The world savings rate has surpassed its modern-era high of 24pc. This is the killer in the global system. It is why we are at imminent risk of tipping into a second, deeper leg of intractable depression.
In Europe, policy is still on deflationary settings, with protestors in Athens fighting back against austerity measures. The International Monetary Fund (IMF) expects the savings mountain to rise yet further next year as the governments of Europe, Britain, and the US tighten belts, in unison, by up to 2pc of GDP.
This is double the intensity of the last big synchronized squeeze in 1980.
They will do so before the private sector is ready to grasp the baton, and without stimulus from the trade surplus states (Germany, China, Japan) to offset the contraction in demand.
Put another way, there is a chronic lack of consumption in the world. “This probably comes as a surprise to most people, gorged on propaganda about excessive debt and the need for retrenchment,” said Charles Dumas from Lombard Street Research.
The inevitable outcome of one-sided austerity polices in the Anglo-sphere and Club Med is a self-feeding downward slide for the whole global system, a variant of 1930s debt-deflation. “Excess savers refuse to acknowledge that if world savings are demonstrably too high, healthy recovery depends on the surplus countries saving less,” he said.
Mr Dumas said China’s “grotesque and destructive” policies of over-investment (50pc of GDP) and under-consumption (36pc of GDP) are unprecedented in history, but at least China’s currency advantage is being eroded by wage inflation.
His full wrath is reserved for the “fallacious and malignant policies” of Angela Merkel and Wolfgang Schauble in Germany. They are enforcing a Gold Standard outcome on the whole eurozone. “Suffused with self-righteousness, they insist that the imbalances must be put right only by deficit-country deflation.”
The sheer scale of global imbalances is made clear in a paper by Stephen Cecchetti at the Bank for International Settlements.
His paper contains a chart showing that combined surplus/deficits reached 6pc of world GDP in the boom, far beyond the extremes that led to the US losing patience in 1985 and imposing the Plaza Accord. The gap narrowed post-Lehman but is widening again.
Money flows are even more out of kilter. Cross-border liabilities have jumped from $15 trillion to $100 trillion in fifteen years, or 150pc of global GDP. This creates a very big risk.
“Gross financial flows can stop suddenly, or even reverse. They can overwhelm weak or weakly regulated financial systems,” said Mr Cecchetti.
Well, yes, this is now happening. Did anybody think about this when they unleashed globalisation with its elemental deformity, free trade without free currencies?
The self-correction mechanism is jammed. China holds down the yuan against the dollar through a dirty peg. Germany and its satellites hold down the D-mark against Club Med covertly through the mechanism of EMU.
This outcome in Europe is not deliberate (I hope); it is not a German plot; it is the unintended effect of a currency union created by ideologues against Bundesbank advice, and which has calamitous implications for German foreign policy and for Latin social stability.
My sympathies go to the hard-working citizens of Germany, Spain, Italy, Portugal, and Ireland for being led into this impasse by foolish elites.
A global system biased towards export dumping has had unhappy effects on the US, UK, and Club Med. These countries have faced a Morton’s Folk over recent years: an implicit choice between job losses at home, or accepting credit bubbles to mask the pain.
They chose bubbles. That was a mistake. This strategy of buying time cannot safely be repeated because fiscal woes are already near “boiling point”, in the words of the BIS. “Drastic improvements will be necessary to prevent debt ratios from exploding,” it said.
Bank of England Governor Mervyn King called recently for a “grand bargain” of the world’s major powers to break the vicious circle and ensure that the burden of adjustment does not fall on debtors alone.
“The need to act in the collective interest has yet to be recognised. Unless it is, it will be only a matter of time before one or more countries resort to protectionism. That could, as in the 1930s, lead to a disastrous collapse in activity around the world,” he said.
We are not there yet, but a global double-dip would take us to the edge. US democracy cannot allow America’s precious stimulus to leak out to countries that have bent their exchange rates, tax systems, and industrial structures towards predatory export advantage. It cannot let broad (U6) unemployment ratchet up to 20pc or more.
If the White House will not do it, Congress will. Capitol Hill is already launching its latest bill to label China a currency violator, and open the way for retaliatory sanctions.
“They get away with economic murder and thus far our country has just said, ‘Oh, we don’t care. This legislation will send a huge shot across China’s bow,” said Senator Chuck Schumer.
The risk – or solution? – is that the US will opt for a variant of Imperial Preference, the pro-growth bloc created behind tariff walls by the British Empire with Scandinavia, Argentina and other like-minded states in 1932. This experiment has been air-brushed out of history by free trade hegemonists.
One can imagine how this might unfold. North America would clamp down on dumping, at first gingerly, before escalating towards a cascade of Smoot-Hawley tariffs and barriers. Mexico and Central America would join. Brazil and Mercosur would find it irresistible because that is where the demand would be, and BRIC solidarity would wither on the vine.
By then you would have the US recovering behind its wall, while surplus states were recoiling from severe shock. Britain would face the moment of truth, offered salvation in the `Pact of the Americas’ or slow asphyxiation by trade ties to EMU’s deflation machine. Portugal and Spain would face the same fateful choice. This is how the EU might end.
Ultimately, America would get its way. Korea and the Asian Tigers would come knocking. The austerity brigade and mercantilists would be shut out until they capitulated. The rules of world trade system would be redrawn.
The IMF’s Christine Lagarde understands the risks intuitively. The global economy is entering a “dangerous new phase”, she warns. Leaders must prepare for “bold and collective action to break the vicious cycle of weak growth and weak balance sheets feeding negatively off each other”. Central banks must stand ready to “dive back into unconventional waters as needed.”
But how many infantry divisions does the IMF command, to paraphrase Stalin? Power resides in the G20, where debtors and creditors have radically contrasting views. The body cannot even start to offer a solution.
A US double-dip is not yet a foregone conclusion. America’s M3 money supply is last growing decently again at 5.6pc, which would in normal circumstances signal some recovery next year. The latest GDP and confidence data in the US have not been as bad as feared.
Ajay Kapur from Deutsche Bank said investors have to decide whether the market slump of recent weeks is a “panic like the LTCM sell-off in late-1998 that proved to be a great buying opportunity, or the first leg in what could eventually be a pervasive global recession. We believe it is the latter.”
He said the triple warnings from US leading indicators (ECRI, the Philly Fed’s ‘Anxious Index’, and the earnings revision index) all point to recession, while China is “probably over-tightening” into a global slump.
In Europe, policy is still on deflationary settings, with Italy and Spain having to tighten fiscal yet further to meet their budget targets. The European Central Bank is overseeing a collapse in real M1 deposits in Italy of around 6pc, annualized over the last six-months.
Michael Darda from MKM Partners said the ECB has made such a hash of monetary policy that nominal GDP for the whole eurozone may even start to contract.
That is astonishing. If correct, there is no hope of averting a debt spiral in Italy and Spain. Any such outcome will test the EU’s bail-out machinery to destruction within months.
Mr King’s “disastrous collapse” is staring policy-makers in the face.