The economy: reasons to be miserable

June 2, 2009

Laurence CopelandLaurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own. –

Is the crisis over yet?

In the last 3 months, the Dow and the FTSE have each risen by about 25 percent, the Standard & Poor’s 500 by a third. House prices appear to be stabilising in the UK. Stress-tested and backed by seemingly unlimited government funding, the banks are lending again (if only to each other), so that 1-month libor is down to only 0.3 percent.

In the Far East, the Chinese economy may be growing again, and even Japan may have pulled out of its nosedive. The oil price has recovered from its lows.

Is there any reason to doubt that the worst is past?

No reason whatever, except the following (in ascending order of gravity):

1. As unemployment increases, defaults on credit card debt are certain to rise, reducing the banks’ ability and willingness to lend to consumers.

2. Even if the residential property market has stabilised, commercial property prices appear to be in free fall, leading to further contraction in the construction sector, more bad debts and knock-on effects on employment and investment in the broader economy.

3. The consensus view is that bank stress tests, in the U.S. at least, were based on optimistic assumptions about the depth and duration of the real estate slump.

4. In order to spare U.S. and UK taxpayers, the bailout burden has been piled on to the bond markets, which have so far proved willing to finance the massive increase in the national debt of the two countries at a cost of only 3.75 percent on 10-year Government debt in UK and 3.5 percent in U.S., which is remarkable considering that both countries appear to be heading for a debt-to-GDP ratio of 100 percent or more.

However, in addition to the recent threat by S&P to downgrade UK gilts, the spread on credit default swaps is an even clearer warning: it costs 86 b.p. to insure against a British government default, and 44 b.p. for the U.S. (compared to only about 40 b.p. for France, Germany or Japan). Outright default by Britain or the U.S. is, in my view, highly improbable.

By far the most likely outcome in the medium term is inflation, or default by stealth. This is how Britain paid the bill for World War Two and the U.S. for Vietnam. So far, however, the bond markets appear to trust the politicians to come up with a plan to pay off these debts. But they will not wait forever.

At some point, they could well take fright and try to dump UK or U.S. government debt, forcing yields up to cripplingly high levels, with disastrous consequences for the real economy.

5. Who are these bondholders anyway? A significant proportion are institutions or governments of countries which, unlike Britain and the U.S., save rather than consume, and hence have balance of payments surpluses, notably the Gulf States, Japan and, most important, China. How long will their patience last? They are locked into their massive accumulation of dollar assets, unable to exit without realising enormous capital losses. But if they decide to stop throwing good money after bad, the outcome could be a dramatic rise in interest rates and a calamitous fall in the value of the Dollar, a final convulsion in this long devastating crisis.

None of these disasters is inevitable. But if you think the worst is over, ask yourself: why is the price of gold – traditionally seen as a safe haven in times of economic turmoil – rising again?


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Laurence, you forgot to mention the inevitable rise in energy. Crude oil in particular will have a devastating effect on the U.S. economy when it marches back up to the one hundred dollar plus range again. We rely on oil for everything. Fuel, agricultural fertilizer and synthetics prices will all rise sharply. That more than anything else is what changed American consumption habits in 2008. So much for Behavioral Economics.

Posted by Anubis | Report as abusive

One thing i would like to see speculated is the possible impact the rail systems will have upon industry in general. It is common knowledge that pound per gallon train freight is the way to go as it always has been. But that would devastate another industry (trucking). This ying-yang effect is mind blowing & all encompassing. With the latest series of events it seems the country I fought for has turned into the proverbial Gotham city. So what has left America that has gotten us away from the superpower we once were? I suppose technology has made us fat and happy. History is known to repeat itself & the definition of insanity is doing the same thing time & time again expecting different results. I refuse to allow this country to become another Rome. Only history will tell.

Posted by Dave Lawson | Report as abusive

My strategy for avoiding being miserable is to read the bad news in the morning, and the good news in the evening. That way I can go to bed feeling happy.

Posted by Peter H | Report as abusive

But Gold, like other commodities, rises on increased demand – for instance on increased economic activity. What I ask myself is how many economists had predicted the recession and its effects. How many have the credibility to predict the future?

Posted by charlie robertson | Report as abusive

No question about it in my mind – the worst is far from over. Certainly, there continue to be problems that will consume the banking industry (e.g., continued loan defaults), and since this is a “balance sheet” recession, the recovery will be anemic and slow at best (since the deleveraging process is so slow and painful).

In my view, however, the most looming problem by far is inflation – Marc Faber and Peter Schiff, two financial analysts with an excellent track record on prediction of financial trends see at best double-digit inflation (a la 1970s) or at worst, Zimbabwe-style hyperinflation in the USA’s future. Ben Bernanke is in a box – if he raises interest rates and starts selling the Fed’s assets (if he can), he risks sending the economy back into a tailspin. However, if he waits and continues the “quantitative easing” strategy for too long (of which there will be massive pressure on him to do so), the dollar could collapse.

In short, I think we’re heading towards a long period of painful stagflation, if not a hyperinflationary depression. I’m just hoping it’s the former and not the latter. Either way, I’m adding precious metals to my portfolio.

Posted by Geoff Lane | Report as abusive

Most of the points raised by Mr. Laurence can be understood. However what I don’t understand how Sterling is gaining against USD despite all financial challenges that UK is facing.
BofE is utilizing quantitative easing which in theory may bring down the Pound, that is not happening we can see the Pound gaining against most currencies.
What would be the outlook of Sterling in the coming few months? Is it going to stabilize, move up or down?

Posted by George F. Y. | Report as abusive

What do Wall St. Executives, International Bankers, and most Politicians have in common? Educated in the same places (Ivy League) and money.

Who among us does not try and find work and money for our friends? How many people in this country have circles of friends (based on Education, Money level, and Ideology) that “Hang Out” and do things together?

I look at Wall St., Bankers, and Politicians (Businessticians really- Businessmen in Politics) as a “Clique” based on Power, Control, and Money. They form “Businesses” together, rewrite laws to help their buddies make money, and funnel money to their “Home States” and the “Friendly Businesses” there(Murtha).

When the people in office USE Government to satisfy their wants and needs, all while changing laws to help their “Business” friends(Happen to be Campaign Contributors as well) look around this country and you can see what selfish greedy leaders do to any economy and Country.

Posted by C. D. Walker | Report as abusive

Here is an example of what I take from Theodore Roosevelt’s example. osevelt

I have mentioned a train system. Well, it will need concrete, and for concrete you need ruble, and the Mountains of West Virginia have whole valleys and waterways that have been filled with ruble from cutting off whole mountain tops to get to the Coal.

I wouldn’t mind taking money (I love to bully the bullies) from those upper execs to pay for the mess they made of the country. Instead of “Printing Money” we can take from those who have been unkind to us (by there actions) to pay the locals to clean up their Home State.
Create local jobs, put money back into the system, use ruble(hey, its a resource) to create a Train system to benefit as many Americans as possible.

I heard someone mention losing trucking jobs with the introduction of more train use(the ones we have and the one i wish to build). I say not so, we must be smart. Instead of having Truckers pull those Long Hauls, lets make Delivery of Products more Localized. Use large cargo vans that run on Gas, or Alcohol(made by GM?). Those vans and local routes should be a snap for a real Trucker. The older Truckers, those who have it harder changing, we simply phase them out as we expand the trains.

Posted by C. D. Walker | Report as abusive