Interview granted to Nova Makedonija, October 2014

Q. The Eurozone have problems with recovery after Germany and France, two biggest European economies showed decline of GDP in the last quarter. Do you think this is the beginning of new economic crisis in Europe?  

A. 3 years ago, I warned of a second round of a European crisis (http://digitaljournal.com/blog/13909). Pundits have hitherto ignored the greatest threat: Germany. With its economy stagnant (1.5% projected GDP growth this year, 4% fall in industrial output in August), Germany has assumed hundreds of billions of euros in new commitments to the faltering euro project. This time around the country cannot extricate itself via an increase in exports: it is in the same predicament as China and Japan with exports slowing across the board. Germany is teetering on a the brink of a mega recession. 

And there is very little it can do about it:  As labour-intensive and globalized industries increasingly adopted information- and automation-driven manufacturing, outsourcing and offshoring, the anemic recovery that attended the 2008-9 conflagration in the industrialized West was rendered jobless. Corporations sit on hoarded cash piles, driven by enhanced profitability and productivity even as workers languish in unemployment lines. Globalized labor and skills markets coupled with technological substitution for human employment dented consumption and this, in turn, adversely affected investments. These classical twin engines of every recovery since the Second World War have thus been somewhat decommissioned. Bouts of fiscal and monetary profligacy failed to resuscitate moribund financial transmission mechanisms.

Dependent heavily on imported energy and exported goods, Europe's economies face a marked slowdown as the region's single currency, the euro, appreciated strongly against all major currencies; as China, India, and other low-wage Asian countries became important exporters; as the price of energy products and oil skyrocketed; and as real estate bubbles burst in countries like Spain and Ireland. Additionally, European banks are heavily leveraged and indebted - far more than their counterparts across the Atlantic. Governments throughout the continent were forced to bail out one ailing institution after another, taxing further their limited counter-cyclical resources.

Denied an autonomous monetary policy by the introduction of the euro and unable to increase taxes, several countries became insolvent and had to be bailed out by Germany and the IMF (=the USA.) This unilateral transfer of conditional funds completed the economic colonization of Europe by Germany, a process which started in the 1870s. Southern Europe is now the hinterland of Germany, its export market, and source of cheap labor. The only power that can challenge Germany in this geopolitical space is Turkey. Hence the reluctance to welcome Turkey to the EU.

Q. What about the situation in Asia? The Chinese banks are on the edge of bankruptcy? Does this mean that there is a possibility of new global crisis?

1. Huge costs are imposed on the developed economies by the global geopolitical realignment following the Cold War and its manifestations - ubiquitous instability, ethnic and national tensions, and terrorism. Military budgets soar and the private sector is crowded out of the credit markets.

2. The ageing of the population in the West portends a crisis of mammoth proportions in the pension and social security systems. The shrinking of the productive age group is not fully compensated for by immigration.

3. The decline of Western science and technology requires the importation of brainpower from other countries. This process - of net brain absorption - is about to reverse and become net brain drain as American scientists flee restrictions in the free flow of scientific information and religious constraints on research (e.g., on stem cell studies).

4. The rise in religious sentiment, the "esoteric sciences", and sheer superstitions carries an economic price tag. As economic decisions - for instance: the allocation of funding for research and the arts, foreign aid, the workings of the Internet - become less rational the allocation of scarce economic resources is rendered more wasteful.

5. The shift from productive economic activities to speculative and derivative pursuits (i.e., trading in financial instruments) transformed the West's into a "paper economy", both literally and figuratively. Consequently, as it increasingly opens up to international trade, it imports more than it exports (generating unsustainable trade deficits). The resultant excess capacity (slack) prevents rapid and energetic recoveries from slumps and recessions. The banking system is severely undercapitalized and unstable.

6. Western (American and European) fiscal and personal profligacy buried the United States and its denizens under a mountain of debt. America has a monopoly on printing US dollars and these have become its main export. A global shift in the composition of international reserves (e.g., the emergence of the euro as a reserve currency) threatens America's ability to erode its debt through inflation. The increasing ubiquity and intrusiveness of government - both Federal and in the various states - adds to the economy's underlying inefficiency.

7. In the United States, several investment banks were brought down by hyper-leveraged investments in ill-understood derivatives. As stock exchanges plummeted, the resulting devastation and wealth destruction spilled over into the real economy and caused a recession which was mild by historical standards. Both the corporate sector and the financial industry have largely recovered and even amassed record profits. The American middle-class has paid the price in stagnating wages, rising taxes, and plummeting home equity. But, despite a rollback of personal credits, consumption has not been adversely affected owing to stable prices and cheap imports. The net result of the panic: a massive transfer of wealth from the middle-class to a tiny elite and unprecedented income inequality. The USA has completed its transition from populist democracy to populist oligarchy.

8. To finance enormous bailout packages for the financial sector (and the auto and mining industries) as well as fiscal stimulus plans, governments had to issue trillions of US dollars in new bonds. Consequently, the prices of bonds are bound to come under pressure from the supply side. 

 

But the demand side is likely to drive the next global financial crisis: the crash of the bond markets. 

 

As the Fed takes effective US dollar interest rates and the ECB takes nominal euro interest rates below 0%, buyers are likely to lose interest in government bonds and move to other high-quality, safe haven assets. Risk-aversion, mitigated by the evident thawing of the credit markets is already causing investors to switch their portfolios from cash and cash-equivalents to more hazardous assets. 

 

Moreover, as countries that hold trillions in government bonds (mainly US treasuries) begin to feel the pinch of the global crisis, they will be forced to liquidate their bondholding in order to finance their needs (China) or as form of political countermeasure (Russia). 

 

In other words, bond prices are poised to crash precipitously. In the last 50 years, bond prices have collapsed by more than 35% at least on three occasions. This time around, though, such a turn of events will be nothing short of cataclysmic: more than ever, governments are relying on functional primary and secondary bond markets for their financing needs. There is no other way to raise the massive amounts of capital needed to salvage the global economy. 

 

9. Five years later, many of the problems and imbalances that gave rise to the Great Recession are still with us and, owing to the might of special interest groups and Wall Street, are unlikely to be effectively tackled. This – coupled with the rampant mismanagement of public finances - virtually guarantee a second leg of this financial crisis in 2014-5. 

 

Here is a partial list: 

 

Synthetic collateralized debt obligations (structures of credit default swaps that yield streams of income identical to payments from pools of profile-specific mortgages) have not been banned or limited to the value of the underlying loans. Thus, leveraged, non-productive “wealth” is still being conjured out of thin air; 

 

Naked short-selling and naked credit default swaps (writing or buying credit default swaps on securities not owned by the seller or buyer) are still allowed; 

 

Brokerage firms and investment banks are still permitted to bet against securities held in their clients’ portfolios (often placed there by the very same “financial experts” and “investment advisors”);

 

 

Profits in the financial system are still siphoned off into huge bonus pools rather than augment balance sheets, capital ratios, and repay the bailout money forked out by taxpayers; 

 

Bank deposits insured by the FDIC are still intermingled with and used in derivatives trading and investments in risky assets, such as equities and corporate bonds;

 

Accounting rules still allow the booking of profits on hedged investments, regardless of counterparty risk (frequently the result of wrong-way risk: when the insurer is as likely to be as damaged by the insurance event as the investor) and systemic or liquidity hazards (market failures); 

 

Compensation in the financial sector is still divorced from long-term performance. This creates moral hazard and agent-principal conflicts.