A World at Risk

♦ The pace of global economic growth started to slow down at the beginning of the year and is now close to zero.

♦ The main cause of this slowdown in growth is an almost universal tightening of economic policy. In the developing world, interest rates were raised to stop inflation. In the developed world, government spending was cut in order to reduce the debt. Thus, irrespective of its motives, tightening of monetary or fiscal policy has caused a slowdown around the world.

♦ The immense power of a uniform policy (tightening in this case) can be appreciated by the fast exit from the large recession once all governments around the globe eased policy. But despite the already obvious result of the tightening measures, policy makers are still tightening in the developing world (China, India) and the developed world (U.S., Italy). Therefore, steps in this direction could guarantee a doubledip in the near future.

♦ The US: Total government spending – – including the federal government and the much larger sector of state & local governments – – has been declining steadily from the beginning of the year. This tightening of fiscal policy, with the added effects of the tsunami in Japan and the slowdown in the rest of the world, slowed growth to a pace that historically ended in a recession. The reaction of Congress was a decision to cutback federal spending in the next ten years. Even worse, this was done in a way that made it clear to everybody that the president is weak and most members of Congress are willing to cause any damage to the economy for their political gain. Not surprisingly this horror show in Washington caused a collapse in consumer confidence, producer confidence, economic growth and the stock market, despite the sharp rise in corporate profits. The danger of doubledip has thus increased considerably in the past few weeks.

♦ Europe: In the Eurozone the rate of growth of the economy also slowed to zero for similar reasons. When the attack on the peripheral economies got started the Eurozone forced them to cut spending sharply in return for the IMF’s help. At the same opportunity it also demanded a budget cut from all other members of the Eurozone, immediately and in coming years. England too joined this move. Lately the bonds of Spain that is already in a recession and Italy that has one of the highest debts/GDP ratio in the world, came under attack and prices of these bonds fell so that the yield increased to over 6.25%. This means a tightening of monetary policy as well as fiscal policy because cost of interest on the debt increased. The automatic reaction of policy makers was to declare a further cutback of the budget. And now when even the strong economy of Germany is slowing down it is doubtful if Europe can escape a doubledip.

♦ China: In many of the developing economies and especially in China and India interest rates were increased and other monetary measures were implemented in order to cool off the economies that suffered from overheating. In China growth of the industrial sector has already stopped while the services sector is still growing but at a slower pace. It appears that policy makers in China still haven’t grasped the relative size of the Chinese economy and the importance of growth there to the rest of the world and vice versa. Therefore it is reasonable to assume that tightening of monetary policy will finally prove to be overdone, as was the case with the easing policy in the big recession.

♦ Japan: In Japan as in Japan. The economy recovered quickly at, least partially, from the impact of the tsunami, but lately it has stopped growing. The big budgets that were promised for the rehabilitation of the areas impacted by the tsunami haven’t been spent yet, but policy makers are already talking about budget cuts and tax increases in order to reduce the deficit.

♦ The banking system: In the large recession the banking system failed in many parts of the world. In the US government was forced to inject capital to several banks and even now banks are still forced to write off loans that were made before the recession, especially mortgages. Their share prices are still about a third of what they were on average before the recession. In Europe too banks were impacted the same way but losses are now increasing on bonds of their governments and other governments in the Eurozone. In China too the banking system is unstable mainly because of off budget loans, loans to foreign entities and to government owned companies, mainly those owned by regional governments. Although the large banks have allocated meaningful reserves to cover such losses it is doubtful if those will suffice in case of recession.

♦ Money & exchange rates: The dollar fell in recent months to new all times lows. This is a result – – maybe intentional – – of massive printing of dollars by the Fed in QE2 and recently of the “horror show” in Washington. The dollar is recently getting some support mainly due to the fact that there is no alternative. The Euro of course is not more stable than the dollar. Scared investors have been moving their money into non-reserve currencies such as the Japanese Yen or the Swiss Franc, or into gold. But all of these have already made sharp new highs so that the risk is high in case the world economy recovers. The gravest risk to the world economy is therefore loss of confidence in fiat money in general, and in such a case the Swiss franc does not provide any protection.

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