November 10, 2011

The Savings Conundrum Writ Large -- Global Depression Threatens

As the first breezes of a gathering storm of great depression begins touching many shores, awareness of the driving forces is starting to spread.  For instance, in this link Ambrose Evans Pritchard nails our current situation -- we are in a global spiral into depression.

This is a good time to reprise and refine views I've presented before.  You see, all of this economic tumult around the globe is but the simple, straightforward outcome of a single dynamic.

When I first wrote on this dynamic, I called it the Savings Conundrum.   We are now beginning to see what happens when the Savings Conundrum operates on a global scale.

We are in the early stages.

Many large nations around the world are tightening budgets, reducing spending, while too many consumers are still cautious to spend and businesses still slow to invest. Only China and Germany --  the nations with the largest trade surpluses (created via currency pegs such as the EMU) -- are in a strong position to change this tune.

When government, business, and households together reduce their spending on net, the result is a vicious economic spiral -- a feedback loop -- that won't let up until some major event (like a world war) or massive intervention (like FDR's) break the spell.

The global economy will shrink if nations around the globe cut spending together, and the economic unraveling would continue not for months or one or two years, but for many years.

There is an explanation why this is no quickly passing storm we sense but is instead the menacing outer bands winds of a massive circling maelstrom -- we are looking at the Savings Conundrum writ large.

As I wrote about a year ago, The World Is Not On A Pleasant Course.


An end is now in sight, an absolute end of our current world order. The beginning of the end of this period of stability we've know most of our lives.

AEP's prediction of the rise of a new protectionist American trade bloc -- free trade among cooperating nations behind high tariff walls to exclude currency manipulators like China -- this is a best possible scenario.

It's a best scenario. A hopeful one.

One that has hope of avoiding the spiral into increasing economic desperation and the resulting rise in demagoguery, and then of demagoguery's children, that would result from general global economic downturn.

Let me be clear. I'm talking about not only global economic depression, but further, the possibility of the rise of power-seeking nationalists who would use external enemies to bend nations to their will, resulting in increasing tensions that could set the stage for large wars.

Widespread wars become possible in that world, like we haven't seen since the 1940s.

That's the less favorable possibility than that of AEP's new American Trade Bloc (which ends trade with China as it has been under the currency peg/subsidy/tariff).

Readers may notice this post is more alarming than posts I've written before. This is because the mistakes of nations around the world are all aligning in the same direction and negative momentum is building rapidly.

The last-chance alternative to these radical changes is for the major surplus nations -- China, Germany and Japan -- to increase their governmental spending as necessary to run governmental deficits roughly equal to all of their trade surpluses each year so as to create increased demand, income, and a circle of spending at home.

Chinese and German spending could rescue the world we've known: improved retirement stipends, infrastructure investments, consumption incentives, and even purchases of goods from deficit nations. For example, China (which still has a significant sector of command economy) might buy additional airplanes, locomotives, software, and more.

Or China could do something more dramatic and necessary in the long run -- simply move to free trade. That is, begin to have a freely floating currency without a peg and without currency controls.

That would be a very different situation than we have now.

But even today with the currency peg, China could immediately take big steps to improve the global economy by: A) ending domestic piracy of foreign goods such as US software and movies, B) greatly increasing their move to establishing a social safety net and retirement system, and C) creating more incentives for domestic consumption. China could easily implement these economy-saving changes now.  (See, China itself, dependent on big exports, is one of the most vulnerable nations to a global depression.)

These steps might save the current world order, but the more basic adjustment is ultimately needed.

An end to the Chinese trade-war via currency peg and to the German trade-war via European Monetary Union would tremendously benefit the global economy, and in turn would benefit China and Germany on net relatively quickly, certainly within years.

In fact, only such true free trade (with freely floating currencies) has any chance of creating truly healthy global growth, which China and Germany need to thrive in a sustainable way.

It's in their national interests.

But that doesn't mean they will see it.  Psychology and mythology normally rule over reason and facts.

As global riots haven't been sufficient yet and economies still sputter along for a while, China and Germany are likely to continue to maintain comfortable national illusions for now, and perhaps until we have irreversibly entered a different and more dangerous world.

They will most likely drive the world into collapse, and most of their citizens -- good Germans, good Chinese of good will -- will wonder to themselves why most of the other nations and peoples in the world are so irresponsible and wrong....

That it is still the greater likelihood, for now -- that the storm will intensify, that a global depression is coming.

Ultimately this is driven by the "global imbalances," by the great excess of Chinese and German savings over consumption.

This can put an end to the current world order of relative peace and relative safety most of us have known all our lives.

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