A brilliant and provocative but pessimistic analysis by Albert Edwards of Société Générale: “To cut or not to cut? Actually it doesn’t really matter. We’re stuffed anyway!”, 12 February 2010. With links to even better analysis by Richard Koo. Must-reading for anyone seeking to understand this crisis. Excerpt:
About Europe
My own view of developments, for what it is worth, is that any help given to Greece merely delays the inevitable break-up of the eurozone. But, for me, the problem is not the size of the government deficit and the solvency or otherwise of the governments in the PIGS (Portugal, Ireland, Greece and Spain we deliberately exclude Italy).
The problem for the PIGS is that years of inappropriately low interest rates resulted in overheating and rapid inflation, even though interest rates might well have been appropriate for the eurozone as a whole. Rapid inflation has led to overvalued bilateral real exchange rates (they do still notionally exist) for the PIGS and in most cases yawning double-digit current account deficits. With most trade done with other eurozone countries, the root problem for the PIGS is lack of competitiveness within the eurozone – an inevitable consequence of the one size fits all interest rate policy. Even if the PIGS governments could slash their fiscal deficits, as Ireland is attempting, to maintain credibility with the markets in the short term, the lack of competitiveness within the eurozone needs years of relative (and probably given the outlook elsewhere, absolute) deflation. Hence the PIGS public sector deficit will inevitably remain large as a direct consequence of this weak growth outlook.
In my opinion this will not be tolerated by the electorates in these countries. Unlike Japan or the US, Europe has an unfortunate tendency towards civil unrest when subjected to extreme economic pain. Consigning the PIGS to a prolonged period of deflation is most likely to impose too severe a test on these nations. And the political consensus within the PIGS to remain in the eurozone could falter in the face of another of Europe’s unfortunate tendencies: the emergence of small extreme parties to take advantage of any unrest. My own view is that there is little help that can be offered by the other eurozone nations other than temporary confidence-giving sticking plasters before the ultimate denouement: the break-up of the eurozone.
About the economic crisis of the developed nations
Note: A copy of this graphic appears in this report (earlier, by different author but same firm).
I am persuaded though by Richard Koo’s book about the lessons from Japan’s balance sheet recession. The crux of his analysis is that governments have no option but to stimulate aggressively all the while the private sector is de-leveraging. ANY attempt at fiscal cuts simply results in renewed recession and a further loss of confidence, thus making it even harder and more costly to sustain any subsequent recovery and hence the budget deficit ends up bigger than before.
For a deeper understanding of these events, I recommend reading Richard Koo
Richard C. Koo is Chief Economist of the Nomura Research Institute, Tokyo.
- “‘Plan B’ for the Global Financial Crisis“, presentation at the Center for Strategic and International Studies, 22 October 2008 — Here is a PDF of his slides.
- Interview of Koo by Kate Welling, Welling @ Weeden, 11 September 2009
- The Holy Grail of Macroeconomics, Revised Edition: Lessons from Japans Great Recession (2009)
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar, including About the FM website page. Of esp relevance to this topic:
Posts about forecasts and warnings :
- We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions.
- Geopolitical implications of the current economic downturn, 24 January 2008 – How will this recession end? With re-balancing of the global economy — and a decline of the US dollar so that the US goods and services are again competitive. No more trade deficit, and we can pay our debts.
- Consequences of a long, deep recession – part I, 18 June 2008
- Consequences of a serious US recession – part II, 19 June 2008
- Consequences of a long, deep recession – part III, 20 June 2008
- The most important news of the month. Perhaps the year., 29 September 2008 — Warnings from our foreign creditors.
- Forecasting the results of this financial crisis – part I, about politics, 13 October 2008
- Forecasting the results of this financial crisis – part II, a new economy for America, 14 October 2008
- A look at out future, 2009 – 2010 … and beyond, 9 November 2008
- America on its way from superpower to banana republic, 28 March 2009
Afterword
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FM, can you link to the original article? I cannot find a link to the Albert Edwards article on the page. I would like very much to see the methodology behind that bar graph. I have my suspicions, as it’s very similar to other charts I’ve seen, but would like to confirm before sounding off.
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FM reply: I don’t have a open link to the article. It gives no hint as to the methodology. However, the OECD data uses a GAAP-like methodology to calucate the present value of the future oblgations.
Here’s a link to some analysis by Econbrowser in July 2009 on the US Government liabilities: “Off-balance-sheet federal liabilities: Just how much has the U.S. government promised to pay?”, James Hamilton, 5 July 2009
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FM reply: The government’s total liabilities — calucated under General Accepted Accounting Principles (real accounting) — was $57 trillion as of the end of fiscal 2007 (see The most important story in this week’s newspapers). It’s much higher now. And that does not include the government’s vast contingent liabilities, many and uncountable. But the sum exceeds out ability to pay, and soft defaults will become inevitiable. Health care reform will eliminate a large chunk of this total.
Here’s another analysis of the Greek situation at the intelfin blog: “Greece – No Short-Term Rest”
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FM note: The link goes to a site where they have reposted some excellent Wall Street research reports.
“PIGS and the ouzo effect“, The Economic Populist blog, 7 February 2010
Link to reports of a “Secret summit of top bankers“, The Daily Telegraph, 6 February 2010
RE: the apparent tendency of Europeans to become politically unstable during times of fiscal crisis moreso than U.S. or Japan, I wonder how much of this is a consequence of proportional representation vs. winner-take-all voting systems?
Koo’s piece is so long and so tedious and so full of speculative hope. He offers that HSG Prices have stabilized and CRE is dropping. They BOTH cannot be sustainable nor BOTH an accurate indicator of reality. One is a chimera. When you discover which one is a false signal you will be able to better understand/predict a plausible future.
“….we will never come out of that recession until the private sector balance sheets are repaired. In the meantime, governments can do a lot of things to prop up the economies, but for the economies to stabilize and then return to self-sustaining growth, we need to have private sector balance sheets in good enough order – and that takes a while.”
When you realize that we live in a very stratified Economy you will not be fooled by an “increase in Savings Rate” nor fooled by a very myopic Picture such as “GDP”.
In essence this Extend and Pretend stuff of Koo (Volcker Rule) is good for the Bankers ONLY…well, it is good for the desperate managers of all things Retirement and Investment which most Americans are now hung with….you know all your near term Funds are broke, right?
The other problem with extend and pretend is that it assumes there is a rebound in the future at some point that allows for the resolution of the underwater value and I have news for these guys, the consumption glut that existed during the past 2 decades is gone…kaput, not coming back, so it matters little how long you wait, we have a vast wasteland of mall space that will serve no purpose and have few shoppers…the shopping spree is done I think and it’s about time.
So good luck out there…it is a Wasteland propped up by accumulated, multi-generaional “wealth”; which does have a finite life.
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FM reply: I don’t understand any of this. Why must housing and commercial real estate prices move in lockstep? The former declined first, and as such might reach bottom first. Neither will go to zero. Nor are your comments about savings and GDP clear. And where does Koo advocate “extend and pretend” Off-topic, where does Volcker do so?
FM reply: “I don’t understand any of this. Why must housing and commercial real estate prices move in lockstep? The former declined first, and as such might reach bottom first. Neither will go to zero. Nor are your comments about savings and GDP clear. And where does Koo advocate “extend and pretend” Off-topic, where does Volcker do so?”
If you think Hsg Values are at a bottom—well, we shall soon see.
If you think defaults will not further erode the real Econ while Balance Sheets “repair”…well, we shall soon see.
If you think the American people will sit around and watch Deficits expand each year for 10 years…ok.
If anyone thinks another Round of Bank Bailouts will not spark strong reactions…good luck with that view.
All I can say is Koo is basically Japanese in all things he is—mind, life experience and outlook. Having worked for Volcker is not an antidote to this fact. Read more of him and maybe you can see where his basic outlook comes from.
We will soon see if internal US demand can replace QE and the Chinese purchasing of the Bonds necessary to avoid a rate uptick and in his view—a drop in yields (!!!) Just watch the % of DIRECT BIDDERS in the Auctions. Deflation is not so easily corraled, I suspect, once it takes hold….but what does anyone know here.
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FM reply: I’ll try again, since you do not seem to have grasped my reply to your first comment. It does not appear to me that you understand what Koo is saying. You make no specific references to his data, analysis, or forecasts. Plus, of course, the significant fact that his forecasts have proven accurate so far.
My goodness. Reading and re-reading this old man is like a serialization of Alice in Wonderland. A fine example of FEDERAL RESERVE speak and Neo-Keynesiam dream state prognostication.
All you need to read is one of the last paragraphs: “Well, that view was the view of Andrew Mellon, who was Treasury Secretary under Herbert Hoover. So that experiment was tried from 1929 to 1933 and almost half of U.S. GDP disappeared. Unemployment rate went to 25% and bringing the economy back to full employment literally took the Japanese attack on Pearl Harbor. I don’t think that’s the way we want the world to come back to life.”
….to graps how Bubble-addicted all his views are. See all these Theoriticians like him and his ilk dominated a version of Econ Thought that simply has no basis in factual reality which is frightening in itself but now he wants to try a Grand Experiment where value literally has no meaning and money is not real. He is nothing but a paid shill for Political and Financial over-reach—–ANOTHER historical example in the History of Man. Note how he is completely “amoral” in his glib discussions. To him, it is merely a simple fact, a random bit of Reality that MOST Financial entities were BROKE (and the architects of their own dermise–and ours)and all that debt was transferred to the PUBLIC which we now know is also BROKE and will be for at least one generation going forward. And JM K. is to rescue THEM at OUR expense!
Do you read anywhere in his analysis of the deep damage done to the social psyche and the new well-placed mistrust of all things Financial? Oh he mentions the Japanese are just fine IF they could only get Co’s and People to borrow! My god what sophistry. People like this guy take the most morally charged area of public life—EXCHANGE of goods and services, credit and debt, promises to pay and responsibility to others and seemingly pass over the demise therof and then pontificate as if we should trust the ideas and the man. PURE RUBBISH! We have not seen even ONE perp of this Financial Debacle brought before a Court. If his ideas are the best and brightest of his generation then I say Bring on and Resurrect Mellon! Who says America deserves to escape the backwash and denouement of its childish/adolescent ways!
So few seem aware of what destruction these Bankers and their apologists have unleashed upon this once fine Country—-but so few are even old enough to have experienced anything but the profligacy of the last 40 years!
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FM reply: He provides a comprehensive analysis, with data and logic. You make big empty statements, and sneer. I believe it is clear who deserves attention.