In 2007, the international financial elite knew very well that there were serious problems with the world’s largest banks. Perfectly good loans were being called, long-standing corporate relationships were being cast aside for short-term benefit and there was a palpable perception of something wicked on its way. While news of the so-called credit crunch was duly reported by all the major newspapers, few outside the financial world had any idea that consequences such as the meltdown of 2008 were rapidly approaching.
But if you knew what to look for, it was fairly obvious that something big and ugly was developing, which was why I wrote that “the United States was fast approaching an interesting juncture” in my WND column published March 24, 2008. In a similar manner, what appears to be the minor matter of a Dubai-based corporation requesting a six-month moratorium on its debt payments looks very much like a warning that the next stage in the global financial crisis will be upon us soon.
Debt is the primary cause of significant economic shocks, both to the upside and the downside. This is because it magnifies profitable activity, and it multiplies losses. The following chart from Morgan Stanley shows the historical level of total debt compared to U.S. gross domestic product; note that the relative amount of debt was actually increasing from 1929 through 1933 as GDP shrank and governments and corporations attempted to stave off the effects of the contraction through debt-financed spending.
The spike in financial and government-sponsored enterprise debt that has taken place over the last decade is particularly problematic because it has only a tangential relationship with genuine market-driven economic activity. For example, Dubai World is a government-sponsored enterprise and its giant, gaudy projects have long been a byword for inexplicable and unsupportable excess. If the emirate does default on part or all of the Dubai World debt, this should serve as confirmation that the debt-deleveraging process indicated in the Federal Reserve’s credit statistics has begun on a global scale.
It is no secret that many of the large banks around the world are technically insolvent. While accounting rules have been rewritten to permit them to continue valuing assets at elevated levels compared to what they could be reasonably expected to command if sold on the open market, this does not change the fact that the collateral supporting much of the world’s public and private debt is worth less than the debt it theoretically supports. This can be seen in the FDIC’s account of estimated and actual losses; I estimate that bank assets are only worth around 60 percent of their reported valuations on average despite the eight-month rally in the stock markets. This is why banks are increasingly unwilling to lend money despite the central-bank-suppressed interest rates that enable them to hold deposits at essentially no cost to themselves.
This is not a sustainable situation. There is presently around $3.75 in debt for every $1 in national income, whereas the historical chart indicates that the national economy can normally support around $1.50. Therefore, the elimination of a significant portion of the cumulative debt should be anticipated; in macroeconomic terms this indicates a decline in total public, private and corporate debt from $57 trillion to $21 trillion. This process of debt-deleveraging last took place during the Great Depression. The fact that the level of global debt is higher now than it was in the 1930s is why I believe that the consequence of the current deleveraging will likely be an economic event that is an order of magnitude larger.
It is important to remember that the signal event of the global Great Depression was not the stock-market crash of October 1929, but the failure of the Austrian Creditanstalt bank 19 months later, in May 1931. (In light of the FDIC’s strategy of having “good” banks take over “bad” bank assets, it is probably worth noting that it was the Creditanstalt’s forced takeover of the bankrupt Bodencreditanstalt that caused it to fail.) Is the feared default of Dubai World the modern equivalent of the Creditanstalt collapse? It is impossible to say at this point, but it is safe to assume that if Dubai is not the first in a wave of international debt-failures, it will be among them once another institution sets the long-delayed process in motion. And in any case, it is certainly a flashing red signal that the economic crisis is far from over despite the widespread reports of global recovery.
If you’re interested in understanding more about the dependence of modern economies and the global financial system on debt, I would encourage you to take a look at “The Return of the Great Depression,” which describes both the system and the debt-deleveraging process in some detail. Amazon is now offering the Kindle edition for only $1.59.