22 September 2007

Leap 2020

As explained many times since the beginning of 2006 by LEAP/E2020's team of researchers, the main cause to the current systemic crisis is in the United States. This “end of the Western world as we've known it since 1945 ” anticipated by LEAP/E2020 in February 2006, is the collapse in all its dimensions (economic, monetary, financial, diplomatic, intellectual and strategic) of the central pillar of the 20th century world incarnated by the US. It is indeed in this country that is to be found the centre of the financial and banking crisis that has been affecting the whole planet since the middle of last summer. The pillar now lies on quick sands, and this of course implies that the global architecture is altogether subsiding, and then will collapse piece by piece.

In this 17th issue of GEAB, our team of researchers has therefore decided to focus on the analysis of the nature of the ongoing global systemic crisis (an analysis already well advanced for all GEAB subscribers) (1) and to publish an explanation in 1000 words only of the current crisis and its articulation with the systemic crisis altogether. We hope that this explanation, using a simple language, will help each and everyone to understand upcoming events. As indeed, and this is a key point, we now estimate that no ruling centre can stop the ongoing systemic crisis anymore, nor even limit the scope of its global impact (2).

Since 1945, and increasingly since the collapse of the Soviet bloc in 1989, the US economy became the single pillar of the entire international financial and banking system. After the August 15, 1971 severing of the US dollar convertibility to gold (3) (or to any other physical counterpart, thus available in limited quantities), the amount of US dollars in circulation worldwide increased dramatically. The emerging of new centres of industrial, technological and service production throughout the world, combined with weakening human resources training (and therefore productivity competitiveness) in the US, resulted in a dramatic increase of the US debt (public and private). Thanks to the creativity of financial operators, with the more of less naive complicity of the entire banking and financial chain (central banks, quoting agencies, financial media, politicians, economists, etc…), this debt progressively became the US main production.

US Household Debt Service Ratio - Source Contraryinvestor.com
With G.W. Bush and his ideological or business partners in Washington, the production of this type of « value » (debts) increased even more dramatically (4), under the active auspices of the Fed's president of that time, Alan Greenspan (5): public debt, real-estate debts, car debts, credit card debts (6),... in every field debt grew on as the good “produced” in greatest amount by the so-called dominant economy. Meanwhile the entire world kept on buying this new “made in USA” good, western elites in particular being completely fascinated by the incredible creativity of Wall Street and its backyard, the City of London.

For many years though, anyone owning two eyes to see (i.e. neither experts nor policy-makers whose eyes only read reports on reality and press releases) and crossing the United States could observe that, contrary to Europe or Asia, the country was in a process of generalised impoverishment: escheated infrastructures (7), free-falling education, growing poorly-trained immigration, increasing dependence on foreign energy, multiple technological retardation,… This statement inevitably raised a fundamental question: who would pay back, and how, this constantly growing colossal debt?

Debt Outstanding by Sector (1974-2006) – Sources: Federal Reserve / ITulip.com
However, until September 11th, until the catastrophic invasion of Iraq, until Katrina and the partial destruction of New-Orleans, and more recently until the Mississippi bridge collapse, everyone – in line with those « experts » - seemed willing to believe in the figures published by the system itself selling them its « debt » product, figures which of course guaranteed that all was well and the average debtor was solvent.

Then, little by little, with an acceleration starting a year ago, reality – this annoying parameter that often disturbs all equations carefully elaborated by experts and ideologists - invited itself to the financial and banking system. Bubble after bubble (Internet, housing, subprime), the attempts to increase the production of debt continued, with the hope that either the real economy would catch up with the level of the debt produced, or the rest of world would endlessly keep on buying US debts refinanced with new US debts (always more sophisticated, such as those famous CDOs, Collaterized Debt Obligations, invented to share risks while in fact they de facto infected the entire system).

However the bursting of the housing bubble triggered a fatal sequence, as the GEAB anticipated month after month since February 2006, progressively leading to mid-2007 and to banking and financial operators becoming aware that the ultimate debtor of this huge debt-producing plant (the US), i.e. the average US consumer, was either already insolvent or about to be (8), in a context of US recession (9).

From spring 2007 onward (tipping point of the global systemic crisis – see GEAB N°12 - February 20067), these large institutions began to try and evaluate their exposure, without taking the full measure of the crisis because, there again, habits, conformism, made them believe that there would be a « rebound in US economy », that « the fall in housing prices would not last », that « employment would stand firm”, that “corporate investment would respond”, etc… All of us read or heard these elements of wishful thinking presented as serious arguments by the big financial media and central banks themselves.

In the middle of summer 2007, large international banks had to admit it: a large proportion (though unquantifiable, the exact measure of the ongoing crisis being impossible to evaluate) of all those debts would never be paid back. It is very enlightening to observe the evolution of the market of « Commercial Papers », asset-backed (mostly financial ones), used in corporate financing and a key to understand the current banking and financial crisis. As shown on the chart below, it is a pure and simple collapse that started last August.

Asset-backed Commercial Paper Outstanding – through 08/22/2007
In consideration of their upcoming deadlines and unavoidable liabilities, large banks decided to start amassing real liquidities (and no longer pseudo-liquidities, such as most of those financial products sold to millions of savers in the past few years, ultimately US debt-backed) (10) rather than keep on financing operations likely to convey massive losses. In this field, they put an end to their mutual lending of funds, as, each of them being largely involved in US debt backed speculation, they now suspect one another to be more exposed and run the risk to go bankrupt.

And that's what it's all about! And that is the reason why the ECB is literally flooding European banks with liquidities. Jean-Claude Trichet probably remembers the collapse of Crédit Lyonnais (11). The subprime crisis is nothing but a trigger. Indeed the whole of the financial bubble based on US debt is bursting, because the US consumer is battered and the US economy is now in recessflation, as described by LEAP/E2020 in GEAB N°16 (June 2007). Behind those subprime mortgages, all US mortgages, car loans, credit cards… are now facing a dramatic increase in the default rate (the public debt follows the same trend as the US dollar and Treasuries keep on dropping).

In other words, the wisest people in the global banking and financial sphere (which excludes most of today's large international bank leaders) know that in the coming six months some entire sectors of activity and corresponding results will either vanish or experience record-losses.

- Foreign ownership of US debt - Source: US Department of the Treasury / Dollardaze
Given that the real economy is already infected not only in the US but all over the world, the collapse of the British, French and Spanish housing markets is next on this year's agenda, while Asia, China and Japan are about to face the simultaneous collapse of their exports to the US market and of the value of all their UD dollar-denominated assets (US currency, treasury bonds, corporate shares, etc…). The chart above is explicit about which countries will be hit hardest when the US debt bubble bursts, i.e. Japan, China, United Kingdom and countries exporting oil in US dollars.

Concerning future steps, LEAP/E2020 only has two interrogations: how many experts, central bankers, financial journalists, politicians fascinated by America will be able to understand this sequence of events that questions so deeply their vision of the world? And shall they understand soon enough, not wasting time expecting « jolts » and « rebounds » from an America that has not much left to do with mid-20th century' America.

A speed race between reality and theory is now open. All in all, a systemic crisis always boils down to such a race and the winner is always reality. Policy-makers, if they are lucid, can avoid a brutal and frontal collision with facts, thus sparing their populations from big damages. Throughout the planet, the months to come will enable to tell the wheat from the weeds in this matter.

LEAP/E2020 is convinced that the “US Very Great Depression” announced for 2007 is indeed next on History's agenda, and that it will have consequences incommensurable with the 1929 crisis, even though a number of indicators common to both crises started blinking a few months ago, and even though 1929 remains the last possible comparison in modern History (12).


(1) As regards the impact phase of the global systemic crisis, LEAP/E2020 now estimates that the third period of this phase as described in GEAB N°8 (10/15/2006) will in fact be a lot longer than anticipated by our teams at the time, and that it could spread until the beginning of 2009.

(2) The Fed's powerlessness in preventing a US recession, an accelerator of the ongoing crisis, will certainly not modify LEAP/E2020's opinion in this regard. Source: CNNMoney, 09/13/2007

(3) For more information: source Sherbrooke University, Canada.

(4) For an illustrated vision of this increase of US debts, it can be useful to visit this website: US National Debt Clock.

(5) Today Alan Greenspan would like to re-write history and claim that he has nothing to do with the financial rout currently sweeping away his country (source: New York Post, 09/14/2007); yet he was among the fervent promoters of one of the main triggers of today's crisis, i.e. adjustable rate mortgages (source Slate, 02/27/2004).

(6) The US consumer's rush on his credit card in an attempt to maintain his living standard, after he awoke from his dream of eternal mortgages, is about to entail new disappointments for large financial institutions in a few months time. Source: Sioux City Journal / AP, 14/09/2007

(7) For instance, the American Society of Civil Engineers estimated to USD 1,600 billion the investments required to put back into order US infrastructures (roads, harbours, airports, water supply and distribution, dams,…) over 5 years. Decades of collective incompetence have thus become a gigantic bill weighing on the future of each and every US citizen. Source: American Society of Civil Engineers.

(8) The US consumer's insolvency was described un GEAB N°9 (December 2006).

(9) The case of US car market, both collapsing and experiencing late payments on former sales, is eloquent. Source: The Colombus Dispatch, 09/02/2007

(10) Cf. on that matter, LEAP/E2020's advices in GEAB N°17 (September 2007)

(11) Cf. GEAB N°17

(12) Cf. GEAB N°17 on the comparison between 1929 crisis and 2007 crisis.

No comments: