posted February 27, 2016
Systemic Fragility in the Global Economy, Part 1 (China, Europe, Japan, & Emerging Markets)

November 27, 2015

Advanced Economies (AEs)

The global economic crisis that erupted in 2008-09 is not over; it is merely shifting. Initially centered in the U.S.-UK economies in 2007-2009, thereafter to Europe and Japan in 2011-2013, beginning in 2014 it shifted a third time, to China and emerging market economies in Latin America, Asia, and Africa, where crisis conditions are deepening and will continue to do so into 2016. As China and emerging markets nearly everywhere slowing rapidly into recessions, the weak links of Japan and Europe also continue to slip in and out of recession.

Japan has experienced no less than five recessions since the 2008 crash, the latest now underway. The Eurozone economies experienced a double dip recession from 2011 to 2013, followed by stagnant growth of less than 1 percent annual GDP. That meager Euro growth appears about to collapse again as of late 2015, as the growth engine of Europe—the German economy—is now, according to latest reports, undergoing a rapid slowing in its manufacturing, exports, and industrial production—a harbinger, no doubt, of another bout of economic stagnation in 2016 for the rest of Europe once again.

Meanwhile, China’s growth is slowing rapidly, well below the official 6.9 percent GDP figure it has announced, and almost certainly no more than 4 percent to 5 percent, according to a growing number of independent sources. That’s a figure less than half its previous 10 percent plus GDP of 2010-2012. As China’s demand for commodities from emerging markets has slowed dramatically as its own economy has slowed, emerging market economies from south Asia to Brazil to South Africa and beyond have slowed, in turn.

Emerging Market Economies (EMEs)

Their economic retreat is further exacerbated by the recent reversal of massive money inflows from U.S.- Japan-Europe from 2010-2013. As interest rates rise in the U.S. and UK economies, money capital has begun to flow out of the emerging markets and emerging market currencies have begun to collapse while exports have slowed and import inflation risen. Emerging markets have been, in turn, forced to raise their domestic interest rates to keep foreign investment capital from leaving, which has slowed their economies still further. Having borrowed trillions since 2010 to finance expansion, the multitrillion dollar debt EME corporations have borrowed must now be repaid. But the money to pay it is flowing out and disappearing. Emerging market economies are thus caught between a rock and a hard place in what will continue in 2016 to be a vicious, downward spiral of their real economies—set in motion by the double impact of slowing China and western demand for their commodities, oil, and semi-finished products and the out-flowing of money capital from EMEs and back to the U.S. and other advanced economies.

As Europe, Japan, and China slow, stagnate, or decline, emerging markets everywhere are experiencing deep recession and drifting toward increasing financial instability, in turn. A financial crisis similar to 2008-09 is approaching—this time, in the third phase of the global ongoing crisis, not in the U.S.-UK or Europe-Japan, but in China and the emerging markets. New rounds of corporate and government debt crises are coming, as are currency crises and stock and bond market collapses in the emerging markets that inevitably follow.

With its great accumulated money capital reserves, China will likely be able to weather the coming storm. Other emerging markets, like Brazil, Venezuela, South Africa and others, will not. The locus of the global crisis has thus shifted. As Europe and Japan stagnate, as China slows and is increasingly focused on its own internal economic problems, and as the U.S. continues on its stop-go trajectory of shallow recoveries followed by repeated relapses of single quarter collapses in GDP.

Debunking U.S. Exceptionalism

In this global sea of economic still waters and evaporating economic growth and world trade, pundits and politicians in the U.S. continue to declare that the U.S. economy is growing robustly and will prove an exception to the negative global trends. Some even suggest the U.S. will pull the rest of the world economy out of its growing economic malaise. We have heard this hype about American exceptionalism for the past five years, and it is no more true today than it was in the past. A longer view of the U.S. economy since 2009—beyond the short-term data selectively reported by the U.S. media—shows the following key characteristics:

• It has experienced no fewer than four relapses in reported growth since 2009, where U.S. GDP numbers have collapsed for at least one quarter to near zero or less;

• Recoveries in GDP from these relapses have not been sustainable beyond a few quarters before the next relapse to zero growth or less occurs;

• U.S. growth has been artificially boosted by convenient and questionable redefinitions of GDP that have added, on average, $500 billion a year to U.S. GDP figures;

• U.S. inflation adjustments to GDP conveniently underestimate inflation, thus resulting in a higher than actual GDP;

• Adjusting for real inflation and redefinitions, when averaged out long term since 2008, the U.S. economy has been growing at an average annual rate of approximately 1.8 percent, or barely one half compared to its 10 previous recession recoveries since 1948;

• U.S. estimates of jobs is also overinflated. Jobs that have been created since 2010 have been predominantly contingent jobs—i.e. part time, temporary—or else contract, gig, or shadow economy jobs—all of which pay well below normal full time employment and provide virtually no benefits, the cost of which workers must absorb. Actual real U.S. unemployment remains around 12 percent;

• The lion’s share of decent paying full time jobs that have been created in recent years has come from a rise in U.S. industrial production, mining, manufacturing, and transport services related to the oil and gas fracking regions—which are now rapidly contracting from manufacturing and exports now in decline—or from low pay service jobs;

• While reports of 6 million low-pay jobs created since 2009 are hyped by the media and politicians, a similar number have either left or not re-entered the U.S. labor force. If counted, there has been no net gain in the employed U.S. labor force.

• Contrary to reported wage gains of 1-2 percent, the wage and income growth for households below the top 10 percent have been stagnant or declining. Wage gains have been skewed to the top 10 percent and for full time employment, leaving out the more than 66 million contingent, contract, minimum wage, low pay, and hidden unemployed in the U.S. economy.

• Another 50 million retirees on fixed incomes have received income adjustments well below even the inflation rate, earn nothing on their savings, or must draw down retirement funds to cover daily expenses;

• The chronically underestimated official inflation rate has reduced real wages far more than reported, as inflation indexes fail to adjust accurately for rising costs of rents, health care and insurance, education, food, and the shifting of costs for benefits from employers to workers;

• The real goods producing sector of the U.S. economy has stalled. The manufacturing sector growth has turned flat, as exports slow and the U.S. dollar continues to rise. Construction jobs and growth remains at levels two-thirds below previous peaks. Business investment and spending grows and then repeatedly contracts as businesses overproduce inventories that cannot be sold due to lack of general income growth. Government public investment has fallen from 3.5 percent to less than 1 percent of US GDP;

• Consumer spending has become increasingly dependent on household debt—to buy autos, pay for student loans, cover medical expenses, and rising rental costs.

• Expansion of low growth-low productivity services and government spending on defense goods is virtually all that keeps the U.S. economy afloat—but at sub-par historical rates less than 2 percent. This is the long term continued scenario for the U.S. economy.

In other words, the U.S. economy is far more fragile than the top-level reported GDP, job and other numbers at first appear. The U.S. economy will most likely, in 2016, experience yet another relapse to near zero growth, as it continues on its stop-go trajectory that it has experienced since 2009.
That means that there is virtually no possibility the U.S. economy will pull up the rest of the significantly slowing global economy in 2016 and beyond. China and emerging markets, even as they themselves boomed in 2010-2012, could not do it. And given conditions globally today, neither can the U.S.

That means in the year ahead China will continue to slow, Japan and Europe will continue to stagnate and slip in and out of recessions, as they have done so in the past, and many of the remaining emerging market economies—especially those dependent on commodity and oil production—will stagnate or descend even more deeply into recession. To reverse the slowing global trend, the U.S. economy would need to grow on a sustained basis of more than 4 percent, consistently, quarter to quarter, for at least six quarters. And there’s no evidence that is about to happen.

Oil Markets at Cliff’s Edge

Against this general scenario, early warning signals of larger problems of financial fragility and instability are simultaneously maturing within the system, beneath the surface, could erupt again, as in 2008-09. Perhaps the most noticeable such warning sign is the collapse of global oil prices that began in mid-2014, thus far having fallen more than 65 percent, to $45/barrel with projections of a further collapse to $30 or less in 2016. Prices of other commodities have deflated as well. A major bout of global commodities deflation is thus underway, the consequences of which for other financial asset markets, and for real economic growth, has yet to fully play out.

Another source of financial instability is the U.S. junk bond market, and the regional banks and financial institutions exposed to losses in the junk debt securities. During recent boom years, shale drillers, railroad, trucking, and other companies borrowed heavily to finance shale expansion and are now seeing their prices and revenues collapsing and their ability to refinance their junk debt disappearing as credit dries up. Will defaults on the oil-related junk debt spill over psychologically to other parts of the already-overextended multi-trillion dollar U.S. junk bond market? How low can global oil prices go, and for how long, before cracks in the junk bond markets begin to spread to other financial assets, institutions, and affect the non-financial real economy thereafter as well?

Then there’s the potential economic repercussion of the oil (and commodities) price collapse on sovereign governments. Not only are collapsing oil prices throwing oil and commodity export dependent economies into chaos—precipitating major recessions in Russia, Venezuela, Nigeria, with rapid economic slowing in Canada, Scandinavia, and elsewhere—but the contagion effects of oil as a financial asset on other financial asset markets has begun to develop as well. As prices fall, will sovereign EME government bond defaults follow, in particular in Latin America, Africa, developing East Europe, in Asia? There is also growing concern with U.S. Treasury bonds. It appears that the availability of bonds to buy and sell by banks and bond traders is drying up. A liquidity crisis in bonds is thus a growing concern. This will have serious implications as well for one of the most critical financial markets for overall financial instability in the U.S. called the Repurchase Agreement, or Repo, markets. If U.S. bonds are in short supply and thus unavailable for private banks to use as collateral for their own short term borrowing, a liquidity crisis in U.S. Treasuries could cause serious contagion effects for the entire U.S. banking system.

Global Currency Wars

Then there’s the early 2015 re-igniting of global currency wars, as the Eurozone introduced its $1.3 trillion dollar Quantitative Easing (QE) monetary program in January 2015, in part in response to Japan’s $1.7 trillion April 2013 massive QE money injection. Contrary to claims by chairpersons of the large global central banks—the U.S. Federal Reserve, the Bank of England, Bank of Japan, and European Central Bank—QE is not about raising price levels to 2 percent targets, nor stimulating real GDP recovery, nor reducing unemployment. QE is about ensuring financial asset markets, like equities (stocks) and bond markets, continue to expand and provide capital gains for investors. It is also about driving down a country’s currency exchange rate in order to obtain a cost advantage vis-à-vis foreign competitors, and, in turn, enabling one’s own capitalists to grab a larger share of their competitors global exports. The problem is that as more and more major economies engage in competitive QEs, as Japan and Europe are now immersed in, the result is a fanning of currency wars that cause instability in global currency markets. Emerging markets follow suit. China devalues its currency. And the war goes on. That financial instability in currencies has negative repercussions on other financial markets, and also slows global real trade and real economies.

Deflating in Stock & Bond Markets

Another sign of growing financial stress in the global economy are events involving China’s stock markets. The bubble that began in China stocks in 2014 burst in June 2015 and has continued to unravel since. That deflation in stock prices has not yet been halted, despite China’s government having committed more than $400 billion to stop the collapse and having introduced draconian measures to boost stock purchases while slowing stock sales. Moreover, it appears some of the key causes leading to the bubble, like the promotion of speculative stock and margin buying, is again being promoted by China’s leaders in a desperate move to halt the stock slide. The potential for contagion effects on global stock prices is significant and a further major contraction in China—and global—stock markets is possible in 2016.

Another indication of growing financial instability is developments within the U.S. corporate bond markets. Apart from the junk bond situation noted above, the corporate bond market—valued at more than $10 trillion today—is showing signs of stress. There was the still-unexplained flash crash of October 2014, when asset values collapsed by major proportions in a matter of minutes. Could the U.S. corporate bond market—junk bonds and even investment high grade bonds—represent the locus of the next major financial crash? More than $20 trillion in corporate bonds have been issued globally since 2010. A crisis in the U.S. private bond market would almost certainly spread to other global corporate bonds. If this occurred, the impacts would make the 2008-09 subprime mortgage-precipitated financial crash appear like a minor event.

Yet another indicator of financial weakness is the general condition of many Eurozone banks. With interest rates, Euro banks earnings are insufficient to weather a major financial crisis event. More than a trillion dollars of non-performing loans remain on Euro bank balance sheets. Many Euro banks are also heavily exposed to losses on investments in eastern Europe, Russia, and the Ukraine. In short, the Euro banks are particularly fragile. It is not surprising, therefore, that their practice has been to hoard available liquidity and assets, cash and not lend to non-financial businesses. That of course explains a good deal why real investment, jobs and growth in Europe has been slowing, and in turn why deflation in goods and services is now emerging.

Unanswered Questions

This all leads to important questions that mainstream economics has still not answered: Why was the 2008-09 crash clearly precipitated by a financial crash? How did the financial crisis contribute to the extraordinary deep and rapid contraction of the real economy in 2008-09, and thereafter prevent a normal recovery for more than six years? How does one distinguish causes that were merely precipitating and enabling from causes more fun- damental —both real and financial? How do financial conditions and events drive real economic contractions—i.e. great recession, or worse, depressions? Why are financial instability events over the last four decades apparently becoming more frequent and severe, and what is happening in the real economy that may be making it more sensitive to the growing frequency and severity of financial instability events in recent decades?
These queries lead to another set of related critical questions: Why have government policies since 2009—i.e. more than $20 trillion in central bank liquidity injections, trillions more in business-investor tax cuts, and still hundreds of billions more in direct and indirect non-bank business subsidies and bailouts—proven largely ineffective in generating a sustained global recovery and been unable to prevent a return of financial asset bubbles that continue to grow and expand and have now begun to unravel again? What are the fundamental changes in the 21st century global capitalist economy that are responsible for the new, more intense interactions between the financial and real sectors of the economy? How and why are financial cycles exerting a relatively greater effect on real cycles today? And why will they continue to do so? The global economy is growing increasingly unstable. So what’s behind it all?

Fundamental Trends & Determinants of Instability System Fragility

• A deeper analysis beyond the failed models of main- stream economics is called for, addressing the following major trends and causes of the global economic slowdown and rising instability in today’s global economy:

• the decades-long massive infusion of liquidity by central banks worldwide, especially the U.S. central bank, the Federal Reserve, along with the increasing availability of what‘s called inside credit from the private banking system;

• the corresponding increase in private sector debt as investors leverage that massive liquidity injection and credit for purposes of investment;

• the relative redirection of total investment, from real investment to more profitable financial asset investment;

• a resultant slowing of investment into the real economy, as a shift to financial investment diverts and distorts normal real investment flows;

• growing volatility in financial asset prices as excess liquidity, debt, and the shift to financial asset investing produces asset inflation, bubbles, and then deflation;

• a long-run drift from inflation to disinflation of goods and services prices, and subsequently to deflation, as real investment flows are disrupted and real growth slows;

• a basic change in the structure of financial markets as new global financial institutions and new financial markets and securities are created, and an emerging new global finance capital elite arises, to accommodate the rising liquidity, debt, and shift to financial asset investment;

• parallel basic changes in labor markets resulting in stagnation and decline of wage incomes and rising household debt;

• growing ineffectiveness of fiscal and monetary policies as debt and income from financial assets rise incomes from wages and salaries stagnate and household debt rises, and debt on government balance sheets increases while government income (taxes) slows—which together reduce the elasticity of the response of investment and consumption to interest rates and multiplier effects from government fiscal policies.

Explaining Global System Instability

Part 2 of this article will explain how today’s key global trends of excessive debt accumulation, the shift to financial investing, and the decline in real investment necessary to create jobs and wage income can be traced to a new global financial structure that has emerged in recent decades; how that structure has enabled the rise of a new finance capital elite of super-wealthy professional investors; a growing global shadow banking network, and the explosion of new financial securities and markets worth more than $100 trillion .

For a more extensive analysis, readers may refer to this writer’s book on systemic fragility.

Jack Rasmus is the author of Systemic Fragility in the Global Economy and the forthcoming Looting Greece: The Emerging New Colonialism ( Rasmus. html.)

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