Despite missing the 2007 global crisis completely and despite dismal policy failures, economists’ predictions for 2011 were uniformly optimistic.

“The recovery is expected to proceed at a reasonably modest pace”

was what the CBI predicted in December, 2010, while as always, warning firmly about the one threat they obsess over:

“We now forecast higher inflation in 2011.”

As 2011 fades away, recovery appears remote, and inflation is expected to fall like a stone in January when George Osborne’s misguided VAT rise drops out.

I am no professor of economics; nor do I have a post at the London School of Economics, but in 2009, at a time when everyone was talking up the recovery, I warned, in an interview with The Times, that ‘ the worst of the slump was still to come’.

I was confident of this prediction because New Labour, Liberal and Conservative politicians were building a consensus around austerity – and had not yet tackled the root causes of the crisis.

So, smart Alec (I hear you say) what lies ahead in 2012?

My humble and not very cheering view is that because of the vast unpayable debts of the global private banking sector; because policy makers will not address the private banking crisis; and finally, because politicians wrongheadedly persist with austerity – we can expect things to get a lot worse.

In fact I believe we are spiralling into a prolonged and ghastly depression. This will lead, in time, to dramatically higher levels of unemployment, the loss of savings, home foreclosures, bankruptcies, emigration, suicides, divorce, social unrest and political upheaval – to name but a few of the consequences.

Why do I, and many others, expect a prolonged depression?

Because the world’s globalised private banks, unable to obtain funding, are now in the process of liquidating the vast expansions of debt generated during the boom, money frequently borrowed for purely speculative purposes.

And let us remind ourselves: these debts were generated because politicians and regulators had removed all meaningful constraints on the creation and pricing of debt, and on the global mobility of capital.

Between 1945 and 1971, when politicians imposed restraints on bankers, on credit creation and on capital mobility, the world enjoyed high levels of employment and stability and virtually no financial crises at all. This is why the Bank of England’s recent paper on reform of the international financial system is welcome.

In Britain, private debts make up about 400 per cent of UK GDP – and public debt only about 65 per cent of GDP. (I am guessing that politicians’ blind spot for Britain’s huge private debts is not accidental, but then I may just be a touch cynical.)

It’s the disorderly de-leveraging (‘liquidation’) of those private debts that is the cause of Britain’s double dip, and of global financial instability. The failure of the global investment bank/brokerage MFGlobal and the downgrading of various banks, is the canary in the global financial gold mine.

The problem is not the UK’s or Eurozone’s public debts or budget deficits. They are both simply a consequence of private sector failure.  Because of this wrong-headed analysis, politicians in all three political parties have been driven down the dead-end of austerity.

Of course, some would prefer not to drive so fast, but they’re all heading in the same direction: towards unnecessary cuts in public spending at a time when private spending is collapsing.

This growing political consensus fills me with foreboding.

Are our politicians planning a government of national unity? A government dominated by ‘technocrats’? Those very architects and defenders of the ‘light touch’ regulatory system that now threatens systemic economic failure?  Will these technocrats impose austerity on Britain’s restless and angry population – regardless?

As the year draws to an end, I simply speculate, and may be wrong. After all, George Osborne’s autumn statement represented a small, but significant u-turn: a belated recognition of the scale of the crisis and an attempt at fiscal stimulus to finance infrastructure investment.

But while his mini u-turn is welcome, we need to remind ourselves that fiscal policy can take malevolent as well as benevolent forms. Hitler embarked on an ambitious ‘corporate’ fiscal policy in the 1930s, aimed at enriching big business, especially the military industrial complex.

(For more, read Guerin’s classic “Fascism and Big Business” first published in 1936.) By contrast, Roosevelt’s fiscal policies were aimed at creating full employment; at funding the arts and literature; at protecting the environment.

So we should remain on our guard when it comes to assessing Treasury ‘u-turns’. Whatever the true nature of the coalition government’s fiscal stimulus, at least it recognises that something must be done. The Labour Party will look pretty foolish if it too does not change tack, and instead keeps on backing public spending cuts – but at a slower pace.

The situation is currently most acute in the Eurozone, where the consequences of private economic failure are reflected in rising sovereign debt. These debts cannot be managed in an orderly way, because of the monetary framework and statutes of the Eurozone.

This system prevents a publicly owned, taxpayer-backed institution, the European Central Bank (ECB) from supporting and lending to sovereign governments. Instead that bank is mandated to lend and support – at almost any cost – the private banking system.

The obverse of that policy is that sovereign governments, like Italy and Greece, are obliged by statute to turn to private banks or the private capital markets for financing.

Unlike Britain, they cannot turn to the central bank for ‘quantitative easing’ and other helpful funding injections. (I leave readers to guess which lobbies may have been behind the drafting of these statutes, enshrined now in the Lisbon Treaty.)

However, while the Eurozone is a depressing mess, we must be careful not to wrongly analyse the crisis. European politicians, like those in the UK, are wrongheaded about causes, and therefore solutions. But they are not the root of the problem, of that we must be clear.

The crisis that will come to a head in 2012 is not a European crisis. It is a global financial crisis.

In that sense the Eurozone is a side-show.

We, and many others, expect the banks of all the major OECD economies to collapse over the next few months. This will drag the UK, Eurozone and US down.  In other words, and to be absolutely clear:the Eurozone and the world will be dragged down by the banks, not vice versa.

Politicians, advised by deranged and culpable economists, will hasten, and intensify this global private banking collapse by accelerating austerity. It is those policies that will prolong and deepen the global economic crisis.

So prospects are bleak. Unless and until, that is, politicians in the UK and Eurozone get real, and face reality. It is time now to stop blaming the victims – public sector workers, pensioners, single mothers, the frail and vulnerable – for a global financial crisis designed by bankers, technocrats, economists and politicians.

It’s time now to address the solution: first, subordination of the private banking sector to the interests of society; and second, policies for employment. Only jobs can now generate the income needed to revive the economy, to pay down private debts, and to stabilise the global economy. “Look after employment” said Keynes, “and the budget will look after itself.”

So if our politicians want to sleep at night, and reduce the budget deficit, they should do so by investing in the jobs needed to restore prosperity and stability – because the private sector cannot.  Only then will we be able to look forward, hopefully.

First posted on Left Foot Forward > 

Source - Office for National Statistics

I was asked, along with 9 other top economists, to share my ‘graph of 2011′ with BBC Newsnight as part of their review of the economic year. I chose the chart above:

“This is the chart that struck me most forcibly, both for what it tells us about the debts of the private sector, in particular the private finance sector; but also because of what the Treasury chose not to tell us: that the public debt to GDP ratio is tiny compared to private sector debt to GDP ratio.” 

View a slideshow of all the graphs here:

http://www.bbc.co.uk/news/in-pictures-16090055

With thanks to Nomura International Securities and Bloomberg

I have been banging on about how this is a global banking crisis, not a eurozone crisis, for some time now. So I find it poignant to watch European politicians and their advisers in Brussels, piling the pressure on their own shoulders and frantically sweating over a solution to “the eurozone crisis”.

The fact is the eurozone is a side show. This is a global financial crisis, and Graph 1 proves it. It shows the Credit Default Swap (CDS) Spreads on EU and US banks (hat tip to Uldis Zelmenis).

CDS’s are an unregulated form of insurance against default by a borrower. Unregulated because speculators can take out this insurance against assets (e.g. loans) they do not own. That is akin to taking insurance out on your neighbour’s house.

The incentive to burn it down and collect is a powerful one – which is why regulators bar you from doing so. But hey, in the City of London’s shadow banking system, anything goes. The rise in these CDSs, and the ‘spread’ or gap between the price of European and American bank CDSs, tells the whole terrifying story.

Namely, while naive European politicians are focusing the attention of their citizens on an issue that is largely marginal to the crisis – eurozone budget deficits – speculators are betting on something far more calamitous: a collapse of the global financial system.

And American banks are deemed more risky than European banks.

Given this context, it is deeply ironic the British prime minister is in Brussels today to defend the interests of the City of London. Ironic because it is the City’s “loose, lax and unregulated system” – not the US or Europe’s – that has got American banks into trouble, and is likely to precipitate a second, more destructive and prolonged systemic failure of the global financial system.

This failure – which daily grows more imminent – will quickly engulf the eurozone, and eclipse the more trivial issue of budget deficits that has so consumed EU leaders, Labour party politicians, and their flawed, and orthodox economic advisers.

The burning fuse that is likely to ignite this conflagration? A failed global financial derivatives broker, MF Global, run by Jon Corzine, formerly chairman of Goldman Sachs. According to Christopher Elias of Thomson Reuters, MF Global slipped the noose of US regulators to shelter within the ‘loose and lax’ systems run by London’s more obliging Financial Services Authority (FSA).

Now each day brings more evidence of how this lax regulation enabled MF Global to use its own clients’ funds:

“…to finance an enormous $6.2 billion eurozone repo bet… a position more than five times the firm’s book value, or net worth.”

The euphemism for this form of gambling with other peoples’ money is “hyper-hypothecation” – a device by which banks create billions of “liquidity” for their own purposes, much of which has no real asset backing. (I strongly recommend that interested readers study both Elias’s report from Thomson Reuters, and this piece by Tyler Durden for brilliant, if eye-watering analyses of the scam.)

Hypothecation is just another way of ripping off foolish investors to leverage Big Monies – or, to quote Damon Runyon, “Big Potatoes” – for the broker.

As Christopher Elias argues, the really scary bit is this: hypothecation by the shadow banking system may have enabled bankers and brokers to increase:

“…the financial footprint of Eurozone bonds by at least four fold. (If so) then a eurozone sovereign default could be apocalyptic.”

That is why yesterday, in a badly-timed action signifying deep alarm, the ECB cut its benchmark interest rate by a quarter – for the second month in a row – to 1%. But it was the ECB’s second action that betrayed the sense of panic that has engulfed Frankfurt.

Europe’s central bank ‘loosened collateral standards’ for all those shadowy banks borrowing for – amongst other forms of speculation – hypothecation. The ECB is acknowledging that most bank collateral is not real. It is phantom.

Touchingly, the banks supported by the ECB are not European banks. They are global banks and/or financial institutions with branches/subsidiaries in Europe, most of which shelter under the regulatory umbrella of the City of London. Their practices are not unlike those of MF Global; but the bulk of their losses, when they come, will almost certainly be transferred to the taxpayers of Europe.

The tragedy is this: when the global financial system implodes in an ‘apocalyptic’ collapse, both our politicians, central bankers and regulators will once again be guilty of wilful and gross neglect. Corrupted by financial interests; ideologically bound to the ‘light-touch regulation’ of monetarists and other quack-economists, they have (deliberately?) been distracted by a far less serious matter: the debts of sovereigns.

These, compared to the debts of the shadow private banking system, can be considered trivial. Furthermore, the rise in public debts is nothing but the consequence of the debts of the private financial system. Without fixing the broken global banking system, there can be little hope of even the European Court of Justice imposing and enforcing ‘budgetary discipline’.

Which is why today’s EU summitry is so futile.

Greek Prime Minister Lucas Papademos assembles his new cabinet.

Because the crisis remains unexplained, it is unresolved. 

Dear readers. This is a piece I have written with Douglas Coe for PRIME – Policy Research in Macroeconomics. Be warned: it’s rather long, more than 2,000 words. For some reason, the references do not appear within the text…but are inserted at the end of the piece….will seek advice, and ensure this problem is fixed. In the meantime, read on:

“As the world economy fails to recover, and instead threatens to implode we are now witness to political and social developments in Europe that are deeply alarming, even if inevitable. It is important that we understand and prepare for the implications of recent events.

The good news is that both politicians and official policymakers at the OECD and EU are finally forced to recognise the scale of the economic disaster that threatens social and political stability. The bad news is this has not led to any better understanding of the crisis, or to an admission of its causes.

Instead the crisis continues to be narrowly represented as a sovereign debt crisis, and not as a crisis of the private, liberalised banking system. Rather than acknowledge that the rise in sovereign debt is both a result, but also a symptom of a crisis in the private financial sector, EU policy-makers continue to blame public debt as causal. Flawed policies for reducing public debt, that instead increase it, are now a constant theme of public discourse. In the meantime the crisis in the private banking system remains neglected – with the impending threat of bank runs and bankruptcies ignored.

As a result the global financial and economic crisis that began in August 2007 has intensified. Because it remains entirely unexplained it remains unresolved. On 14th November, 2011, in evidence to the German Parliament’s Finance Committee Jens Weidmann, the new president of Germany’s Bundesbank “assigned the blame for the crisis of confidence in the Eurozone to politicians” reported Des Spiegel.

Because of this flawed diagnosis and misplaced focus by influential technocrats and policy-makers, the economic ‘remedies’ applied serve only to prolong and exacerbate the crisis.

And let us be under no illusion about how severely the situation is deteriorating. According to the Economist the number of underemployed 15- to 24-year-olds in the OECD – the richest countries in the world – is higher than at any time since the organisation began collecting data in 1976.

In Spain unemployment stands at 5 million, or 21.5% of the workforce (and this despite the departure back to Latin American of thousands of jobless immigrants.) Amongst young Spaniards unemployment is a staggering 46.2%.

In Ireland, much celebrated as a success story, the jobless rate has tripled to 14.2% since Europe’s worst banking crisis and the subsequent collapse of the property boom in 2008. This despite the fact that emigration is now the highest since the 19th century with an estimated 100 people leaving Irish shores each day.

Greece’s jobless rate hit a record high of 18.4 percent in August this year, when the number of the unemployed grew by almost 50 percent over the year, to 907,953. Young Greeks continue to be the hardest hit, with the jobless rate in the 15-24 category soaring to 43.5 percent, twice its level three years ago.

In the US, in spite of a less vigorous approach to austerity, the official unemployment rate of 9% has more than doubled from its pre-crisis low of 4.4% in 2007. But this statistic does not include workers discouraged from seeking work, or those working part-time when they would prefer full-time work. If the latter are included, then according to the Bureau of Labour Statistics (and quoted on the “Bond Vigilantes website) “11.4m Americans do not have an income, do not pay income tax, and do not contribute to producing goods and services.” Almost 15% of Americans (45.8m) are now on food stamps.

Attention is presently focused on the Eurozone. Its badly-conceived monetary union, modelled on the 1920s gold standard which imposed similar constraints on sovereign governments – has begun to unravel. Simultaneously, sovereign debt crises proliferate. But the latter are again merely symptoms, not cause.

We assert once again: the crisis is not one of sovereign debt. Instead it is one of the underlying bankruptcy of the private, globalised financial system, and the implosion of unpayable debts built up over thirty years by private bankers and other financial institutions.

As a result, globalisation – a liberalised financial system that has favoured the powerful – is imploding. And the blame for its implosion – by both ‘technocrats’ and politicians – is directed not at central bankers, policy makers and private bankers – but at the weak. As richer Eurozone countries blame poor ‘peripheral’ economies, we think of parallels: the Captain of the Titanic clinging to the wreckage of his ship, while blaming drowning victims for its fate?

With this flawed approach, it is now the apparent and terrifying intention of the authorities to enforce the wrong ‘medicine’ – austerity – down the throats of Europe’s victims – and to do so at the expense of democracy.

This process began of course in Greece. If rumours are to be believed, faced by the threat of a military coup Prime Minister Papandreou put his country’s fate in the hands of its people – via a referendum along the lines conducted by the President of Iceland. ‘Markets’ and Western politicians went ballistic. Papandreou was removed and the Orwellian construct of a government of national unity appointed. The government is led by Lucas Papademos, a former ECB central banker who once argued that: “The macroeconomic and microeconomic benefits for Europe and Greece from the introduction of the euro are numerous”. The coalition that Mr Papademos leads “includes four self-declared racists some of whom are neo-Fascists and one a neo-Nazi of some renown” writes Yanis Varoufakis.

As we have repeatedly argued and predicted, particularly in our report “The economic consequences of Mr Osborne” (published in July, 2010) austerity or ‘fiscal consolidation’ does not ‘slash’ the debt, but instead increases it. Austerity does not stimulate economic activity, it depresses it – as is evidenced everywhere it is practiced. The reckless imposition of austerity policies has intensified the financial crisis and may well lead finally to a modern form of fascism, as Gideon Rachman warned recently in the Financial Times.

“Marine Le Pen of the far right National Front will have a big impact on the 2012 presidential election in France, although she is unlikely to win. In the Netherlands the government is now reliant on the votes of the Freedom party led by Geert Wilders, which is running second in the polls. Austria’s far right Freedom party is at level pegging in the polls with the governing People’s party. In Finland the nationalist True Finns are still gaining ground and are easily over 20 per cent in the polls.

“Imagine” wrote Rachman “what the European political landscape would look like if banks started to collapse, people lost their savings and their jobs, and there was another deep recession. At that point voters would be desperate and disillusioned enough to turn to the extremist parties in much larger numbers.”

The idea of a technocrat is meant to re-assure. These individuals, we are led to believe, have mastery over the economic matters that are beyond the skills and intelligence of victims of the private financial crisis – ordinary people and their democratic representatives. By accepting government by ‘technocrats’ we are assured that policies will be applied to stabilise debt markets, avoid further unemployment, bank failures or lost savings. Yet these are the very officials and authorities responsible for the financial liberalization course that triggered the 2007 bank failures, rises in unemployment, and lost savings. These are the blind-sided technocrats that failed to predict the global collapse; that have acted only in the interests of the financial master at the expense of the victim, and that are now installing themselves in the highest political offices of Europe without a mandate from the people.

In reality these technocrats have operated inside the machinery of Haute Finance at every level, both within the private financial sector and the associated governance structures. Now at the highest level they represent the interests of bankers, including Goldman Sachs, the bank notorious for its “Vampire Squid” greed and grip on the minds of senior policy-makers.

Mario Monti, hurriedly appointed a senator for life in the Italian senate so that he could take up his post as Italian Prime Minister in November, 2011, has been European Chairman of the Trilateral Commission, a think-tank founded in 1973 by David Rockefeller. He is also a leading member of the exclusive Bilderberg Group of economists ; and an international adviser to Goldman Sachs and The Coca Cola Company. Mr Monti chaired the Italian Treasury’s committee on the banking and financial system, which set the country’s current disastrous financial policies.

Another powerful ‘technocrat’ is Mario Draghi, head of the European Central Bank (ECB) and a former Goldman Sachs executive. Lucas Papademos, Greek PM is a former vice-president of the ECB and also ran the Central Bank of Greece at a time when the Greek government worked with Goldman Sachs to devise complex derivatives that would disguise the apparent size of its government debt and enable it to qualify to join the euro.”

The idea that these people will serve the greater good of society is a deception of the most dangerous and invidious kind. Dangerous because of the public reaction and backlash likely to result from their flawed diagnosis of the crisis, and their determination to force the wrong austerity ‘medicine’ on innocent victims of the crisis.

With the failure of austerity now entirely apparent, the technocrats will continue to deflect responsibility or blame. Rather than acknowledging a failure of the bankers’ and economists’ diagnosis and strategy, technocrats will continue to blame politicians, pensioners and trades unionists for not implementing the austerity strategy forcefully enough.

In the meantime, arguments are marshalled against those that contest the value of austerity policies. The most current is the idea of inherent ‘structural’ problems. On the 21st November, 2011, the ECB’s Juergen Stark was quoted as saying:

“There is an urgent need for fiscal consolidation but it is more, it is also the structural weaknesses some countries are facing.”

The reference to ‘structural weaknesses’ is to the social welfare systems, reasonable working hours, wages and conditions of EU countries. All these it seems, stand in the way of resolving a private banking crisis of excessive, unpayable debts: a crisis which now threatens to bankrupt banks across the world. In the case of Greece and Italy, the rhetoric aimed at pensioners, the unemployed and the poor is racist and imperialist.

As Lord Skidelsky has reminded us,  in the early 1930s the same orthodoxy driving western austerity policies directed the actions of Germany’s 1931 Bruning government. These policies paved the way for the rise of Nazism. Austerity policies – vigorously opposed by Keynes – were the final straw for a Germany crushed by defeat and the disastrous boom-bust cycle that followed the country’s return to the gold standard between 1924 – 1931. Reparations were easily circumvented by wildly excessive borrowing from financial institutions around the world, in a manner that even Keynes did not anticipate. It was these financial and fiscal policies that brought Hitler to power. He was the technocrats’ choice and was advised every step of the way by Hjalmar Schacht who served as President of the Reichsbank and Minister of Economics until 1937. Schacht was a close friend and confidant of the equivalent of today’s ‘Frankfurt group’: Montagu Norman, then Governor of the Bank of England; and Benjamin Strong, Chairman of the Federal Reserve.

However while this dismal parallel is alarming, there is also a more hopeful parallel.

Perhaps just as instructive to the present day may be the suspension of British democracy in September, 1931 when the National Government replaced the Labour-led coalition of 1929. This Government quietly abandoned austerity, and proceeded slowly to adopt measures promoted by progressive forces – not least Keynes – policies ignored or denied to the earlier Labour government. The National Government freed Britain from the ‘fetters’ of gold; proceeded to expand monetary policy and more quietly to expand fiscal policy.

It is quite possible that the technocrats in the Greek and Italian governments will follow their example and do the same, gradually distancing themselves from failed austerity policies. However, while they must know that the present course is disastrous – and we have already seen ungraceful policy contortions on the part of, for example, the OECD – the ‘technocrats’ do not want to lose face and permit progressive policies by a genuine, democratic opposition – because that would disturb the status quo.

After all, the greatest threat to the established order is that genuinely representative forces take control of their own destiny on the streets of Athens, Milan, New York and London. That would set in motion a restoration of democracy, policies for a prosperous and fair society, and the dismantling of today’s established order.

While we wait for such a restoration, the devil we know must be served at all costs, setting the world on a very dangerous course indeed.

[1] See PM David Cameron’s speech to the CBI: “Getting debt under control is harder than envisaged.” November 21^st 2011. http://www.bbc.co.uk/news/business-15816199.

[1] “Germany’s Central Bank Against the World” – November 15^th  2011.

[1] As above.

^[1] Financial Times, October 28^th  2011: “Spanish Unemployment nears 5m”.

[1] Economist “Left Behind: The harm today’s youth unemployment is doing will be felt for decades, both by those affected and by society at large” September 10^th 2011.

[1] Eurostat: Harmonised unemployment rate by gender – total. http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&language=en&pcode=teilm020&tableSelection=1&plugin=1

[1] Reuters, “Greek unemployment hits record; youth jobless soar” November 10^th 2011.

[1] “Why you shouldn’t just read the headlines on US unemployment” by Anthony Doyle, Bond Vigilantes website, November 3^rd 2011.

[1] Yanis Varoufakis: “The Serpent’s Egg hatchlings in Greece’s postmodern Great Depression” November 18^th 2011. http://yanisvaroufakis.eu/2011/11/18/the-serpents-egg-hatchlings-in-greeces-postmodern-great-depression/

[1] “The economic consequences of Mr Osborne.” Fiscal consolidation. Lessons from a century of macroeconomics.” By Victoria Chick and Ann Pettifor. First published, July, 2010 by PRIME – Policy Research in Macroeconomics. http://www.primeeconomics.org/wp-content/uploads/2011/06/The_Economic_Consequences_of_Mr_Osborne.pdf

[1] Gideon Rachman “Look behind you, Lucas and Mario” Financial Times, November 14^th  2011. http://www.ft.com/cms/s/0/6913807e-0ebb-11e1-b83c-00144feabdc0.html#ixzz1eHcMD000

[1] Bilderberg Meetings: governance. http://bilderbergmeetings.org/governance.html

[1] “What price the new democracy? Goldman Sachs conquers Europe” by Stephen Foley, the Independent, Friday November 18^th 2011.

[1] Mario Monti profile, Wikipedia. http://en.wikipedia.org/wiki/Mario_Monti

[1] “Europe facing a fate worse than debt” by Paul Vallely in the Independent, November 20^th, 2011. “As the eurozone crisis sees elected governments replaced by technocrats, democracy seems a high price to pay for market stability.” http://www.independent.co.uk/opinion/commentators/paul-vallely-europe-is-facing-a-fate-worse-than-debt-6264954.html

[1] Forex News November 21^st 2011. ECB’s Stark Warns of Dampening Effects on Q4 Growth; Calls for Urgent Fiscal Consolidation.

http://www.forexbrokerz.com/news/ecbs-stark-warns-of-dampening-effects-on-q4-growth-calls-for-urgent-fiscal-consolidation

[1] Eight Fallacies in the BBC’s “Keynes vs Hayek Debate”at the LSE, 3^rd August, 2011. By Victoria Chick, Douglas Coe and Ann Pettifor. PRIME. http://www.primeeconomics.org/?p=635

[1] Austerity: OECD economists show clear signs of ‘cold feet’ by Ann Pettifor. June 2^nd 2011.

http://www.primeeconomics.org/?p=534