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Global Crisis Blog

The Next Crisis: How a Headline Can Deceive

By Shlomo Maital

Can Israel anticipate the next global crisis  in time to act to avoid it?

On Aug. 3, all of Israel’s daily papers reported good news about exports.  The headlines screamed:  “India leaps to No. 2 export destination”.  Data from the Ministry of Industry, Trade and labor showed that in the first half of 2010, exports to India rose to $990 m., second only to exports to the U.S. and up from 8^th place in the first half of 2009.  Exports to China climbed from 11^th place to 5^th place.   Conclusion:  Exporters have been targeting the fast-growing markets of Asia, while U.S. and European markets “have stayed firm”.   Good news.

So where is the crisis?   It is hiding – under a load of “fertilizer” (India sharply boosted its purchases of Dead Sea chemicals and fertilizer).   A third of Israel’s exports go to Europe, and 28 per cent to the U.S. These two key markets are about to decline sharply.   Together they comprised about $10 b. of  Israel’s exports in the first half of 2010.    The table accompanying the glowing report of success contains the real story:  Israel’s vulnerability to economic decline in its two main markets, America and Europe.

Global markets are supposedly going through a transition, known as “rebalancing”.  In this process, Americans save more, spend less, borrow less, export more and import less, while Asia (mainly China) saves less, spends more, imports more and exports less.  This will rebalance the global economy, which crashed when imbalance – money poured out of the US, goods poured in, mainly from Asia – ruined it.

This is a pipe dream.  Rebalancing will not happen.  China’s growth model is built on exports, and its success with the model means China will not abandon it, even if it continues to lend to the Americans.  Americans cannot spend less until governments slash “entitlements” (social security, health care), and politically this will not, cannot happen.  Meanwhile the US economy has begun to slide again.  New York Times columnist Bob Herbert reports that if you add to the official 14.6 million unemployed, the 5.9 million workers who have stopped looking for jobs, and the 8.5 million who have part-time jobs but want full-time, you get 30 million Americans who need work and cannot find it.  There are 3.4 million fewer private-sector jobs in the U.S. than a decade ago. This is why Americans feel down when G.D.P. numbers are up.  A slowdown has already begun.

As for Europe, it is confused, stumbling and in trouble.  The stabilization fund to bail out bankrupt EU countries is a fiction and may not be renewed in three years.  Europe is expert at keeping out imports to help its struggling economies.

The global system was designed to create growth. It was not designed to deal with global crisis and recession.  Most countries are now engaged in budget tightening – the opposite of what is needed.  Conclusion:  For exporting nations (like Israel), crisis looms.

What will replace collapsing markets in America and Europe?  Does Israel, and its exporters, have Plan B?

Global Crisis Blog

If You Don’t Believe Me,  Ask the REAL Experts!

Why Top Economists See Crisis Looming Ahead — and “We  Don’t Have Plan B!”

By Shlomo Maital

Peter Day

BBC Global Business broadcaster Peter Day recently interviewed four top economists and economic historians, all of whom have deep experience in the real world, and came away with some alarming predictions about the rocky road ahead.

The economists were:  Kenneth Rogoff (formerly chief economist for the International Monetary Fund), Simon Johnson (MIT Sloan School management professor), Raghuram Rajan (Booth Business School, Univ. of Chicago, professor, who predicted the current crisis)  and Sushil Wadhwani (City of London Wadhwani Asset Management fund manager, former director of strategy at Goldman, Sachs, and a member of the Bank of England’s monetary policy committee).

If you prefer not to read this overly long blog, here are a few excerpts.   If they worry you, then please do read on.

“We seem to be forgetting 1937,  we’re getting significant global tightening, grafted on to a tightening of the global banking system”, precisely what happened in 1937..”  “We’re still winding up for another global meltdown”…   “we shouldn’t delude ourself…in some ways we’ve postponed the day of reckoning.. V shaped recovery?  No, it’s a V-sign recovery, we’re going to get a big shock about the hangover that this crisis has left us with”.

1.   Kenneth Rogoff, Harvard U. Professor, co-author of the new book  This Time is Different: “Is this crisis different?   No.  I think arrogance, ignorance are eternal characteristics of man   Americans want to put off the day of reckoning… we should try to close up deficits in 4-5 years, convince financial markets they will do it… try to be credible, not to go too far too fast…  Could there be a downward spiral, a tipping point?  Absolutely, if you owe a lot of money, keep needing more, to fund new deficits or to pay back old loans as they come due, you need credibility… if financial markets decide not to lend to you….you’re greased, no-one will give you money, so governments just have to be credible, they can’t just spend and spend.  The capital markets need to see there is some discipline down the road…  if they see you riot in the streets when little spending cuts happen (Greece)… they (markets) can be merciless… “

2.  Sushil Wadhwani:    “Policy makers said 18 mos. ago, they wouldn’t make the mistakes made in 1937, or that Japan made… but we now have the tightest fiscal stance in 30 years, this could be a significant mistake..we have almost coordinated global fiscal tightening at a point in the business cycle when the global economy was set to slow anyway, because the inventory contribution was set to diminish,  fiscal tightening will make the shift to consumption and investment less likely… I think this significantly increases the downside risks to this recovery… my real worry is, we don’t seem to have a plan B. Support for fiscal tightening …we can’t suddenly reverse it… interest rates are already very low,  quantitative (monetary policy) easing effects are unproven…in economies with debt hangover where an asset bubble has burst it is hard to get monetary policy to be effective…we are now vulnerable, if a horrible event tips us into a recession, the markets will start worrying there is no policy ammunition left. Policy makers have no Plan B!!   Three things could go wrong. a) The Greeks could decide to restructure their debt before 2012,  if no firewall is in place, this could be problematic, b) Europeans have announced a 750 b. Euro stabilization package, but we all know the money isn’t really there, it includes the German quota from
the IMF, and contributions from Spain, Italy, Portugal, which may not be there… c)  in 3 years time, the stabilization mechanism expirres,  and the renewal date is just a few months before the German election… there is no Plan B”.

“It is sad we are not learning the correct lesson, people are not always wiling to admit to mistakes,  there is not enough contrition being shown.  We are not reforming the system in the way it needs to change. Wall St.:  the banks have recaptured the system, gotten off lightly so far,  they have political clout. Central Banks have not observed the appropriate lessons, not even willing to admit to their mistakes, same is true of financial regulators who made grievous mistakes, there were plenty of warnings around, not just stopped clocks in the private sector…Central bankers of smaller countries regularly warned the big Central Banks.  In larger countries, no one paid attention…    e.g. Sweden, Australia, Norway…they frequently warned their colleagues, no attention was paid, the opposite:   e.g.  in 2001  in a G10 working party, what should be done with financial regulation?   Chair was the Gov. Of the  Swedish Rijksbank, he made impressive recommendations, US and UK suppressed the report, it came out only as a think tank report…it got in the way of free markets, so it was not what  the US and the UK wanted then.  There were plenty of warnings.  It was a classic bubble. Hard to know when and how it bursts, but it is clear that at some point it will go awry,  we relied on the Greenspan mopping up doctrine, we could deal with it afterward, even though history shows mopping up doesn’t work.  “

3.  Raghuram Rajan  “Banks got themselves into such a mess, governments had to bail out system.  They are now at the mercy of the verdict of the same financial markets.  There is an unholy nexus. The Political Left wants to see bankers as the problem. The Political Right wants to see the government as the problem. The fundamental problem of capitalism is: how to get them to work together in a way that is sensible, with  bankers not feeding off govt. and vice versa…govt. in US wanted a political goal, more lending to low-income segments,  bankers took advantage of this and made a ton of sub-prime loans and got into trouble, govt. came to their rescue with bank bailouts…  this is an unholy nexus, taken to the next stage,  banks now hold a significant portion of govt. debt, govt. And govt. is the backstop for the banks..this is where we need to figure out how to break the bank/govt.  nexus.   Small steps in financial sector reform are not enough.”

4. Simon Johnson   (author of The Baseline Scenario, a widely-read blog and co-author of 13 Bankers: on the way banks have the whole American system in their bear hug…)

“We have 2,400 pages of Financial Reform Act legislation, very little of it will make any difference, the lobbyists have done a terrific job… it won’t reduce risk as we go forward in the next cycle.   The next bailout could be bigger…   as a Greece scenario, you can’t afford to do a bailout,  too big to fail becomes too big to save…very bad further outcomes,  Great Depression…nowhere is it written you can’t repeat the 1930s, you can, if you let the financial system go mad…    There’s enough debt to be dangerous,we  don’t even know its dimensions, derivatives are opaque, have been secretive, we don’t know if derivative positions would limit the damage of an asset crash or amplify it… you only find out, the Minister of Finance only finds out a few hours before the decision of bailout or bust.

“Is Chinese growth a global trump card?  The G20 hopes so.  At their last summit, they said, expect everyone to engage in austerity, but we don’t think it will lead to serious downturn, something good will happen to offset it —  growth in China.  In China they are trying to cool things down. Chinese academics, those who study the Chinese economy, they were sceptical about China.  …  Is a Third Great Depression is looming?     There may be a financial boom, not so good for regular people, and another form of debt cycle, expansion, funded by inflow of capital, mostly debt,  things will go well for a while, optimism everywhere,  you won’t interview us negative peole, and then, another crash — how big, how damaging?  The financial system is too big, it doesn’t help, it only transfers money from us to the financial sector, but it has political power that is resisting reform, politicians if they try to reign in financial power, think it will cause economic disaster — but the exact opposite is the truth!”

Peter Day. “History teaches us something is wrong here,  but I doubt many of us know what it is.”

Global Crisis Blog

“Cash for Clunkers” Was Itself a Clunker

By Shlomo Maital

Ford Explorer 4WD: Most popular “cash for clunkers” vehicle – green?  fuel efficient???

America’s “Car Allowance Rebate System” (CARS), or “Cash for Clunkers” was a $3 b. fiscal stimulus program giving Americans each $4,500 for scrapping old cars and buying new ones.  The program began officially on July 1/2009 and ended on Aug. 24.  When the initial $1 b. appropriated by Congress was exhausted, an additional $2 b. was allocated.

Of the new cars sold under the program, Toyota sold 19%, GM 18%, Ford 14%, Honda 13% and Nissan, 9%.  Japanese and Korean car companies gained significant market share as a result of the program, at the expense of embattled American firms. (A similar program in Japan excluded US vehicles.)   According to Wikipedia,  “a study published after the program by researchers at the University of Delaware concluded that for each vehicle trade, the program had a net cost of approximately $2,000, with total costs outweighing all benefits by $1.4 billion.”

Democratic politicians claimed Cash for Clunkers was a big success, citing all the new car purchases it created (690,000 dealer transactions).  But writing in The American, the journal of the American Enterprise Institute (a right-wing pro-free-market think tank), Max Borders lists 10 separate reasons why the program was a major badly-planned failure.

1. The policy concentrated benefits on political interests. Because the stimulus focused on the auto industry, many wondered whether the policy was a means not only to rescue a bloated, wasteful U.S. auto industry, but to pay back the unions—particularly the United Auto Workers—for their support for presidential candidate Barack Obama and the Democratic Party in the 2008 election.

2. The policy had the effect of sucking revenues from other industries ailing from recession. In other words, if people are paid to spend money on cars, they’re less likely to spend money in other sectors.

3. The policy destroyed goods that had value, which means it destroyed value. Professor John Quelch of Harvard Business School writes: “A $2,500 incentive would have attracted the older, most fuel inefficient used cars.  Instead, a $4,500 incentive attracted many perfectly serviceable vehicles. Because of government concerns over fraudulent recycling of trade-ins, vehicles had to be destroyed.”

4. The policy distorted the used-car market by reducing the availability of cars desired especially by the working poor. Why, in the middle of a recession, would anyone want to drive up the price of goods used by society’s most vulnerable people?

5. The policies’ stated goals, if met at all, were met inconsequentially. Shikha Dalmia, writing for Forbes, shows improvements in air quality and fuel savings were virtually undetectable: “Even if one accepts [Transportation Secretary Ray] LaHood’s numbers, the fuel savings add up to only 72 million fewer gallons of gasoline every year—about what Americans consume in four and a half hours.”

6. The policy generated considerable opportunity costs. Even if you grossly overestimate the success of the policy, the costs of forgone uses of the resources are, though impossible to measure, still considerable. In other words, every dollar you spend on x is a dollar you cannot spend on y.

7. The policy successfully purchased a prophecy that would have fulfilled itself within two or three months. Most of the people who participated in Cash for Clunkers would have bought cars soon anyway. As car review company Edmunds famously pointed out, the policy shifting buying patterns forward a few months at most. Here are the results: “Nearly 690,000 vehicles were sold during the Cash for Clunkers program, but Edmunds.com analysts calculated that only 125,000 of the sales were incremental. The rest of the sales would have happened anyway.

8. The policy subsidized people to make unwise purchases. It may take more time to determine this fallout, but—like subprime mortgages and artificially low interest rates—some people had incentives to get into cars they would have wisely avoided.

9. The policy allowed politicians to claim success despite failure. When any macro-economic policy measure is complicated and convoluted, it’s easier to obscure what goes wrong. This is exactly what Congress and the Obama administration did in this case. A lot of politicians deluded themselves so thoroughly that Congress went back for another round, extending the program.

10. The policy was an old-fashioned wealth transfer. “A and B put their heads together to decide what C shall be made to do for D” wrote William Graham Sumner in 1883. “The radical vice of all these schemes, from a sociological point of view, is that C is not allowed a voice in the matter, and his position, character, and interests, as well as the ultimate effects on society through C’s interests, are entirely overlooked. I call C the Forgotten Man.” But let us not forget C.  Government resources come from somewhere, as did the cash for all those clunkers.

Global Crisis Blog

The New Crisis is Now!

By Shlomo Maital

Within the 500-word discipline of a brief blog, is it possible to explain why the global crisis, often listed as 2007-9, is in fact ongoing and about to get much worse?

Let me try.

The crisis occurred because the world became imbalanced.  America spent, consumed and printed endless quantities of dollars, scattered throughout the world, in order to import.  The period 1980-2007 was an American party that lasted a whole generation. Asia saved, invested and exported, accumulated dollars (to keep Asian currencies and goods from getting too expensive) and grew rapidly, lending America the funds to keep the party going.  Never in history have wealthy nations borrowed so much, so rapidly, from many poor ones.  In such a tilted world, with goods flowing in one direction (east to west), and money flowing in the other (west to east),   it was clear the situation could not continue (although it lasted longer than should have been possible, with the partying Americans conspiring with the nose-to-the-grindstone Asians to keep it going).

Now, it is time for rebalancing.  That means:  Americans save, invest and export.  Asians spend, consume, and import.

It has to happen.  But — it cannot happen.

To save, America must slash its government deficit. To slash the deficit, it must cut entitlements (Medicare, Social Security).  Politically, this is impossible.   Besides, in order to boost exports, you have to make something (goods, not services). But America long ago shifted its production to Asia; U.S. manufacturing is less than 10 per cent of GDP, mostly, items that do not enter into world trade.

To spend, China must boost its domestic consumption.  For this to happen, China’s corporations must stop hoarding profits and reduce their investment.  But why?  The fundamental business model built on exports has created enormous wealth.  It supports rapid growth.  China must grow, in order to employ hundreds of millions of workers migrating from the farms in the West to the factories in the East.  Why fix it, if it isn’t broken? (China, it will be recalled, continued to grow rapidly despite the global crisis).

The only chance for job creation in the U.S. is for exports to rise and imports to fall. But neither import substitution nor export growth can occur until America reinvents its manufacturing.   But President Obama recently offered the Chinese to produce Boeing aircraft in that country.  Brilliant!  An American job creation program that creates jobs in Shenzhen.   In America’s “cash for clunkers” program, widely praised, most of the clunkers were traded in for foreign fuel-efficient cars.  Korea got the jobs.

If rebalancing cannot occur, then imbalance will continue, as will the ongoing crisis.  And it will get worse.   Germany pursues a self-interest policy of boosting exports, at all costs, ignoring American pleas to import more.  European nations pursue an “every country for itself” policy, at a time when political unity is more vital than ever.   Asian leaders listen politely to American lectures on how to restructure their economies,  watch America’s economy stagnate, and  smile politely.

A recent study of global risk  by the World Economic Forum  lists some 50 risky events, together with their magnitude and probability.  Risks include social, political, technological, medical and economic.  The five top risks are all economic, including the leading candidate — a risk of “asset price collapse”, causing trillions in losses, with probability exceeding one in five.  Without rebalancing, asset prices will again collapse.

Readers, fasten your seat belts. Get out of debt, if you can.  We will all need every ounce of resilience and courage we have.