Markets are falling now because the US, and probably the world, is tipping into recession again.
This morning’s 200-point sell-off on the Dow Jones comes on the heels of the Economic Cycle Research Institute’s call a few days ago that the US is indeed beginning a new recession “and there’s nothing that policy makers can do to head it off”. That’s because a recession “isn’t just a statistical event. It’s a vicious cycle that must run its course”.
ECRI’s weekly leading index has fallen for the eighth week in a row and is at the same level it was at in October 1990, March 2001 and January 2008. If ECRI is right in its new prediction of a US recession — and it has a good record — then global sharemarkets have further to fall.
It’s not all bad: last night saw an unexpected lift in the purchasing managers’ index, the ISM, from 50.6 to 51.6, making the US one of only a handful of countries where manufacturing activity appears to be expanding.
In China it contracted for the third month in a row, which is a big factor in the big declines seen over the past few weeks.
German retail sales fell 3% in August, the biggest fall in three years and, unsurprisingly, activity across the eurozone is weakening in response to the endless talk of a Greek default.
Ambrose Evans-Pritchard, writing in the London Telegraph, nailed the bigger problem yesterday when he wrote that the global savings rate has surpassed its modern era high of 24%: “Put another way, there is a chronic lack of consumption in the world.”
In one way this is simply a result of new era of deleveraging from the excessive levels of debt that led to the 2008 crisis.
But at a deeper level it is the fallout from the global imbalances that resulted from the globalisation of trade without free currencies — specifically the manipulated Chinese currency and monetary union in Europe.
Evans-Pritchard pointed to a paper last week by Stephen Cecchetti, head of the monetary and economic department of the Bank for International Settlements, in which he said that cross-border liabilities have risen far more than global GDP.
They have gone from $US15 trillion to $US100 trillion in 15 years, or 150% of global GDP. Says Cecchetti: “The message here is that financial globalisation has been even more profound than trade globalisation. International balance sheet growth has far outpaced economic growth.”
He goes on: “To see why I am concerned, consider a world composed of three banks in three countries. Bank A in country 1 lends to Bank B in country 2, which in turn lends to Bank C in country 3. Bank C in country 3 lends back to Bank A in country 1.
“Now, as things progress, the banks do ever more business with each other, and their balance sheets grow. The gross bilateral flows are big, and the net flows are non-existent. What matters is that the balance sheets get big and, because of the interconnectedness, if something goes wrong in one of the banks, the whole system can blow up. If one of the banks runs into trouble, so will the other two.”
As financial flows start to unwind, and even go into reverse, weakening economies everywhere are raising the prospect of capital controls and, more worryingly, trade protection.
There must be concerted action to prevent deflation in deficit countries, not forcing deflation on them as Germany seems to be doing to Greece at the moment.
As Cecchetti points out, the global current account imbalances that exist now are far greater than they were in 1985, when world leaders rushed to adopt the Plaza and Louvre Accords for co-ordinated exchange rate action.
These days there seems to be no point even trying for co-ordinated action about anything. The G20 is the main forum for this, but is little more than a PR exercise.
*This article first appeared on Business Spectator