From: HighPtFarm@aol.com [mailto:HighPtFarm@aol.com] Sent: Friday, March 27, 2009 10:35 PM To: john.swinehart@gmail.com; kbierkor@columbus.rr.com; sballer@lobatek.com Subject: A Special Report
If things feel bad now, how much worse could they get?
In line with our previous risk reports (Heading for the Rocks and Shooting the Rapids), we have identified three macroeconomic scenarios for the evolution of
the crisis that began in the US sub-prime mortgage market and is now
reverberating throughout the world economy.
Scenario 1: Our central forecast (60% probability)
Government stimulus stabilises the global financial system and restores
economic growth in leading developed markets during 2010, albeit at lower
levels than in recent years. This scenario underpins our regular analysis and is
not the subject of this report.
Scenario 2: The main risk scenario (30% probability)
Stimulus fails, leading to continued asset price deflation and sustained
contraction in the leading economies.a depression persisting for some years.
The stubborn decline in global economic activity is punctuated by occasional
rallies that are taken as signs of recovery, but these quickly fade as the
underlying downward trend reasserts itself. The prominent role of governments
in propping up banks and reviving domestic demand leads to strong political
pressure for protectionism, effectively putting the process of globalisation into
reverse.
Scenario 3: The alternative risk scenario (10% probability)
Failing confidence in the dollar leads to its collapse, and the search for
alternative safe-havens proves fruitless.
Economic upheaval sharply raises the risk of social unrest and violent protest. A
Political Instability Index covering 165 countries, developed for this report,
highlights the countries particularly vulnerable to political instability as a result
of economic distress. The results of the index are displayed in map form and in
a ranking table in the centre pages, along with a brief methodology.
The political implications of the economic downturn, informed by the results
of the Social and Political Unrest Index, are discussed at length in the second
half of the report. . . ."
" . . .Deflation and depression in the OECD
As good assets are sold to cover losses on the bad, deflation
sets in and the slump deepens
In our main risk scenario (30% probability), the global economy endures a
multi-year depression characterised by bankruptcies and job losses. In a vicious
cycle of debt deflation, the burden of debt rises in real terms as collateral
declines in value and incomes contract. As bad debts pile up, banks’ balance
sheets are further weakened, resulting in forced asset sales. These drive down
prices further. Like banks and financial institutions, households and companies
are engaged in a process of deleveraging in which they dispose of assets in
order to pay down debt. . . .
". . .Alternative risk scenario: Dollar collapse
What happens when the financial hurricane destroys the
world’s safe-haven currency?
The current financial and economic crisis was caused by decisions that
contributed to the build-up of large economic imbalances.most importantly, in
the US current account. Under our alternative risk scenario, the external
imbalance is corrected through sharp currency movements; the dollar
depreciates to US$2:€1 for a sustained period, overshooting temporarily to an
even weaker level. The depreciation occurs relatively quickly, in a period of less
than a year.
Even under our main scenario, gross US federal government debt rises from
US$9trn (66% of GDP) in fiscal year 2006/07 (October-September) to US$14trn
(104% of GDP) in fiscal 2009/10, including the cost of support measures well
beyond the US$700bn of the Troubled Asset Relief Program. The alternative
scenario sees debt surge higher still, as economic growth remains weak and
financial sector rescue efforts fail.
A successive series of expensive fiscal stimulus packages scares holders of US
treasuries and other assets affected by the US fiscal position. Although the US
avoids default, the country.s sovereign credit rating comes under increasing
pressure, the more so as the administration fails to deal with long-term fiscal
challenges such as Social Security and Medicare. Spooked investors leave the
US for other assets, sinking the dollar on their way out. . . .
". . . Political Instability Index: Vulnerability to social and
political unrest
We define social and political unrest or upheaval as those events or
developments that pose a serious extra-parliamentary or extra-institutional
threat to governments or the existing political order. The events will almost
invariably be accompanied by some violence as well as public disorder. These
need not necessarily succeed in toppling a government or regime. Even
unsuccessful episodes result in turmoil and serious disruption. . . .
". . .Underlying vulnerability indicators are: inequality; state history; corruption;
ethnic fragmentation; trust in institutions; status of minorities; history of
political instability; proclivity to labour unrest; level of social provision; a
country’s neighbourhood; regime type (full democracy, .flawed. democracy,
hybrid or authoritarian); and the interaction of regime type with political
factionalism. [The US ranks 109 out of 165 in terms of most threatened, receiving a score of 5.3 out of 10, i.e., the most threatened.] . . .
". . .Governments under pressure
How sustained economic upheaval could put political
regimes at risk
Popular anger around the world is growing as a result of rising unemployment,
pay cuts and freezes, bail-outs for banks, and falls in house prices and the value
of savings and pension funds. The extent and speed with which the global
crisis has intensified, with much of the global economy slowing dramatically in
the final quarter of 2008, has been a major shock.
The global economic crisis is already having a severe social impact in many
countries, primarily in the form of rising unemployment. Many emerging
markets are especially exposed as the crisis increases the number of people in
poverty and reduces the size of the middle class. As people lose confidence in
the ability of governments to restore stability, protests look increasingly likely. A
spate of incidents in recent months shows that the global economic downturn
is already having political repercussions. This is being seen as a harbinger of
worse to come. There is growing concern about a possible global pandemic of
unrest.
Warnings of dire social unrest are coming with increasing frequency from the
highest sources. One of the most striking and closely argued came on February
12th in testimony before the US Senate by Admiral Dennis C. Blair, the new
director of national intelligence. He declared: .The primary near-term security
concern of the United States is the global economic crisis and its geopolitical
implications. The longer it takes for the recovery to begin, the greater the
likelihood of serious damage to US strategic interests. . . .
". . .The Economist Intelligence Unit believes that the threat of unrest is grave, and
that the risk of complacency far outweighs any risk of exaggerating the dangers. Threat posed by social unrest if real and substantial. . . .
". . .There are at least four sets of factors suggesting that the threat of widespread
political unrest is substantial.
•The depth and nature of the economic crisis Sharp income falls are expected
in many countries in 2009, with all the attendant repercussions, including
increased poverty and unemployment. The sheer depth of the downturn is
important. Clearly, it is the most serious since the 1930s and could yet match
that period. It is global and synchronised as never before. In an integrated
global economy, shrinking demand in the developed world is feeding quickly
through the supply chain, leading to job losses worldwide. Our Political
Instability Index suggests that it is the interplay of acute economic distress
with underlying.previously often dormant.structural vulnerability to
instability that has pushed a large number of countries into the high risk
category.
•A very personalised crisis This is a very specific crisis of capitalism that is
linked to the avoidable near-collapse of the financial system. It is not seen as
a "normal recession", a product of impersonal social forces that are difficult to
identify. Instead, there are identifiable culprits. The ineptitude and greed on
display are fuelling a deep anger, which in certain circumstances could lead to
a popular explosion.
•Underlying anxiety There is a suspicion that things are even worse than
officials are saying, and this may fuel unrest. The anxiety is fed by the
seeming powerlessness of authorities to stem the crisis.
•The contagion factor Just as the economic crisis has proved to be global in
ways not seen before, so local incidents have a potential to spark unrest not only in neighbouring areas but even further afield, especially' in view of the almost instantaneous nature of modern communications. The riots that erupted in the first half of 2008 in response to rising food prices illustrated the power of contagion and speed with which economically related violence can spread. Riots occurred in Cameroon, Egypt, Ethiopia, Haiti, India, Indonesia, Côte d’Ivoire and Senegal. The riots only abated when falling energy costs brought food prices down as well. . . .
". . . So far, only two governments have fallen as a result of the crisis and associatedunrest (in Iceland and Latvia), and it can be argued that this may not even be undesirable.although bringing down governments through extraparliamentary action is hardly consistent with a sound democracy, particularly if accompanied by violence. However, as the economic crisis worsens, some incidents will transform into far more intense and long- lasting events: armed rebellions, military coups, civil conflicts and perhaps even wars between states. . . . " . . . Many of the members of the group seen as being the highest risk in 2009-10
will not surprise. These include countries like Afghanistan, Zimbabwe, Chad,
Sudan and Pakistan, which are in a state of almost permanent conflict or
upheaval. Other members of the group may be less obvious. Of the 27, 13 are
from Sub-Saharan Africa.historically, Sub-Saharan African countries make up
about one-half of the number of instances of serious political instability.
There are six Asian countries, four from Latin America and three from eastern
Europe. There is only one Middle Eastern country in the very high risk group
(Iraq). This is only surprising until one remembers that authoritarian states,
which proliferate in the Middle East, are historically even less at risk of
instability than fully democratic states (as noted, the intermediate regimes are
most at risk). Among developed states, a fairly large number are rated as having
a moderate risk of unrest, whereas until recently almost all would have been
rated as low risk. The US is not considered free of risk. It has significant
problems with minorities and social provision is low relative to levels of
development. . . .
". . .Beyond unrest
Social discontent is far from being the only source of risk to governments
Beyond the immediate risks of political instability, the current crisis also points
to other, in part related, forms of political risk. Three stand out:
•
threats to democracy over and above outbreaks of political unrest;
• a negative impact on economic policies and longer-term potential growth
rates.in particular, there is a risk of a descent into protectionism;
• a host of geopolitical risks, including ultimately the outbreak of large-scale
international conflicts. . . .
". . . Governments in both the developed and developing world are likely to
strengthen non-tariff barriers to trade, and to raise retaliatory measures for
trade-distorting measures by other countries. The US government’s bail-out of
General Motors and Chrysler constitutes a subsidy that amounts to a trade
barrier for foreign carmakers. At the same time, the US itself is on the lookout
for trade-rule violations by other countries. Anti-dumping cases have been
rising, and more cases are likely in 2009. There is much room within the WTO
framework to increase protection without overtly violating the agreement. . . .
". . .Wheelbarrow time?
The onset of an economic crisis that exceeds anything in recent memory has sparked
a flurry of interest in historical episodes of extreme economic stress. One that has
attracted more than passing attention is hyperinflation in Weimar Germany in 1923,
when the Reichsbank issued a Mark100trn note and a wheelbarrow of money was
needed to buy a loaf of bread. Savings carefully accumulated over a lifetime’s work
were wiped out, and the debacle contributed to the rise to power of National
Socialism.
Hyperinflation (classically defined as inflation of over 50% a month) is less unusual
than commonly supposed. Argentina, Brazil and Peru (1989-90), Ukraine (1991-94)
and, at present, Zimbabwe are among the recent victims. But since the 1950s the
phenomenon has been limited to developing and transition economies.
So could it happen again in the developed world? Morgan Stanley rated the
possibility high enough in January 2009 to recommend that companies buy
insurance. Concerns have been raised by massive fiscal stimulus measures (such as
the Obama administration’s US$787bn package) and liquidity injections (with the
Bank of England in March following its US counterpart, the Federal Reserve, in
announcing "quantitative easing"). Policymakers might even be tempted to induce
inflation to erode large debt burdens. But hyperinflation, strictly defined, remains
unlikely . . .
". . .Hyperinflation (classically defined as inflation of over 50% a month) is less unusual
than commonly supposed. Argentina, Brazil and Peru (1989-90), Ukraine (1991-94)
and, at present, Zimbabwe are among the recent victims. But since the 1950s the
phenomenon has been limited to developing and transition economies.
So could it happen again in the developed world? Morgan Stanley rated the
possibility high enough in January 2009 to recommend that companies buy
insurance. Concerns have been raised by massive fiscal stimulus measures (such as
the Obama administration’s US$787bn package) and liquidity injections (with the
Bank of England in March following its US counterpart, the Federal Reserve, in
announcing "quantitative easing"). Policymakers might even be tempted to induce
inflation to erode large debt burdens. But hyperinflation, strictly defined, remains
unlikely.
First, the high demand for liquidity that prompted the cash injections is not the result
of higher demand for goods and services. Banks will be using the money to shore up
their own balance sheets rather than reinjecting it into the real economy. And
quantitative easing is designed not to send the money supply into orbit but to stop it
from crashing.in other words, to ward off deflation.
Second, policymakers are still going to be on their guard against renewed
inflationary pressures (at least in developed economies). Hyperinflation occurs
when deliberate attempts to stimulate inflation get out of hand. In Weimar Germany,
the major concern for the government and the big industrial combines was
unemployment, which they feared could lead to a Communist takeover. A cheaper
currency was seen as useful to boost exports and keep people in work.
The costs of excessive inflation are now more clearly understood. Indeed, there is a
widespread feeling that loose monetary policy earlier this decade was an important
cause of the financial bubble that has now burst.
The greater risk, rather than a renewed surge in inflation as a result of the current
massive monetary stimulus, is that the first signs of an upturn prompt an unduly
rapid tightening of monetary policy that chokes off the nascent recovery . . .
" , , , US policy will be the main determinant of which model emerges. However, the
US can no longer be viewed as an unambiguous champion of unfettered
globalisation and associated international political processes. For one thing,
there has been a marked worldwide decline in respect for the US.unlikely to
be reversed simply by the arrival of a new administration in Washington.that
constrains US influence. For another, aside from the impact of domestic politics
in the US, there is also what might be called the .paradox of globalisation.: the
fact that the US benefits from globalisation comparatively less than others, . . .
". . .The greatest danger, dwarfing all other risks, is the possibility of an outbreak of
major inter-state conflict, an all-too-common feature of past episodes of
extreme economic distress. The British historian, Niall Ferguson, has recently
talked of an imminent "age of upheaval". Looking at the causes of 20th century
upheavals, he concludes that just three factors made the location and timing of
large-scale conflict more or less predictable: ethnic disintegration, extreme
economic volatility and the decline of empires. All three are very much present
today. Before such theses are just dismissed as scaremongering, two things
should be remembered: first, very few in the pre-1914 world predicted the
disaster ahead; and second, in our own times very few predicted the depth of
the financial and economic meltdown now afflicting the world."
“History does not entrust the care of freedom to the weak or timid.”~Dwight D. Eisenhower Copyright 2007-2010TALK CITIZEN ™ is a trademark of LobaTek Incorporated