Thursday 22 March 2018

Paul Sommerville: The wheel turns, but the hamster is dead

Despite nonsensical calls for growth, the endgame for the world economy is debt restructuring and forgiveness

Paul Sommerville

AS THE eurozone hurtles towards the abyss, political paralysis reigns. Ineffective policymaking compounds the problem and a disorderly break-up of the euro can no longer be ruled out.

Most commentators believe that this cannot happen as European leaders will do everything to save the single currency.

But "official" experts are always the last to realise the obvious. Just because they wish it not to happen does not mean they can stop it.

Botched financial manoeuvring has done little to dent the delusion that politicians can control the world economy. They cannot. They merely react to each phase. They may delay the inevitable, but they can't prevent it.

This was the biggest credit bubble in history and it will take much longer to resolve. The crisis comes in waves as the market turns from pessimism to optimism, from despair to euphoria.

The short-term panacea -- the ECB's long-term refinancing operation -- has come to a shuddering halt.

May was a bloodbath for the financial markets. Commodities plummeted, capping the biggest monthly slump since 2008, as Europe's escalating debt woes dimmed prospects for demand while Chinese manufacturing slowed.

The S&P GSCI Spot Index of 24 raw materials tumbled 13 per cent in the month. The index declined 6.4 per cent the last week of May, a fifth straight drop and the biggest since September. Wheat, heating oil, cotton and gasoline led the losses.

Crude oil prices sank 4 per cent on Friday, June 1, alone, after it had dropped 17 per cent in May -- the biggest monthly decline since December 2008. Copper fell 12 per cent and is down nearly 18 per cent since its February high. In May cotton prices dropped 20 per cent, the biggest decline among GSCI components. Coffee fell 11 per cent, the sixth straight monthly decline.

Stocks were no better. The FTSE suffered its worst month in more than three years, down 8 per cent. The MSCI Asia Pacific Index fell 10 per cent, the steepest monthly decline since October 2008, when global markets tumbled after the Lehman Brothers' collapse.

Across the globe the slowdown became evident.

India's economic growth weakened to a nine-year low last quarter, GDP increased 5.3 per cent last quarter from a year earlier, the least since 2003, Inflation accelerated to 7.23 per cent in April, the fastest pace among the largest emerging economies. A sharp slowdown in India's foreign trade added to the woes of Asia's third-largest economy; its currency, the rupee, has declined about 19 per cent in the past year.

Reports showed China's official Purchasing Managers' Index eased to its weakest reading this year and Germany's manufacturing sector contracted at the fastest pace in almost three years.

Finally, when many thought things could not get much worse, the USA announced monthly job numbers weaker than expected, leading to near panic as traders rushed for the exits in all asset classes.

It is important to realise that Greece is now irrelevant. Whether they find a temporary solution to keep it on life support or expel it from the euro, their debts are unserviceable and unpayable. The wheel may be still turning but the hamster is dead. Secondly the idea that Spain will be able to get out of this mess without external help is laughable. Thirdly, and most importantly, the ideas such as eurobonds and European universal bank guarantees will be fiercely opposed by Germany, but also, crucially, do not solve the problem, merely helping to hide it temporarily. Lastly, the ubiquitous calls for "growth" are mostly vacuous nonsense. Being in favour of growth is like being in favour of world peace. Unless the huge debt overhang is tackled, growth strategies will favour banks, not the real economy.

The problem now is that the market is addicted to the crack cocaine of stimulus. Last week we saw a fierce rally as China lowered interest rates and the Federal Reserve's QE3 was anticipated. But even with ultra-low interest rates the demand for credit is falling. Deleveraging is only just beginning and that is why the money supply is contracting, and no amount of statements declaring the worst is over will change that. Governments pin recovery hopes on cheap credit, but new debt has gone out of style.

Banks also are hoarding cash by buying government bonds to save themselves.

Credit is the lifeblood of the world economy and its contraction is an ominous warning of an intensifying deflationary trend. Sovereigns take over the lending by issuing IOUs, but eventually the debts overwhelm government efforts to inflate. The idea that sovereigns can inflate at will is challenged by the bond markets -- hence the austerity measures already forced on governments that have been reckless. The level of outstanding debt is unsustainable and will become unserviceable and unpayable. The endgame is debt restructuring and debt forgiveness. The longer we avoid that harsh truth, the longer it will go on.

Politicians will do everything to keep the show on the road without tackling the underlying causes, so another round of stimulus must be on the cards.

This may bring some respite -- but as the man says: "If you can hold your head while all about are losing theirs, you don't understand the enormity of the situation."

Paul Sommerville is a financial analyst

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