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Friday, July 9, 2010 A Long Economic Winter Ahead
"A State divided into a small number of rich and a large number
of poor will always develop a government manipulated by the rich to protect
the amenities represented by their property.": Harold Laski (1893-1950), British political theorist, 1930 “Money becomes evil not when it is used to buy goods but when it
is used to buy power... economic inequalities become evil when they are
translated into political inequalities.” Samuel
Huntington (1927-2008), political scientist “…
if financial markets are skittish and don't have confidence in a country's
fiscal soundness, that is also going to undermine our recovery." President
Barack Obama, June 25, 2010 “Any
intelligent fool can make things bigger, more complex, and more violent. It
takes a touch of genius, and a lot of courage to move in the opposite
direction.” Albert
Einstein (1879-1955) Physicist and Professor, Nobel Prize 1921 The bond market is
telling us that there could be hard economic times ahead and that deflation,
for the time being, is more of a threat than inflation. -Leading
indicators are also pointing to possible economic weakness
ahead. -The Euro zone is
being pulled apart by the economic asymmetry of its members, the less productive
among them (Greece, Spain, Ireland, Portugal and Italy) being unable to keep
pace with the very productive German economy. -The U.S. money
supply M3 is contracting. -The Chinese
bubble is dangerously approaching the bursting point. -And,
the deflation of debt all
over the place threatens to plunge the world economy into a deflationary
tailspin. —In this context, there is a good chance of a double-dip
recession next year, in 2011. Readers of this
blog know where I stand on this issue. One year ago, on July 10, 2009, when
everybody and his uncle was declaring the recession over and the return of
business as usual, I wrote a piece announcing that my analysis was pointing
out to ten years of economic hardship entitled “We are in the
Midst of the Great Baby-Boomers Economic Stagnation of 2007-2017”.
I wrote then that “many observers think that 'prosperity is around the
corner' and that this recession, like others since World War II, will end as
soon as the stock market, as a leading indicator, recovers and people start
spending again. This is a myopic view of the current economic big
picture.” Let us keep in
mind that in May
of 1930, President Herbert Hoover was also proclaiming that “the
danger ... is safely behind us.” This was ten years too early for such a declaration. Just
as in the 1930s, the U.S. economy and many part of the world economy suffer
from a debt overhang that usually takes at least ten years to correct. When
overall debt is four times larger than the economy, as it is the case today
and as it was close to being the case in the 1930s, a debt deflation becomes
unavoidable. Economic
booms built on a mountain of debt, some of which is fraudulent and
speculative debt, tend to end badly. The higher the debt mountain relative to
the real economy,
the more serious is the following economic meltdown. This is because an
unsustainable debt level means that some of the investments and projects thus
financed make no economic sense and no sufficient income can be forthcoming
to service and repay the debts. The first consequence is excess capacity and
falling asset prices. The second consequence is an unavoidable liquidation of
debts and a debt deflation. The third consequence is economic stagnation. The
danger that accompanies a protracted period of debt-liquidation and debt
deflation after a binge of over-indebtedness is well known in economics. In 1933, Yale economist Irving Fisher
published his debt-deflation
theory of economic depressions. The core of the theory is that
over-indebtedness leads to deflation, which in turn leads to an economic
contraction. Fisher summarizes the links between debt liquidation and
economic contraction in nine interacting steps: 1- Debt liquidation leads to distress selling. 2- Contraction of deposit
currency, as
bank loans are paid off, and to a slowing down of the velocity of circulation
of money. 3- A fall in the level of
prices. 4- If the fall of prices is not
interfered with by reflation or otherwise, this is followed by greater fall
in the net worth of business, precipitating bankruptcies. 5- This leads to a like fall
in profits. 6- A reduction in
construction, output, trade and in employment of labor results. 7- Losses, bankruptcies and
unemployment lead to pessimism and loss of confidence. 8- The result is hoarding and
a contraction in bank credits, which contribute in slowing down even more the velocity of
circulation of money. 9-
The overall deflation causes a fall in the nominal or money interest rates
accompanied by a rise in the real or commodity rates of interest as prices
fall. A similar self-reinforcing spiral-down of
debt-deflation and economic contraction can be feared in the coming years as
the level of debt to the economy goes from about four times the economy to a
more manageable two times the economy. In other words, it should not take
more than $1.50 or $2 of new debt and credit to generate one dollar of new
output. When it takes more debt than that to generate new production, this is
an indication that the economy is becoming over-leveraged with debt. Judging by the
pronouncements made by leaders at the recent G8
and G20 meetings in June, and their collective commitment to cut
governments’ deficits in half by 2013, I don't think that politicians fully understand the
danger presently facing the world economy. In fact, any new shock hitting the
world economy, economic or political, risks accelerating the collapse of the
debt house of cards, with dire consequences for production and employment. Austerity fiscal measures may raise government efficiency,
but they are not what will cushion the real effects of the debt deflation.
Both reflationary monetary policies and overall stabilization policies are
needed, especially in the banking sector, in order to make sure that
producers and employers are not frozen out of new bank credit. Rodrigue Tremblay
is professor emeritus of economics at the University
of Montreal and can be reached at rodrigue.tremblay@yahoo.com. He is the author of the book "The
Code for Global Ethics"
at: www.TheCodeForGlobalEthics.com/ The book “The Code for Global Ethics, Ten Humanist Principles”,
by Dr. Rodrigue Tremblay, prefaced by Dr. Paul Kurtz, has just been released
by Prometheus Books. Please visit the book site at: www.TheCodeForGlobalEthics.com/ See it on Amazon
USA: See it on Amazon
Canada: See it on Amazon
UK: or, in Australia
at: Please ask your favorite bookstore and
your local library to order the book: The Code for Global
Ethics, Ten Humanist Principles, by Dr. Rodrigue Tremblay, prefaced by Dr.
Paul Kurtz, Prometheus Books, 2010, 300 p. ISBN: 978-1616141721. *****The French version of the book is also now
available. See: www.lecodepouruneethiqueglobale.com/ or on Amazon
Canada _____________________________________ Posted, Friday, July 9, 2010, at 5:30 am Email to a friend: http://www.TheNewAmericanEmpire.com/tremblay=1127 or click on Blog at: www.TheCodeForGlobalEthics.com Send contact, comments or commercial reproduction
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