Is Capitalism doomed? - An excellent albeit dark look at the world economic crisis.

Once again I have come across an excellent piece by Nouriel Roubini who is Chairman of Roubini Global Economics, Professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics. I felt it very important to pass this along to all followers of my blog. My tow cents - it is indeed poignant reminder that unless the powers that be take pragmatic steps to right the post de-leveraging era with appropriately progressive policies we might very well be staring at a 1930s style Depression. I however do not agree that Capitalism is doomed, only it is going through a serious test of its power to bring sustainable prosperity to the majority.





The massive volatility and sharp equity-price correction now hitting global financial markets signal that most advanced economies are on the brink of a double-dip recession. A financial and economic crisis caused by too much private-sector debt and leverage led to a massive re-leveraging of the public sector in order to prevent Great Depression 2.0. But the subsequent recovery has been anaemic and sub-par in most advanced economies given painful deleveraging.
Now a combination of high oil and commodity prices, turmoil in the Middle East, Japan's earthquake and tsunami, eurozone debt crises, and America's fiscal problems (and now its rating downgrade) have led to a massive increase in risk aversion. Economically, the United States, the eurozone, the United Kingdom, and Japan are all idling. Even fast-growing emerging markets (China, emerging Asia, and Latin America), and export-oriented economies that rely on these markets (Germany and resource-rich Australia), are experiencing sharp slowdowns.


Until last year, policymakers could always produce a new rabbit from their hat to reflate asset prices and trigger economic recovery. Fiscal stimulus, near-zero interest rates, two rounds of "quantitative easing", ring-fencing of bad debt, and trillions of dollars in bailouts and liquidity provision for banks and financial institutions: officials tried them all. Now they have run out of rabbits.


Fiscal policy currently is a drag on economic growth in both the eurozone and the UK. Even in the US, state and local governments, and now the federal government, are cutting expenditure and reducing transfer payments. Soon enough, they will be raising taxes.


Another round of bank bailouts is politically unacceptable and economically unfeasible: most governments, especially in Europe, are so distressed that bailouts are unaffordable; indeed, their sovereign risk is actually fuelling concern about the health of Europe's banks, which hold most of the increasingly shaky government paper.


Nor could monetary policy help very much. Quantitative easing is constrained by above-target inflation in the eurozone and UK. The US Federal Reserve will likely start a third round of quantitative easing (QE3), but it will be too little too late. Last year's $600bn QE2 and $1tn in tax cuts and transfers delivered growth of barely three per cent for one quarter. Then growth slumped to below one per cent in the first half of 2011. QE3 will be much smaller, and will do much less to reflate asset prices and restore growth.


Currency depreciation is not a feasible option for all advanced economies: they all need a weaker currency and better trade balance to restore growth, but they all cannot have it at the same time. So relying on exchange rates to influence trade balances is a zero-sum game. Currency wars are thus on the horizon, with Japan and Switzerland engaging in early battles to weaken their exchange rates. Others will soon follow.


Meanwhile, in the eurozone, Italy and Spain are now at risk of losing market access, with financial pressures now mounting on France, too. But Italy and Spain are both too big to fail and too big to be bailed out. For now, the European Central Bank will purchase some of their bonds as a bridge to the eurozone's new European Financial Stabilisation Facility. But, if Italy and Spain lose market access, the EFSF's €440 bn ($627bn) war chest could be depleted by the end of this year or early 2012.


Then, unless the EFSF pot were tripled - a move that Germany would resist - the only option left would become an orderly but coercive restructuring of Italian and Spanish debt, as has happened in Greece. Coercive restructuring of insolvent banks' unsecured debt would be next. So, although the process of deleveraging has barely started, debt reductions will become necessary if countries cannot grow or save or inflate themselves out of their debt problems.


So Karl Marx, it seems, was partly right in arguing that globalisation, financial intermediation run amok, and redistribution of income and wealth from labour to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labour income, increases inequality and reduces final demand.


Recent popular demonstrations, from the Middle East to Israel to the UK, and rising popular anger in China - and soon enough in other advanced economies and emerging markets - are all driven by the same issues and tensions: growing inequality, poverty, unemployment, and hopelessness. Even the world's middle classes are feeling the squeeze of falling incomes and opportunities.


To enable market-oriented economies to operate as they should and can, we need to return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model oflaissez-faire and voodoo economics and the continental European model of deficit-driven welfare states. Both are broken.


The right balance today requires creating jobs partly through additional fiscal stimulus aimed at productive infrastructure investment. It also requires more progressive taxation; more short-term fiscal stimulus with medium- and long-term fiscal discipline; lender-of-last-resort support by monetary authorities to prevent ruinous runs on banks; reduction of the debt burden for insolvent households and other distressed economic agents; and stricter supervision and regulation of a financial system run amok; breaking up too-big-to-fail banks and oligopolistic trusts.


Over time, advanced economies will need to invest in human capital, skills and social safety nets to increase productivity and enable workers to compete, be flexible and thrive in a globalised economy. The alternative is - like in the 1930s - unending stagnation, depression, currency and trade wars, capital controls, financial crisis, sovereign insolvencies, and massive social and political instability.

The US Debt Crisis and what we can expect down the road - politics and economics should not mix!

The antiquated two party system has really deepened the divide and ensured that extremist political agendas are being forced on a very real economic crisis to hit the United States of America, when the need of the hour is to come together and lead by economic common sense.

Debt default. A ratings downgrade. Political deadlock. Such terms, once associated primarily with the developing world, now abound in the mighty United States.

Jennifer Ablan & Dale Hudson - Reuters.

As the U.S. Congress flirts with the once-unthinkable prospect of not paying the country's bills, the heated battle over a usually routine vote to lift the country's debt ceiling is dealing another blow to America's image.

The global financial crisis, which was rooted in poor regulation of the U.S. housing and banking sectors, already tarnished perceptions of the United States overseas.

For political economy experts who have spent their careers focused on the emerging world, Washington's protracted debt stand-off is all too reminiscent of the divisions more typical of developing-country politics.

"We attend a lot of meetings with Latin Americans and we used to complain to them about the problems they had, and now they like to say to us: 'That sounds just like the U.S.'," said Peter Hakim, head of the Inter-American Dialogue, a policy group in Washington.

"What's really shocking is the inability to reach agreement. All of a sudden the U.S. is a democracy that is unable to find a compromise. We're polarized."

That sort of polarization is common in the developing world. The United States was often a critic of institutional disarray in places such as Brazil, where a multitude of parties makes it difficult to enact legislation, or Mexico, where the opposite problem -- long-standing one-party rule -- stifled political choice.

Yet the stalemate now facing the U.S. two-party system demonstrates the challenges of the divided government Americans voted for last November.

Given that the United States is home to not only the world's largest economy but also its most liquid and safe debt market, the repercussions of a U.S. financial meltdown are potentially much larger than a more contained emerging-marketscrisis.

British Business Secretary Vince Cable told BBC television on Sunday that "right-wing nutters" in the U.S. Congress were holding up a deal to prevent a catastrophic default, posing a greater threat to the global financial system than the euro zone, which has been grappling with a debt crisis of its own.

Argentina's President Cristina Fernandez, whose own country defaulted on about $100 billion in debt a decade ago, asked last week: "When did the American dream become a nightmare?"

When advising the United States on how to deal with the budget crisis, ratings agency Moody's last week suggested the country eliminate the debt ceiling to prevent repeats of the kind of uncertainty now gripping financial markets.

Instead it suggested following the example of Chile, where increases in debt are constrained but not technically limited.

Fast-growing countries in Latin America, including Chile and Brazil, achieved a more sustained growth path in part due to reforms aimed at reducing their debt loads and reining in budget deficits.

COURTING A DOWNGRADE

The push from Republican leaders for sharp cuts in U.S. government spending, which many economists say would hurt a fragile recovery, has made the rating agencies a driving force for policy. They had come under fire for giving top-notch grades to shoddy real estate securities, contributing to the financial meltdown of 2007-08.

Ratings agencies played a central role in the emerging-market debt crises in Russia, Asia and Latin America in the late 1990s. Back then they were also criticized as too late to downgrade countries with questionable credit records.

If the United States is downgraded, interest rates could rise, risking a new recession. Some Wall Street economists say the recovery is already being hampered as the threat of a debt defaultdeals a further blow to consumer confidence.

Another damaging consequence of the debt limit scuffle has been to shift the discussion away from doing more to bring down a 9.2 percent jobless rate to a debate over spending cuts that will most likely put a damper on economic growth.

Investors, who long brushed off the prospect of an outright default as highly unlikely, are increasingly concerned and shocked that the politicians in Washington have allowed the crisis to get this far.

"The extent of political dysfunctionality will stun many, especially at a time when America needs unity and common purpose in D.C. to also address high unemployment and other challenges," said Mohamed El-Erian, co-chief investment officer of the mega bond fund PIMCO, who writes columns for Reuters.

Haag Sherman, managing partner at Salient Partners, an investment firm in Houston, Texas, said the angry tone of U.S. politics harked back to the early days of the Republic, when the United States really was a developing nation.

"We were an emerging market then, and you have some of the hallmarks of an emerging economy today: increasing concentration of wealth, an entrenchment of the political class," he said.

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My final two-cents forecast for the world economy 

- Rising Inflation and a dip in growth

- A very real devaluation of the US Greenback as a currency of trade

- Very slow economic recovery for the US

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