The decisive six months to avoid a global recession: Five strategic advices for central banks, governments and other regulatory authorities
- Excerpt GEAB N°26 ( June 16, 2008) -
If you were a subscriber to the GEAB, you would have read what will follow as early as June 16, 2008:
As underlined in the anticipation we develop in this 26th edition of the Global Europe Anticipation Bulletin (and of previous editions as well), the coming six months are crucial for the next steps of the global systemic crisis. Despite the fact that the next six months will inevitably plunge into the impact phase of the crisis, central banks, governments and other regulatory authorities still have a possibility to curb part of the most negative implications of the current crisis. Nevertheless, according to our researchers, it is a case of emergency; indeed, if the pre-emptive actions are not initiated by the end of 2009, after that they will no longer enable to reduce the depth of the world’s plunge into the systemic crisis, therefore contributing to extend the length, scope and impact of the crisis. For instance, they will no longer be able to moderate the collective panic overwhelming financial, economic and social players when they are faced, by the end of 2009, to what will be understood as complete impotence on the part of the authorities in curbing the crisis. Global leaders’ capital of confidence is now almost entirely squandered. It is urgent to rebuild it by means of readable and wide-ranging actions likely to impact on both macro- and micro economic levels, otherwise the worst scenario – i.e. the collapse of the global financial system - will become the most certain option. LEAP/E2020 here wishes to highlight five types of actions which appear necessary (and probably sufficient) in order to limit the length and scope of the global systemic crisis, and to rebuild this « capital of confidence » of banks, governments and other policy-making institutions.
These five strategic advices apply to all great regions of the world, even if they should be modulated according to the region. Four of them are true global replies to a global crisis; the fifth is not exactly an advice but more a summary of reactions major world political and economic entities should undertake in case the four previous measures have not be implemented. An « everyman for himself » rule would in this case prevail, as any chance to find collective means to cross over the collapse of the system inherited from 1945 will be out of reach - implying for the United States in particular a formidable aggravation of the outcome.
A. Two measures must be implemented urgently as early as this summer 2008
1. Raising interest rates before the end of 2008 in order to curb soaring «globalflation”
2. Enforcing a transparency plan on CDS and other OTCs
B. Two measures must be launched in the second semester of 2008
3. Launching a political plan of global recovery of 5,000-billion euro over five years of infrastructure construction projects financed by public loan
4. Creating a currency basket to determine the price of energy (oil in particular)
C. A general stampede in case the two first measures are not implemented by the end of summer 2008
5. Emergency rescue of each region that can be rescued when the global financial system collapses
A. Two measures must be implemented urgently as early as this summer 2008
1. Raising interest rates before the end of 2008 in order to curb soaring «globalflation”
If, by the end of 2008 the economic previsions concerning global inflation have not be domesticated, « globalflation » will accelerate in a way that no central bank will no longer be able to handle. In some regions of the world (United States, EU periphery, Asia…), globalflation will combine with the unfolding recession giving birth to a « globalrecessflation », or in other words a major socio-economic depression worldwide with an inflationary trend. For psychological reasons, the role of central banks is key in breaking such inflationary trends, but they need (like in the case of the other measures) the collaboration of political leaders to act efficiently and avoid stimulating inflation.
Today, such a policy can only be organised around the European Central bank (ECB), which has unquestionably (and unintentionally) become the most powerful central bank in the world since the US Federal Reserve is caught between the hammer of the dollar collapse and the anvil of US economic recession. Today’s US authorities’ (Fed included) attempts to save the dollar indicate that the impulse must come from outside. Indeed, fears that China, Japan and oil-exporting countries drop the dollar urge Washington to make announcements about a reversal of the interest-rate policy conducted since last summer. But the pressure thus exerted is still insufficient to counterbalance the domestic oppositions (announcements remain mere declarations of intention). At the instigation of the ECB, the other major central banks (namely Asian ones), and the political leaders of the corresponding countries, must urge their US counterparts to reverse their interest-rate policy and break inflationary previsions (1). In doing so, they will do great service to the Americans, avoiding them to be confronted, all alone, to the collapse of the dollar a few months later and to the resulting surge in the US interest-rates up to two-digit figures in order to rescue what it will be possible to rescue of their currency and credit.
If this collective measure, on a global scale, is not implemented by the end of summer 2008, then each region, apart from the United States, will have to introduce as soon as possible the emergency measures described to the fifth bullet point.
2. Enforcing a transparency plan on CDS and other OTCs
At the end of 2008, in case the unfolding crisis of the CDS (Credit Default Swaps) and other OTC (Over-The-Counter securities) is not channelled, the subprime crisis will appear as a mere « trigger-device ». Indeed, as explained by LEAP/E2020 in previous issues of the GEAB, the amount of money concerned by these CDS – USD 45,000-billion - must be compared to the meagre USD 1,000-billion worth of US subprime mortgage loans (2007 estimation). Besides, far from being concentrated in the US mostly, CDSs are literally scattered all over the global financial system, directly affecting hundreds of thousands of counterparties, i.e. companies from all over the world. It is clear that the CDS crisis expected to surge in the next semester will be far more important than we experienced last summer 2007. By the way, it was as much for the sake of saving JP Morgan Chase from a complete CDS rout in case Bear Stearns failed than for the sake of saving Bear Stearns that the Fed imposed the second’s bailout by the first (2). It is therefore vital that the global financial system supervises as soon as possible the unfolding process of CDS burst, before it becomes too obvious, entailing bankruptcies among large financial institutions and a correlated panic worldwide. Contrary to the first stage of the crisis (the subprime crisis), we are now entering a phase when banks could become “too big to be saved” instead of “too big not to be saved”.
The inverted pyramid of global liquidity - Sources: Bank of International Settlements / Independent Strategy
In order to channel the derivative product crisis, it is urgent to enforce four simple rules:
a. compel financial institutions to identify clearly their exposure on derivative products, and make it public every three months
b. ban, in the next two three years, any possibility to securitize mortgage loans worth more than 50% of the purchase price
c. empower internal and external control organisations in the field of derivative products and risk assessment (concerning risk assessment, it is important to base these studies upon long-term series instead of just a few years (3))
d. train leaders and managers to anticipation processes and the management of unexpected risks.
In case this collective measure, on a global scale and in particular in the United States, is not implemented by the end of this summer 2008, then each region, apart from the US, will have to set up as quickly as possible the emergency measures described in the fifth bullet point.
B. Two measures must be launched in the second semester of 2008
3. Launching a political plan of global recovery of 5,000-billion euro over five years of infrastructure construction projects financed by public loan
The now well-established tendency to global recession must be fought against. The US are already in recession; the periphery of the EU is entering into recession; and Asia will soon be thrust into recession before the end of 2008. Latin America and Africa will not avoid being dragged into it as well, or at least to experience a stagnation. However, each of these regions have tremendous needs in collective infrastructures, while other parts of the world (oil-producing countries namely) have no idea what to do with their financial reserves. The whole world is about to stop financing US deficits. The process must be organised and alternative options must be found, otherwise, there again, the global financial and economic system will burst into chaos.
The European Union needs vast trans-European networks of infrastructures to improve the organisation of its territory and service better its 500 million citizens, as well as the connection with its Russian, Turkish and Maghreb neighbours. These projects have already been designed and are in need of funds for an estimated EUR 379-billion (4).
The United States have been suffering from chronic under-investment in infrastructure for more than 30 years. There again the needs are identified and the money only is missing, i.e. USD 1,600 billion over five years according to the American Society of Civil Engineers Moreover, the United States, more than any other country, must get out quickly of the situation of energy inefficiency where they are trapped, and that will require huge collective investments.
Asia countries, China in the first place, suffer from a severe lack of modern infrastructures, with needs easily identifiable but money missing.
Latin America to is suffering from the same problems and has undertaken with USAN (Union of South American Nations, launched in May 2008) to initiate vast programmes of infrastructure construction on a continental scale (500 projects worth USD 68-billion) (5).
Africa too is in great need of investments in this field.
Meanwhile, oil producing countries, the sovereign funds, do not know where to invest their huge reserves in foreign currencies because sovereign funds no longer rely on US dollars, T-Bonds, Wall Street and the City, or any of the financial investments which used to recycle their petrodollars. If they do not find their way to the real economy, these enormous amounts of money will simply end up fueling the “globalflation”.
Central bankers, governments and international organisations must therefore, before the end of the year 2008, prepare for the launching of a vast global programme of infrastructure construction, including of course the improvement of energy efficiency, financed by a public loan in currencies on the rise (Euros, Yuans, yens) and secured on a global scale by the international organisations and the main governments. In the case of the United States, who are financially battered, this plan could take the form of a loan secured by the Europeans and the Asians until the country has finished its « Very Great Depression », some sort of a contra-Marshall Plan so to speak.
Without a similar initiative conducted on a world scale, the global economic slowdown will turn into a global recession in 2009; and inflation will continue to surge.
Trans-European Transport Network - Source: European Commission
4. Creating a currency basket to determine the price of energy (oil in particular)
The time of the Dollar as the unique currency for oil transactions, is already over. As anticipated by our team at the beginning of 2006, from Russia to Iran, Venezuela, and soon the Gulf’s petromonarchies, all oil producing countries are speeding up the pace of diversification out of the dollar for their transactions. The question is no longer whether “the US Dollar will lose its status of single currency for oil transactions”, but whether “this evolution will happen chaotically”, as it is case now, or “organisedly”. According to LEAP/E2020, the answer is clear: the evolution must be organised because current chaotic developments are partly responsible for the sudden hikes in energy prices contributing to the general instability of our planet. It is just as obvious for our researchers that everything must be done to avoid the Euro from being substituted to the US Dollar. Two reasons to this statement:
. on the one hand, being energy’s sole exchange currency is a curse on the long-run, as proved by the United States today, because it carries a country along the way of facility and inadaptability to changes of reality, thus creating the conditions for severe crises to happen in the future for the country and its partners.
. on the other hand, for oil-producers themselves, this apparent simplicity conveys medium-to-long term problems of over-dependence to one country and one economy alone.
Therefore it is in the interest of neither the Europeans nor oil-exporting countries to turn the Euro into the heir of the Dollar.
On the contrary, it seems to our team that it is in everyone’s most obvious interest to base the price of energy, oil in particular, on a basket of currencies reflecting at best the reality of the global economy and energy market. This basket of currencies could consist of currencies representing the main economies of the planet (Euro, Dollar, Yen, Yuan, Real...), and of the main energy producers (Rouble, future Gulf States common currency… ), allowing a balancing process every ten years.
According to LEAP/E2020, if such an initiative is not planned by the beginning of 2009, interweaving of Dollar and oil-price crises will entail a serious aggravation of the global economic crisis, as well as a severe increase in the risk that an armed conflict grows over energy stakes.
Current account surpluses of oil exporting countries - Source: OECD
C. A general stampede in case the two first measures are not implemented by the end of summer 2008
5. Emergency rescue of each region that can be rescued when the global financial system collapses
LEAP/E2020 is convinced that if the first two measures are not implemented by the end of summer 2008, the entire planet will plunge at the heart of the global systemic crisis in the worst possible conditions. In this case, as a result of a paradoxical game of simultaneous causes and consequences, the global financial system will collapse because each major player of this system will undertake to save himself alone, at the expense of the system altogether. Today already, our team noticed that central banks act less and less together, while large dollar reserve holders observe one another to make sure they are not last to get out of the dollar-trap. If the urgent measures we advise are not implemented before the end of this summer, it will be a general stampede on the part of both public and private operators. So to speak, Summer 2008 is the last opportunity to handle organisedly the collapse of the system we inherited from post-1945.
In this case, the European Union, and Euroland in the first place, will take the necessary moves to reduce to the minimum its exposure to the collapse of US real economy and dollar. The United Kingdom, itself dragged down the American crisis, will no longer be able to stop the Europeans from taking these radical measures, i.e. policies decided by the ECB without any consultation of Washington, the substitution of the Euro to the Dollar for European energy purchases (including a quick strengthening of energy ties with Russia), the implementation of privileged processes of monetary and financial cooperation with China and Japan, the reduction of financial operations and flows with the Dollar-zone in order to curb the consequences of the derivative product crisis, and the enforcement of constraining rules regarding the market of financial derivative products.
Asian countries, which have already began their economic, commercial and financial refocusing on their own region, will contribute to spur this type of evolution as they will suddenly break free from the US Dollar, Treasury bonds and other Dollar-denominated assets.
Gulf countries will give up their Dollar-peg by the end of 2008, contributing in their turn to accelerate the US currency plunge and to increase the US trade deficit (as a result of a subsequent rise of oil-prices in Dollar).
Oil trade flows - Source: British Petroleum, 2007
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Notes:
(1) The LEAP/E2020 team is now convinced that it is also necessary to harness in a sustainable manner the risks of inflation, and that central banks must stop letting money supplies explode. But, in the short term, the most important thing is to send a clear signal likely to impact on the psychology of economic players. Interest rates are the most likely to convey this type of message. Action on money supplies must be conducted in the background.
(2) Given that JP Morgan Chase is the world’s largest CDS operator (with USD 8,000-billion of notional exposure), a failing of Bear Stearns (the world’s second largest CDS operator (with USD 2,700-billion of notional exposure) – would have provoked a formidable tempest on the CDS market, dragging JP Morgan into bankruptcy as well. Once again when it comes to Wall Street, appearances are for from reflecting reality: what was rescued (temporarily) is not necessarily what they want us to believe. Source: Stockbuzz/Reuters 06/11/2008
(3) We see it clearly today in the US: the evolution on the housing market is similar to the 1920s/1930s.
(4) Source: European Federation for Transport and Environment 04/16/2008
(5) Source: Le Monde 06/12/2008
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