 2013 seems an excessively optimistic hope given commodities prices. Also on the optimistic side: the housing price-to-rent ratio is much less out of whack than it was in 2006. So we do not still have a large housing bubble to pop.

If we go into another recession in the next 12 months (or even the following 12 months) we will go into it from a lower weaker starting point in several respects. Unemployment is still quite high, governments at all levels are having hard times balancing their budgets (at least those trying to balance their budgets), total public debt has soared, and the percentage of mortgages that are underwater (for more than the house's value) is still quite high. Living standards have declined. For example, 5 years since the 2006 peak US rail freight traffic still hasn't revisited 2006 highs and yet the US population has grown by almost 5% in the last 5 years. So in per capita terms freight traffic (and therefore living standards) has dropped.

Frankly, I do not see how we avoid a premature recession. For every month the global economy can sustain growth the demand for oil will grow faster than supply. There's no supply-side relief for high oil prices in sight. Rising oil prices are already cutting into personal consumption spending. So GDP growth has slowed. Will consumers shift their behavior toward lower energy usage lifestyles fast enough to take enough pressure off of further oil price rises? We should be so lucky.

Richard Heinberg makes the same point I keep making about our perilous economic state: we no longer have the capacity to respond to another recession like we responded to the last one. Peak Oil Recession 1 was (and still is) a very expensive affair.

During the past three years, the Fed’s balance sheet has swollen to more than $2 trillion through its buying of bank and government debt. Actual expenditures included $29 billion for the Bear Sterns bailout; $149.7 billion to buy debt from Fannie Mae and Freddie Mac; $775.6 billion to buy mortgage-backed securities, also from Fannie and Freddie; and $109.5 billion to buy hard-to-sell assets (including (MBSs) from banks. However, the Fed committed itself to trillions more in insuring banks against losses, loaning to money market funds, and loaning to banks to purchase commercial paper. Altogether, these outlays and commitments totaled a minimum of $6.4 trillion.
 
Documents released by the Fed on December 1, 2010 showed that more than $9 trillion in total had been supplied to Wall Street firms, commercial banks, foreign banks, and corporations, with Citigroup, Morgan Stanley, and Merrill Lynch borrowing sums that cumulatively totaled over $6 trillion. The collateral for these loans was undisclosed but widely thought to be stocks, CDSs, CDOs, and other securities of dubious value.

We can't afford to do the financial and fiscal injections in Peak Oil Recession 2 that we need for Peak Oil Recession 1. Once Peak Oil Recession 3 hits our response to Peak Oil Recession 1 will seem luxurious and wasteful.

The stimulus-bailout efforts of 2008-2009—which in the U.S. cut interest rates from 5 percent to zero, spent up the budget deficit to 10 percent of GDP, and guaranteed $6.4 trillion to shore up the financial system—arguably cannot be repeated.

Future rounds of Quantitative Easing (QE3, QE4, QE5) can certainly be repeated. It is just the cost of those rounds will be high inflation. One of the biggest questions about the next 10 years is which governments will try to combat Peak Oil recessions with monetary inflation? I want to know because I want to get my finances and my person out of harm's way.

Update: To predict when rising oil prices will cause the next recession watch energy expenditures as a percentage of consumer spending. In February it was at 5.98%. If energy costs go up another 17% from February then the percentage would go over 7% and I think we'd be in recession territory. That does not mean a 17% rise in oil prices will put us into recession. Consumers use electric power and natural gas. Gasoline and heating oil are just part of the equation.

Update II: Pedro Noronha, a fund manager at Noster Capital in London, says the economy is more like at the 2007 stage rather than already at 2008 stage. That sounds right. The stock market is fully or over valued. Oil prices still have a way to go up yet.

Share |      By Randall Parker at 2011 April 09 06:26 PM  Economics Business Cycle


Comments
A.Prole said at April 10, 2011 1:20 AM:

It was a big mistake to let the globalists and free-traders effectively dictate policy in the last 40 odd years or so.
In retrospect it will be seen as a huge mistake for the west to have actually engaged and traded with China in the past 30 years.
Despite economists patting themselves on the back about how clever they are and how smart they are for understanding the theory of comparative advantage, the point is that China's rise to economic supremacy was bought at the expense of western living standards.
May God damn the WSJ and 'The Economist'.

James Bowery said at April 10, 2011 8:53 AM:

The source of the dominance of these economic policies was desire for sociosexual status over founding stock Americans. If you let them do things their way, it would have resulted in an emphasis of "industry over finance" in the words of Henry Ford. America could have totally cut off not only all immigration, but all trade and communication -- total isolation -- at the time of the closing of the American frontier and the "Posterity of the Founders" would have been vastly better off.

Randall Parker said at April 10, 2011 5:45 PM:

A.Prole,

We are certainly in a zero sum game with China that is driving up the cost of oil and many other commodities.

RX said at April 10, 2011 8:08 PM:

Private banks create credit money. It comes into being when you make a loan. When you have a bubble economy, credit money expands at too fast a rate, outpacing actual wealth. Then when the bubble collapses, the loans are still there, but the actual assets have declined in value. This is what has happened in the U.S. due to the housing market. Most people are underwater with assets they bought high, and now they are low. The borrowers are underwater, and the only way to get out, is to tighten their belt and pay down the loan. We see that now in terms of higher savings and people buying only the things they need.

The same thing happened in Japan in the 80s and the U.S. in the 20's. If an economist doesn't mention the terms "balance sheet recession" then they are not anywhere near the target.

When assets drop rapidly in value, then private banking folks want their credit money bailed out. They demand real money from the government be printed to fill in the gap between what is in the money supply, and the values on their banking ledgers. The credit money mechanism also freezes up. What bank is going to give another loan to somebody who is upside down on their mortgage? So, we have savings and paying down of the mortgages, but no new loans being made. Since loans are most of the money supply, the supply begins to contract. This eventually leads to a depression. The credit bankers have the government by the family jewels. Back up their credit money, or the economy will depress. What the government is not smart enough to figure out, is that they could direct spend debt free into labor. Labor then takes their wage money and buys down their loans. Eventually the credit mechanism is unfrozen.

This is how we got out of the great depression. Government spend money was 3/8 of 1% interest rate, and it was spent into industry. People had enough extra cash to pay down their debts, and during the war, they even had enough extra money to save. The planes and tanks were a loss, but the debt left behind was low due to the low rates Today we deficit spend into banks, this is wrong, and it creates sector inflation as most of it does not find its way to paying down the housing bubble.

RX said at April 10, 2011 8:27 PM:

The way it works with China, is that you buy a POS Chinese good. Your dollar ends up over there, and the Chinese goverment wants to take it from their manufacturer. China's state bank prints up a debt free Yuan and trades it our for your dollar. Your dollar then comes back to the U.S. and gets locked up as a treasury. In the meantime, an extra Yuan entered into the Chinese economy. If they can grow the economy at the same rate as the money supply, then no inflation.

Since wall street is always looking for returns, they take your 401K money and fund the displacement of U.S. industry. After all the wages in China are lower, due to the currency peg. Importing back into the U.S. is a no brainer, because the U.S. has to keep tariffs low. Why? Because we are the reserve currency of the world. That means we have to accept imports in order to export dollars to a world in need. How would international trade, and buying of oil happen if there were not enough dollars? So, U.S. mainstreet industries get shafted due to low tariffs, and dollars that are held artificially high. Supply and demand, and the world wants dollars. China was also taking dollars out of the market by buying up TBills.

Dollar Hegemony and the Reserve Status of the dollar worked for awhile, but now it is up against debt free issuance of Yuans. China state banking system and peg prevents Western Bankers from entering their system to manipulate it - China will win. So your dollar started out in private bank as credit money, it came into being with debt. Then your dollar went to China, and eventually back to the U.S. as more debt (Treasury). China traded out a debt free Yuan for your debt instrument. So, their money system does not have a lot of debt riding around on their money. That is why they can make cheap goods, yet their people are not starving. Instead they are thriving.

The money system is the most important thing. It signals what is important and how the economic man should act. If our money is a ball and chain debt bomb attached to our legs, then how do we win the economic race? We have to reform our money system as it is the root of our malfunction.

no i don't said at April 11, 2011 11:35 AM:

Why do people still continue to embrace Capitalism?? It's madness!

RX said at April 11, 2011 2:06 PM:

Capitalism OK. Pariah Capitalism bad. We don't have language for what is going on today. We should not conflate pariah capitalism with the proper market capitalism.

My fear is that rigged pariaha capitalism (what some call financial capitalism) will give market capitalism such a bad name, that we will usher in communism or fascism. Then, liberty will truly be lost to mankind.

Not dealing with our money system and just kicking the can down the road will have very serious consequences.

not anon or anonymous said at April 11, 2011 3:21 PM:

RX, actually, Chinese inflation has risen quite a bit recently. Given the pegged exchange rate regime, this essentially offsets their nominal currency devaluation; it leads to real appreciation of Chinese goods compared to American goods.

You raise a good point in that money is too tight right now and this is playing a significant role in the current recession. Yes, of course the supply side is important, e.g. energy. Also, yes, some banks engaged in excessive lending and took on too much risk. But this does not explain the current recession, since banks get bailed out in good times as well and this does not cause any broader issues.

A. Prole, the per-capita use of resources in China or India is a tiny fraction of what western folks use. You call this "economic supremacy", but it looks more like a natural rebalancing in energy use patterns.

Check it Out said at April 12, 2011 2:17 PM:

More than Capitalism this feels like Fascism


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