FOR weeks now, a global market rout had looked inevitable – so the chaos should hardly have come as a surprise when it finally began in earnest in the last couple of days. The fact that the US stepped back from the brink earlier this week provided some short-lived respite; but nobody believed America would really default, or at least not permanently. There were always two bigger threats to world prosperity: an intensifying growth slowdown; and the gradual implosion of the Eurozone, a dysfunctional grouping which cannot survive in its present form. It is these twin threats causing the market bloodbath.
Proof of the slowdown can be found in this week’s manufacturing purchasing managers’ indices: they were down in the US, Eurozone, China, Taiwan and elsewhere – and factory output shrank in the UK. Services are still doing better so the situation is poor but not disastrous – not yet, anyway.
What could tip the world economy over the edge is the Eurozone. Its woes could be ignored when the only casualties were small, misgoverned states such as Greece. But now that it is becoming apparent that Italy, a member of the G8 yet a country which has barely seen any growth at all in ten years, is on a trajectory that guarantees long-term insolvency, shell-shocked investors are finally paying attention. When the euro was launched, critics (such as myself) argued it would never work, urged the UK to stay outside and warned the project would end in tears. We were ridiculed but we were right. The single currency’s internal contradictions are the real problem today; the latest pronouncement or blunder from José Manuel Barroso, the European Central Bank or Silvio Berlusconi are merely amusing colour. Diverse economies can only successfully share a single currency but retain their fiscal independence if two key conditions are meant.
Wages must be flexible because countries lose the ability to devalue their currencies. The only way for firms and workers to price themselves back into world markets after a major economic problem is for wages and prices to drop – an internal devaluation, as opposed to an external devaluation caused by a lower currency. People must also be prepared and able to move in large numbers to anywhere in the currency area in search of work. Because neither of these conditions properly hold across the Eurozone, the only answer is either a break-up – or full political unification, complete with massive, permanent handouts from successful countries to incompetent ones, combined with compulsory reforms. There is no appetite for this in paymaster Germany, or in Italy or Greece, which means the single currency won’t survive. It may limp on for a while, with politicians calling ever more absurd meetings, agreeing to anti-democratic treaties and to federalise or even monetise everybody’s debts – but none of this will work.
The global over-borrowing crisis is now well into its most dangerous phase, almost four and a half years after the credit bubble began to burst. It was in February 2007 that HSBC wrote down the value of its portfolio of US mortgage backed securities by $10.5bn, in the first major subprime loss. The problem then was toxic mortgages; today it is toxic IOUs from incompetent, stupid governments that thought that they could ignore economic reality in the pursuit of grandiose political dreams. Hold on tight – the ride will be bumpy.
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