The depression quietly deepens

The depression quietly deepens
It is lonely in the diminishing camp of bears, says Ambrose Evans-Pritchard

Those of us who still question whether the world has purged its toxins are reduced to the same tiny band of moaning Druids from early 2007, when we shook our heads in disbelief as the carry trade swept Iceland to fresh madness and bankers laughed off sub-prime rot at Bear Stearns.

We learned then to thicken our skins with walnut juice, lie down in dark rooms, and dissent from Goldman Sachs. Such seclusion is called for once again as Goldman replays its BRIC anthem and raises its oil forecast to $85 a barrel this year, betting that the world will roar back on a tidal wave of liquidity.


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Note that Total's Jean-Jacques Mosconi said markets are awash with so much crude that almost 100m barrels (a near record) are stored on tankers at sea. Note too that May electricity use fell 10pc in China's industrial hub of Guangdong from a year earlier. This is revealing, given that China's fiscal boost has reached peak and will fade later this year.

For guidance on where we are in this long-drawn saga, I look to Berkeley's Barry Eichengreen, author of the Great Depression classic Golden Fetters – which avoids the error of viewing the 1930s through a US prism.

He has crunched the latest data with Trinity College Dublin's Kevin O'Rourke for VoxEU, concluding that the global rupture over the last nine months has been more violent than in the early slump. This is logical. Global debt leverage is much greater this time.

The fall in industrial output has been roughly equal to the 1929-1930 stage for Germany and the Anglo-Saxons, but worse for Japan, France, Italy, and Eastern Europe. The collapse in world trade has been swifter: the global equity crash has been twice as bad. "It's a depression alright. The good news is that the policy response is very different. The question now is whether that response will work," they said.

The elastic was bound to snap back, just as it did in the bear rally of early 1931. Whether the underlying economy has begun to heal is another matter. World Bank chief economist Justin Yifu Lin said capacity utilization is running at an historic low of 50pc-60pc. Companies will have to fire a lot of workers. This is where the danger lies, and why he fears that deflation is creeping up on us.

Trade data from Asia are flashing warning signals again. Korea's exports were down 28.3pc in May, reversing the April rebound. Malaysia has slipped to -26pc, and India has touched a new low of -33pc.

US freight data is getting worse, not better. The Association of American Railroads said traffic was down 22pc in the third week of May from a year earlier. Canadian freight was down 34pc.

The American Trucking Association (ATA) said it saw fresh drops of 4.5pc in March and a further 2.2pc in April. Tonnage is down 13pc over 12 months. Bob Costello, the ATA's chief economist, said companies have not cut inventories fast enough to keep pace with declining sales. The contraction in truck volume has "accelerated".

Yes, the Baltic Dry Index for bulk shipping of resources has quadrupled since January, but this reflects China's bid to stockpile metals while prices are low.

Stephen Roach, Morgan Stanley's Far East chief, fears an "Asian Relapse", saying the region is prisoner to its fatal dependency on exports to the West. The export share of GDP has risen from 36pc to 47pc across developing Asia over the last decade.

"China's incipient rebound relies on a time-worn stimulus formula: upping the ante on infrastructure spending in anticipation of an eventual rebound of global demand," he said. The strategy cannot work this time because Americans have exhausted their credit, and their desire to borrow. Consumption will fall from its peak of 72pc of GDP to the "pre-bubble norm" of 67pc, if not more.

David Rosenberg from Gluskins Sheff expects Americans to retrench ferociously as 78m baby boomers face the looming threat of penury in old age. "The big story is that the personal savings rate hit a 15-year high of 5.7pc in April. I believe it could test the post-War peak of 15pc. Too many pundits are still living in the old paradigm of Americans shopping till they drop," he said.

If he is right, this will shatter the surplus economies of China, Japan, and Germany, unless they adjust fast to the new world order. Germany does not even seem to understand the problem it faces. Chancellor Angela Merkel lashed out last week at quantitative easing by the Fed, the Bank of England, and the European Central Bank, repeating the silly mantra that this will set off an inflationary storm.

How can it do so when the velocity of circulation has collapsed, and unemployment is rising everywhere? The Fed's "monetary multiplier" ended last week at 0.867, half its average of 1.7 over the last decade. The credit mechanism is still broken. This is what happened in Japan in its Lost Decade.

The ECB says the eurozone economy will contract until mid-2010, at best. Germany's trade association (Wirtschaftsverbände) warned Mrs Merkel last week that the credit drought threatens to become "life-threatening by the summer at the latest".

The list of countries in deflation is growing every month: Ireland (-3.5), Thailand (-3.3), China (-1.5), Switzerland (-1), Spain (-0.8), the US (-0.7), Singapore (-0.7), Taiwan (-0.5), Belgium (-0.4), Japan (-0.1), Sweden (-0.1), Germany (0).

Yet markets seem to think otherwise, and this has its own awful consequences. Inflation fears have driven 10-year US Treasury yields to 3.86pc, a full point above levels in March when the Fed intervened to force rates down. US mortgage rates have jumped to 5.29pc. Gilts have reached 3.92pc, and French 10-year bonds are at 4.05pc.

This bond revolt is enough to bring any global recovery to a shuddering halt. The irony is that those fretting loudest about inflation may themselves tip us into outright deflation, with all the perils of a debt compound trap. It is Angela Merkel who plays with fire.
http://www.telegraph.co.uk/