High debt levels threaten another sudden stop for global economy

Across the world bond yields have been rising over the past couple of months. It seems investors are exiting debt instruments and buying commodities, especially precious metals like silver and gold. This is being done quietly so as not to upset markets but there gets to be a moment where a trickle becomes a flood.

The anatomy of financial crises is actually fairly well understood. Professors Carmen Reinhart and Ken Rogoff made the point with the ironic twist of the title of their book on this subject, ‘This Time is Different’. The whole point being that it never is different this time. And what do they note of this phase of a financial crisis?

Tipping point

‘Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! – confidence collapses, lenders disappear, and a crisis hits.’

Why would such a crisis come now, quite out-of-the-blue? Well, is it not simply that the lesson of the first crisis was not learnt, and that borrowing increased and did not go down. It merely shifted to the governments?

You can no more solve a debt crisis with more debt than cure an alcoholic with another round of drinks. The problem is by storing up the problems for another day they actually become bigger. In a debt crisis that means more bankruptcies and unemployment than would have occurred in an earlier correction.

So what are we worrying about. US factory output grew 0.3 per cent in November, the fifth straight month of very modest gains. Indeed,factory output has recovered by 10.6 per cent from its low point in June 2009, albeit still a thumping 9.1 per cent below its April 2007 peak.

Contagion process

However, the US is not the weakest link right now, and that also explains why all can see calm at home while destruction threatens from abroad. Europe is facing a Lehman style collapse of its periphery economies whose debts belong to the global banking system (click here). Moody’s warned on Spain yesterday but the UK has the biggest debt mountain (click here).

Then again the Chinese economy is overheating with 60 per cent of GDP from construction and only five per cent from exports (click here). How much of this economy is running on money borrowed overseas from the global credit bubble? How sustainable is it with the developed world still struggling to make any headway?

Now the good professors Reinhart and Rogoff are wise to warn that financial crises have a repetitious nature and that it will be no different this time. And the next phase is a shift out of bonds, equities and real estate and into cash, commodities and precious metals. Is that not what we are already starting to see happen?