Risk of Global Financial Freeze-up Rising

August Forecast & Review
November 15, 2013

If you thought it couldn’t happen again, get ready: A new global finan­cial freeze-up could be straight ahead.

It’s too bad that eco­nomics, trade, finance, etc., are such boring topics to most people. Well, they actu­ally are boring because they are hard to under­stand, fraught with erro­neous data, and dif­fi­cult to relate to per­sonal circumstances.

By neces­sity, most Amer­i­cans are con­cerned with their own crit­ical prob­lems, like paying the mort­gage, keeping their job and holding their fam­i­lies together. That’s under­stand­able. In spite of the rosy spin on eco­nomic data, the middle class con­tinues to get squashed.

In Jan­uary 2013, 23,087,866 house­holds received food stamps. That’s 889,154 more house­holds than Jan­uary 2012. Given that there are some 115,310,000 house­holds in the U.S., it means that a full 20 per­cent of America cannot ade­quately feed itself.

The above chart shows the Labor Force Par­tic­i­pa­tion Rate (LFPR) since 2000, when the baby-boomer demo­graphic dynamic kicked in. The red line is simply the demo­graphic ele­ment, while the blue line is the actual par­tic­i­pa­tion rate. Since 2000, the actual rate has declined from 67.3 per­cent to 63.3 and since the reces­sion, has sig­nif­i­cantly plunged below the “norm.” The LFTR has fallen back to a level not seen since 1980.

What­ever the reason might be for someone who leaves the work­force (retire­ment, gave up looking, dis­ability) the fact is that since the reces­sion, there has been no real employ­ment recovery, and things con­tinue to get worse, not better.

Not unex­pect­edly, the increase in food stamp recip­i­ents just about matches employ­ment dropouts. If this is the case, then there are a mul­ti­tude of other sta­tis­tics that would follow along: Med­ical pay­ments, unem­ploy­ment, wel­fare pay­ments, etc.

What­ever fragile uptick in eco­nomic activity that might have occurred in the last 24 months, it hasn’t been been enough to reverse the dete­ri­o­ra­tion of the middle class and the swelling of those on poverty roles.

America is not iso­lated in this expe­ri­ence. Europe, China, Aus­tralia, India, Brazil, Japan, etc., are gen­er­ally worse off than we are. Ambrose Evans-Pritchard writes in The Tele­graph (UK):

The closely-watched ISM index of US fac­to­ries tum­bled through the “boom-bust line” of 50 to 49, far below expec­ta­tions. It is the lowest since the depths of the crisis in mid-2009 and a clear sign that US budget cuts are starting to squeeze the economy. New orders plunged 3.5 to 48.8 on weak for­eign demand and reduced fed­eral contracts.

The news came hours after HSBC said its index for China also fell below 50, a major inflexion point for the world’s indus­trial workshop.

“This is not a good moment for the world economy,” said David Bloom, cur­rency chief at HSBC. “The man­u­fac­turing indices came in weaker than expected in China, Korea, India and Russia, and then we got America’s ISM.

“We thought we had a clear pic­ture that the US was recov­ering, Japan was printing money and were we’re back to happy days, and now sud­denly a huge spanner [wrench] has been thrown in the works.”

On June 2, Bloomberg reported that “Global Inter­bank Lending Falls to Record Low, BIS Reports.” The fra­ternal global banking com­mu­nity is har­boring a mutual dis­trust as they wonder who will implode and leave them with huge losses. It’s get­ting pro­gres­sively worse as cur­rency and interest rate wars heat up. The liq­uidity crisis of 2007 – 2008 was caused by the same type of dis­trust, when banks refused to lend to each other.

Liq­uidity in the global finan­cial system is like oil to a car engine: If it drains out, the engine will freeze up and burn. With eco­nomic malaise infecting the entire global economy, the entire engine of the global economy is at risk of seizing up, which could push the entire system into deep reces­sion or even depression.

Adding to the strain is the sharp rise in interest rates on a global basis, and espe­cially in the U.S. The Fed’s policy of lower interest rates is being tor­pe­doed by market forces, putting it at risk for huge port­folio losses. Why? because all of its Quan­ti­ta­tive Easing pro­gram involves pur­chasing and holding Trea­sury bonds, bills, notes and mortgage-backed secu­ri­ties, in return for which the Trea­sury received cash. When rates go up, the value of bonds declines. As of June 5, 2013, the Fed’s com­bined bal­ance sheet was valued at $3.43 trillion.

Here’s the dilemma: The Fed is trapped. If it were to stop pur­chasing addi­tional Trea­sury oblig­a­tions, then QE would be offi­cially over and the mar­kets would crash. If it con­tinues its pur­chasing pro­gram and swells its bal­ance sheet, it is guar­an­teeing itself even more future losses. If it were to sell any por­tion of its port­folio, it would suck liq­uidity (cash) out of the banking system and cause the mar­kets to crash even harder.

The global banks are in a sim­ilar dilemma since they are also hold huge amounts of gov­ern­ment debt that will decline in value as rates rise. Banks have ignored this risk since the last finan­cial crisis of 2007 – 2008, but it will bite them hard this time around. If major banks start dumping their bonds into the open market, it will risk causing a panic sell-off with other bond owners.

Those policy-makers who think that we will “grow our way out” of this will soon come face to face with the hard data of reces­sion – there isn’t going to be any growth! To the con­trary, the global economy is con­tracting. Any fur­ther decrease in liq­uidity, for what­ever reason, may well cause another “Lehman Brothers moment” where the whole finan­cial system simply freezes up.