THE BEAR'S LAIR Prolonged global winter
By Martin Hutchinson
With increasing frequency over the past few weeks, statistics have emerged
suggesting that the first shoots of economic spring are emerging and that the
bottom of the US and global recession is only just round the corner. Higher
vehicle sales and factory orders, the Institute of Supply Management monthly
index and slightly higher personal income and retail sales figures have all
burgeoned like early crocuses, suggesting that the slope into economic decline
has turned shallower, so we may reach bottom about mid-year.
Had we not been afflicted with a global epidemic of panicking governments,
those modest green shoots might indeed have blossomed into a genuine spring.
However, governments' misguided activities have darkened the global outlook.
entering spring, we are still in the opening stages of a winter that has become
nuclear and will blight the world for the best part of a decade.
There is no necessity for a severe recession, such as the present one, to be
excessively long; it depends on the government policies pursued. At one extreme
are the Great Depression, both severe and lengthy, and the Japanese rolling
recession of the 1990s, appallingly lengthy but at no time particularly severe.
As is generally agreed, both these downturns were artificially prolonged by
misguided government action.
At the other extreme, we can examine the British recession of 1816-17, after
the end of the Napoleonic Wars. This would have been severe in any case because
of the transition to peace after 20 years of war and the immense financing
difficulties and investment "crowding out" effect caused by Britain's 1815
public debt burden of over 250% of gross domestic Product (GDP), 50% larger
than Japan's today and double Italy's.
However, the downturn was made much worse by the April 12, 1815, eruption of
Indonesia's Mount Tambora, the largest volcanic eruption in recorded history.
This deposited 100 billion tonnes of volcanic ash over the world's surface and
caused in 1816 the "Year without a summer" - with fairly mild effects in
southern climates and the United States, but causing the entire British harvest
to rot in the fields. More serious, therefore, than a mere banking crisis.
Lord Liverpool, Britain's prime minister, implemented only one policy to fight
recession. In February 1817, with parliamentary approval, he suspended the
operation of the Habeas Corpus Act, in order that any impending riots could be
efficiently quelled. This well-designed "stimulus package" proved remarkably
successful. Only one small disturbance occurred and by December, 1817, after a
bountiful 1817 harvest, Liverpool was able to end the suspension, as the
recession was over and the threat to public order gone. Total recession
duration: about a year, though there was a second "dip" in 1819 because of the
20% deflation needed to put Britain back on the gold standard.
In the current global unpleasantness, there are alas no world leaders with
Liverpool's economic grasp (having David Ricardo as economic advisor doubtless
helped). Even compared with other recessions within living memory, such as 1974
and 1982, the reaction from the global political class has been notably panicky
and hysterical - US$5 trillion of global stimulus programs, largely consisting
of public spending, are unlikely to increase the stability of the global
economy, and nor are the moves by three of the world's four most important
central banks to "quantitative easing'' - the monetary policy of the early
Under Weimar, the profits from "seigniorage" - the issue of new money -
financed around 50% of public spending in 1919-23. Notoriously, this resulted
in a trillion-fold devaluation of the mark by November 1923. In the United
States today, around 15% of public spending is being financed through
seigniorage - the Fed is purchasing $300 billion of Treasury bonds over six
months, an annual rate of $600 billion per annum, 15% of 2009 federal spending
of $4 trillion.
The US may still be the right side of the Weimar dividing line, but in Britain
the figures are more alarming. The Bank of England is purchasing 75 billion
pounds of gilts over three months, an annual rate of 300 billion pounds per
year or more than 65% of Britain's projected 2009 central government
expenditure of 454.6 billion pounds. Of course, the Bank of England may not
repeat its gilt purchases every three months, but at least in the short term it
is disturbing that Britain is currently "printing money" faster than Weimar
On the fiscal side, the figures are equally exciting. The United States,
Britain and Japan are all running fiscal deficits of more than 10% of GDP in
2009. Once you factor in the newly released Organization for Economic
Cooperation and Development's more pessimistic economic forecasts, they will
run even larger deficits in 2010. Furthermore, if recovery is at all sluggish,
the "output gaps" between those countries' actual GDP and their increasingly
theoretical "full employment" GDP are likely to produce fiscal deficits close
to the same level in 2011 and possibly thereafter.
There seems to be no recognition among policymakers of how dangerous these
profligate policies are. Only last week, at the Group of 20 meeting in London,
the world agreed to provide yet another $1 trillion of capital to the
international bureaucrats of the International Monetary Fund and the World
Bank, who will on past form divert it almost entirely to governments of the
countries most devoted to overspending.
Deserving countries, in Latin America and East Asia, which have managed their
affairs properly without excessive balance of payments or budget deficits will
see little of this money, and nor will the beleaguered emerging markets private
sector. Like the world's other fiscal deficits, the IMF and World Bank funding
will have to be borrowed, and in being borrowed will create either inflation or
"crowding out" of truly productive Western and emerging market corporations,
whose funding needs will become more desperate as the global recession drags
Except in a few countries such as Germany and China, which had previously been
fiscally conservative with low or negative budget deficits, the correct amount
of "fiscal stimulus" in this downturn was zero or negative. Most countries were
already running substantial budget deficits in the boom, and the automatic
stabilizers in all big-government economies would anyway have widened budget
deficits beyond all past peacetime records, even without stimulus.
Similarly, the global economy has been bedeviled for the last decade by
excessive money creation. The correct policy in the downturn would have been to
hold monetary policy tight, in order to fight the inflation threatened through
past excesses and the budget deficits, providing only the minimum liquidity
needed to ensure that the money markets continued functioning.
Given the marginal short-term benefits of current global policies and their
huge long-term costs, one would imagine that the world's politicians were all
running for election this year, perhaps about August, after the bottoming out
of the initial recession has become fully apparent but before the long-term
disasters of inflation and sluggish recovery are fully manifest.
However this theory doesn't quite work. Germany's Angela Merkel is running for
re-election but has been notably cautious on both fiscal and monetary policy,
while France's Nicolas Sarkozy, Russia's Dmitry Medvedev and, in the US,
President Barack Obama are with us until 2012.
Nevertheless, imminent re-election is certainly a factor with the enthusiastic
expansionists Taro Aso of Japan, Manmohan Singh of India and Gordon Brown of
Britain. In all three countries, near-term fiscal disaster is close enough and
unpleasant enough that rational people would prefer retirement to having to
face it after winning re-election - but these people are politicians!
While the current downturn may reach bottom by the summer, therefore, recovery
is likely to be very slow indeed. Government borrowing will crowd out much
private investment, reducing the potential of the global economy as funding is
diverted from new investment into less productive courses. At the same time,
inflation, caused by excessively stimulative monetary and fiscal policies, will
return to plague the global economy as in the 1970s, forcing a return to
restrictive monetary and fiscal policies if a global repeat of the Weimar
disaster is to be avoided. (Chinese central bankers seeking to invest their
reserves in something sound will find no available outlet other than gold).
Political panic may have marginally reduced the depth of the recession, but it
will enormously increase its duration.
It therefore follows that the sharp recoveries in global stock markets in the
last few weeks are wildly premature. At current levels, US stocks are only
marginally above their equilibrium value, based on US economic performance in
the decades to 2007, but there is now no certainty that we are in the economy
of 2007, or anything like it. With higher taxes and a large "output gap" such
as is appearing between actual and potential GDP, which will remain with us for
many years, the profitability and growth of US industry will be permanently
damaged, so stock prices should in equilibrium be correspondingly lower.
There is thus likely to be another downward "leg" in the US stock market's long
decline from its bubble-induced euphoria of 1995-2007, taking it to around the
historical low valuations of periods such as 1949 when the cult of the equity
was dead and buried. Taking "normalized" post-recession earnings on the
Standard & Poor's 500 as being around $60, and applying a 1949 multiple of
about seven times earnings, would give a bottom for the S&P 500 of about
420, equivalent to below 4,000 on the Dow. In other words, the likely market
bottom is at about half its current level.
The global economic climate, far from bursting into bloom, is likely to endure
a prolonged winter, extending over several years, as if nuclear war or a
volcano larger than Tambora had struck the world in 2008. For the global
economy, it will be the White Witch's Narnia - always winter and never
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-2009 David W Tice & Associates.)