The Warning Bell


In late February 2007, while the markets were racing up amid general euphoria, the Dow Jones Industrial Average index suddenly plunged over 400 points. Stocks then quickly resumed their upward march.

Two weeks ago the markets were just upbeat: the recovery was progressing, consumers were buying and the Fed was providing additional stimulus. As if on cue, the DJIA plunged over 400 points in a few days, and may well drop further.

In 2007 the credit boom was in full swing and glowing reports of the "new capitalism" filled the financial press. Today the news is that that a "double-dip" recession has been avoided and global growth has resumed.

Such similarities can be attributed to random coincidence but they can also have a similar origin. We have now learned, at considering cost, that the euphoria of spring 2007 was a false beacon. It covered substantial systemic problems which appeared several months after the February market drop.

Are we in a similar state of denial today? Are our predictions of full recovery well founded, or are they based on flawed assumptions as was the 2007 boom? The underlying facts are not positive:

First is China, without which the global recovery would be minimal or nonexistent. Systematic mercantilism has secured her the lion's share of global growth, and massive credit creation avoided a serious recession. The first policy, however, has generated both global disequilibrium and increasing political resistance; The second has fueled dangerous internal inflation. There is now doubt that both can be deal with without under China's growth.

Chinese appetite for raw materials drives the commodity boom, enriching Brazil, Australia and other suppliers. But this also drives currency appreciation, threatening their non-commodity exports and related national industries.

In Europe the recession has widened the gulf between strong and weak economies. Rescue packages from the EU and IMF are doubling in value year on year. It is doubtful the newest one (Ireland) will be the last.

The US has improved something, but huge issues remain to be resolved: toxic assets on bank balance sheets; High and persistent unemployment; Unfunded liabilities at all levels, and yet to be reduced budget deficits. How sustainable is this "recovery" once bail-outs and stimulus packages end?

One view is that the problems created by the 2007 crash have been deal with and will gradually fade away. Another would be that cracks were papered over but nothing was resolved, with the final reckoning only postponed.

We have long believed that the key issue is the imbalance between the global monetary mass and the total amount of assets available against it. While large trade and budget deficits have increased the global store of loose capital, available assets have in fact shrunk. The result is a series of asset bubbles, each ending in a damaging bust. As money moves ever faster around the globe no institution, national or international, has either the power or the means to control it. We are on a runaway train with no brakes, and no engineers at the switch.

In this second view, the means used to fight the recession, while dampening its effects in the short term, have in fact aggravated the problem. The large increase in liquidity effected by central banks and governments have only "fed the beast", resulting in greater imbalance and more instability.

The unresolved and growing problems listed above are so likely to provoke a second crash, to be expected in the spring of 2011.

The great efforts and means expended to tame the recession were aimed at "saving" the financial system, with some regulatory tinkering at the edges, but no structural re-design. As these efforts end in failure, the realization will set in that the system is irretrievably flawed and in the end self-destructive.

At that point public pressure for alternative policies will become irresistible. In the United States, with political volatility at record levels and the 2012 presidential election eighteen months away, temporization will be impossible. Politicians unwilling or unable to act will be replaced.

The current political and economic gridlock will break, and the country will move in a new direction. Where the US leads, other nations will follow.


Source by Jacek Popiel