Prolonged Global Winter
Will inflation stemming from $5 trillion of global stimulus programs lengthen the recession?
- At least in the short-term it is disturbing that Britain is currently "printing money" faster than Weimar Germany.
- There is no necessity for a severe recession, such as the present one, to be excessively long — it depends on the government policies pursued.
- The British recession of 1816-17 was made much worse by the eruption on April 12, 1815, of Indonesia's Mount Tambora, the largest volcanic eruption in recorded history.
With increasing frequency over the last few weeks, economic statistics have emerged suggesting that the first shoots of economic spring are emerging, and that the bottom of the U.S. and global recession is only just around the corner.
Higher vehicle sales and factory orders, the Institute of Supply Management monthly index and slightly higher personal income and retail sales figures have all burgeoned like early crocuses, suggesting that the slope into economic decline has turned shallower, so we may reach bottom about mid-year.
Had we not been afflicted with a global epidemic of panicking governments, those modest green shoots might indeed have blossomed into a genuine spring. However, governments' misguided activities have darkened the global outlook.
Far from entering spring, we are still in the opening stages of a winter that has become nuclear — and will blight the world for the better part of a decade.
There is no necessity for a severe recession, such as the present one, to be excessively long — it depends on the government policies pursued. At one extreme are the Great Depression, both severe and lengthy, and the Japanese rolling recession of the 1990s, appallingly lengthy but at no time particularly severe. As is generally agreed, both these downturns were artificially prolonged by misguided government action.
At the other extreme, we can examine the British recession of 1816-17, after the end of the Napoleonic Wars. This would have been severe in any case, because of the transition to peace after 20 years of war and the immense financing difficulties and investment "crowding out" effect caused by Britain's 1815 public debt burden of over 250% of GDP — 50% larger than Japan's today and double Italy's.
However the downturn was made much worse by the eruption on April 12, 1815, of Indonesia's Mount Tambora, the largest volcanic eruption in recorded history. This deposited 100 billion tons of volcanic ash (more than the volume of Lake Geneva) over the world's surface.
It caused 1816 to be named the "Year without a Summer" — with fairly mild effects in southern climates and the United States, but causing the entire British harvest to rot in the fields. This was clearly more serious than a mere banking crisis.
Lord Liverpool, Britain's prime minister, implemented only one policy to fight recession. In February 1817, with parliamentary approval, he suspended the operation of the Habeas Corpus Act, in order that any impending riots could be efficiently quelled. This "stimulus package" proved remarkably successful.
Only one small disturbance occurred, and by December 1817, after a bountiful 1817 harvest, Liverpool was able to end the suspension, as the recession was over and the threat to public order gone. Total recession duration: about a year, though there was a second "dip" in 1819 (because of the 20% deflation needed to put Britain back on the Gold Standard).
In the current global unpleasantness, there are alas no world leaders with Liverpool's economic grasp (having David Ricardo as economic advisor doubtless helped). Even compared with other recessions within living memory, such as 1974 and 1982, the reaction from the global political class has been notably panicky and hysterical.
Five trillion dollars of global stimulus programs, largely consisting of public spending, are unlikely to increase the stability of the global economy. Nor are the moves by three of the world's four most important central banks to "quantitative easing" — the monetary policy of the early Weimar Republic in Germany.
During the Weimar Republic, the profits from "seigniorage" — the issue of new money — financed around 50% of public spending in 1919-23. Notoriously, this resulted in a trillion-fold devaluation of the mark by November 1923.
In the United States today, around 15% of public spending is being financed through seigniorage. The Fed is purchasing $300 billion of Treasury bonds over six months, an annual rate of $600 billion, and equal to 15% of 2009 U.S. federal spending of $4 trillion.
In Britain, the figures are more alarming. The Bank of England is purchasing 75 billion pounds of gilts over three months, an annual rate of 300 billion pounds per year, more than 65% of Britain's projected 2009 central government expenditure of 454.6 billion pounds.
Of course, the Bank of England may not repeat its gilt purchases every three months, but at least in the short term it is disturbing that Britain is currently "printing money" faster than Weimar Germany.
On the fiscal side, the figures are equally exciting. The United States, Britain and Japan are all running fiscal deficits of more than 10% of GDP in 2009. Once you factor in the OECD's more pessimistic economic forecasts, they will run even larger deficits in 2010.
Furthermore, if recovery is at all sluggish, the "output gaps" between those countries' actual GDP and their increasingly theoretical "full employment" GDP are likely to produce fiscal deficits close to the same level in 2011 and possibly thereafter.
While the current downturn may reach bottom by the summer, recovery is likely to be very slow indeed. Government borrowing will crowd out much private investment, reducing the potential of the global economy as funding is diverted from new investment into less productive courses.
At the same time, inflation, caused by excessively stimulative monetary and fiscal policies, will return to plague the global economy as in the 1970s. Political panic may have marginally reduced the depth of the recession, but it will enormously increase its duration.
The global economic climate, far from bursting into bloom, is likely to endure a prolonged winter extending over several years — as if nuclear war or a volcano larger than Tambora had struck the world in 2008.
For the global economy, it will be the White Witch's Narnia — always winter and never Christmas.
Editor’s Note: This feature is adapted from a version of this article published on the Prudent Bear website, www.prudentbear.com.