Alasdair Macleod's Outlook for 2013
I have not faced the prospect of a new year with so much trepidation as when I contemplate what is in store for 2013. Systemic risks abound, which of themselves are not the main story, only milestones on the road to final currency destruction, unless governments somehow regain their senses.
To help understand the perils of 2013 I shall give them their background context first before listing them individually. No such list can be exhaustive or temporally sequenced, but all on it have the same root: the long-term accumulation of a burden of unsupportable debt.
This is a story that started with the end of the First World War, and involves a world which replaced laissez-faire with political motivation in economic and monetary affairs, moving away from wealth-creation into wealth-destruction in the cause of the common good. This was what motivated Keynes. In his Concluding Notes to his General Theory he said as much: he looked forward to the "euthanasia of the rentier" (a term for saver he intended to convey disdain), to be replaced by "communal saving by the agency of the state to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce". Monetarists in charge of central banks join Keynes in this objective, acting as the agency by which savings are destroyed and capital is made to be no longer scarce.
I shall not go into business cycle theory, beyond to say that government and central bank manipulation of their economies and fiat monies has succeeded in deferring the bankruptcies and liquidation of accumulated malinvestments, to the point where their cost can no longer be sustained. By 2007/08 the accumulation of debt was too large for distorted, burdened and weakened economies to support. And this is not just a single-country problem, because it has become a problem everywhere. The United States, the United Kingdom and the eurozone countries reached this terminal point together while Japan had been waiting in the wings for them to catch up. These nations alone account for about half global GDP. The banks to which all this debt is owed are financially interconnected and also linked to other banks in countries where the debt bubble is not so acute.
The coincidence of all nations following the same path to destruction is the result of international coordination that has increasingly dominated global politics since the Bretton Woods Conference in 1944. The response to the financial crisis of 2008 was to draw in more participants, leading to the G20 becoming the post-crisis forum for international economic coordination. Never in modern history have we seen so many governments agreeing to make the same mistakes; and it is hard to see, with the underlying inter-connectivity of their banks, how there is room for dissent.
The global banking system for the last five years has struggled with insufficient capital, over-valued collateral, and an underlying tendency for balance sheets to deflate. Their respective governments through their central banks are back-stopping these insolvent institutions by flooding them with both sovereign debt and fiat money, and manipulating credit markets to maintain valuations. Take these distortions away and we see the private sector economy still contracting four years after the credit bubble burst, a fact that is concealed by the expansion of both government spending and fiat money. Otherwise, bank balance sheets would have contracted, wiping out their aggregate capital, in some cases several times over.
Governments do not generally realise they are in the midst of an economic collapse. The manipulation of credit, money and prices has made economic calculation impossible. There is little difference in this respect between the communism of failed states in the past and the regulated and planned economies of today, except perhaps in the degree of state interference. As happened with the Soviet Union, eventually ordinary people, by acting in their individual interests, will bring about the downfall of their governments. It is bound to happen unless governments reverse course.
That is a very brief summary of the global crisis, and being fully committed to Keynesian fallacies it is immensely difficult for governments to turn back. In the longer term, government health and welfare spending is also escalating beyond control. Furthermore attempts to reduce persistent budget deficits through higher taxes on the private sector will only depress economic activity, reducing tax revenues. The majority of economists, the neo-classicists who misunderstand the very basis of their subject, seem unable to grasp the origin of the problem they themselves have helped governments to create.
Systemic risks in 2013
Banks are interconnected through interbank and cross-border loans. They are also linked by counterparty risk in derivatives and by off-balance-sheet hypothecation of collateral. Collateral is always someone else's property used and reused profitably without their involvement and often knowledge. The level of bank capital behind on- and off-balance sheet liabilities is inadequate to cover either hidden losses, systemic contagion or a resumed downturn in the global economy. Hidden losses are those covered up by earlier changes in accounting rules and from malinvestments not yet recognised. Systemic risks include sovereign defaults, significant falls in collateral values, and counterparty failure in derivative markets. And the slump in the private sector, stripped out from national statistics, continues.
The banks have become corrupted institutions continually on the verge of failure. They serve themselves and their governments at the expense of their customers. Nevertheless they will continue to be rescued by central banks through further monetary expansion and by state guarantees irrespective of the cost. This will be particularly dangerous for countries with large bank balance sheets relative to their GDP, such as the UK and Switzerland.
The US economy, as well as facing the immediate fiscal cliff crisis, is caught between the economically destructive effects of increasing taxes, and rapidly escalating health and welfare costs. The economic recovery upon which forecasts of future deficits depend is made more remote by erroneous economic and monetary policies, and there is little appetite to address mandated spending. The outlook is therefore one of deteriorating government finances, and a possible need to raise interest rates sooner than expected to curb the inevitable price-inflation effects of accelerated money-printing.
The eurozone is clearly in a financial and economic crisis. The ECB is prepared to do all that is necessary to stop the problems of Greece being replicated elsewhere, but it is almost certainly too late. The burden of the euro-system on Germany, the Netherlands, Finland and Austria is far too great for them to bear, and we can expect mounting political dissent in this election year for Germany. In 2013 we should see the combined problems of Spain, Italy and France begin to undermine the value of their sovereign debt. Their bonds are over-valued, and owe their status mostly to Basel Committee rules on capital adequacy and on misplaced confidence in the ECB. The eurozone's banking system is under-capitalised and already bankrupt on realistic assumptions.
In Japan the Bank of Japan faces irreconcilable difficulties. With one quadrillion yen of government debt the new government is now forcing the BoJ to finance its continuing deficit by monetary means. Furthermore savers are now dissaving at an accelerating rate, leading to a developing trade deficit. Japan at last appears to be entering the final stage of her economic collapse, which started with the end of her bubble exactly 24 years ago.
The UK faces similar problems to the US, with taxes actually designed to discourage wealth, and she faces intractable welfare and health costs. Her government is politically weak with a coalition that prevents all attempts to move away from social priorities towards economic reality. She is also exposed to a disproportionately large finance and banking sector with high international exposure, particularly to the eurozone, which will be an unsupportable burden on the state if the banking crisis develops further in 2013.
Watch out for developments in the following
Inflation, which will pick up unexpectedly if there is a shift of preference from money to goods, the consequence being accelerating stagflation. Bear in mind that governments usually under-report inflation, and prices in the US, UK and other nations are already increasing at a significantly faster rate than CPI measures suggest.
Interest rates, which may have to rise sooner than expected due to inflationary concerns. This being the case, an implosion of asset prices could begin if markets price in rising interest rates before they happen, destroying the ability of central banks to retain control of prices in credit markets.
A further downturn in the US private sector economy, (excluding government).
Rising bond yields for Spain, Italy or France.
Deterioration in Japan's trade balance and weakness in the yen.
The bursting of bond market bubbles, particularly in the US, UK, Germany, Japan or France.
Crisis meetings by governments and central banks that resolve nothing and only further public understanding of their inadequacies.
Derivative markets, and their exposure to counterparty risk, hypothecation and rehypothecation of collateral.
Silver markets, where there are large short positions held by the bullion banks and so are vulnerable to a vicious bear-squeeze. If this happens a sharp rise in gold prices will also be triggered, and possibly spread to other metals and beyond.
Growing social unrest.
Further clampdowns on personal freedom
Is there a solution?
Yes, but it is unlikely to be taken. All that is required is for enough of the G20 membership to stop destroying wealth, in order to contain near-term global systemic risks. A government that understands this will cut its own spending and obligations, remove taxes from savings and discourage its citizens from relying on state welfare. By removing itself from provision of health and education services, the costs to society will be substantially reduced and they will become focused to provide only what is actually wanted of them. Unnecessary resources will be released to be deployed more effectively elsewhere.
Such a government will learn the value of sound money and its importance for economic calculation, and it will move as a matter of policy towards securing sound money in everything it does. It will understand it has no role in the trinity of consumer, saver and entrepreneur, restricting its role to ensuring that property rights are inviolate. It will dispense with its central bank as a tool for intervening in markets. Interest rates will be set by markets in accordance with users' needs.
And above all it will remove all government regulations, forcing businesses to value and enhance their own reputations, individuals to make their own choices, and savers to decide for themselves how much to save and who to invest it with.
We are one year closer to a renewed banking and financial crisis, the pace of which is quickening, and which can be expected to turn eventually into a fiat currency collapse. These systemic risks increased in 2012, most notably in the eurozone, but also elsewhere. None of the solutions applied anywhere did any good.
On the evidence to date, it has become less likely any Western government can or will take the right steps to avoid an eventual collapse of their currency, so 2013 is more likely to realise systemic failures than 2012