Warning that downturn will see unemployment hit 4.7m by 2010
A clutch of political and labour leaders in Germany have raised the spectre of civil unrest after the country's leading institutes forecast a 6pc contraction of gross domestic product this year, a slump reminiscent of 1931 and bad enough to drive unemployment to 4.7m by 2010.
Swiss risk advisers Independent Credit View said a "second wave" of debt stress is likely to hit the UK and Europe this year as the turmoil moves from mortgage securities to old-fashioned bank loans. A detailed "stress test" of 17 lenders worldwide found that European banks have much lower reserve cushions than US banks, leaving them acutely vulnerable to the coming phase of rising defaults. "The biggest risk is in Europe," said Peter Jeggli, Credit View's founder.
Deutsche Bank has reserves to cover a default rate of 0.7pc, against non-performing assets (NPAs) of 1.67pc; RBS has 1.23pc against NPAs of 2.43pc, and Credit Agricole has 2.63pc against NPAs 3.64pc. None have put aside enough money.
"The Americans are ahead of the curve. European banks are exposed to US commercial real estate and to problems in Eastern Europe and Spain, where the situation is turning dramatic. We think the Spanish savings banks are basically bust and will need a government bail-out," said Mr Jeggli.
Analysts say America's quicker response has given the impression that US banks are in worse shape, but this is a matter of timing and "transparency illusion". Europe risks repeating the errors made by Japan in the 1990s when banks concealed losses, delaying a recovery.
Europe's banks are exposed to a hydra-headed set of bubbles. They not only face heavy losses from US property, they also face collapsing credit booms in their own backyard and fallout from high levels of corporate debt in the eurozone.
Mr Jeggli said the financial crisis was "front-loaded" in the Anglo-Saxon countries and Switzerland because their banks invested heavily in credit securities. As tradeable instruments, these suffered a cliff-edge fall when trouble began, forcing harsh write-downs under mark-to-market rules.
It takes longer for damage to surface with Europe's traditional bank loans, which buckle later in the cycle as defaults rise. The ferocity of Europe's recession leaves no doubt that losses will be huge this time.
The reversal came after a raft of strong economic data in March convinced pundits that green shoots are starting to reappear in the Chinese economy, which could shortly overtake Japan as the world's second-largest.
Previously Goldman Sachs forecast that China would only grow by 6pc in 2009. Other economists have predicted growth to be as low as 5pc; strong compared to the rest of the world, but lower than the magic 8pc threshold that China believes is essential to maintain calm.
After exports fell by nearly 20pc in the first quarter, the government has poured money into the economy to keep it running. As well as a 4 trillion yuan (£400bn) fiscal stimulus package, Chinese banks have made 4.8 trillion yuan in new loans so far this year.
In order to finance the sudden increase in credit, the Chinese central bank has started printing huge quantities of money. In March, the increase in M2 money supply was 25.5pc, the highest it has been since the Asian financial crisis.
"We are fully confident that we will overcome difficulties and challenges and we have the ability to do so," said Wen Jiabao, the Chinese prime minister, at the National People's Congress in March, as he underlined the government's determination to keep GDP growth at 8pc.
"Since the announcement of the fiscal stimulus package last November [...] the pace of implementation of new infrastructure investment and the scale of domestic credit expansion have been unprecedented," said Helen Qiao, an economist at Goldman Sachs. She added that growth next year would be 10.9pc.
Economic growth was just 6.1pc in the first quarter of this year, the lowest on record. However, commentators suggested that the figure was the bottom of the cycle, and that increases in industrial production, retail sales and fixed asset investment would soon buoy the Chinese economy.
However, Stephen Green, an economist at Standard Chartered in Shanghai, expressed some skepticism that there was a full-blown recovery underway. He said growth had accelerated from the end of last year, but cautioned that "there is a huge amount of volatility in the numbers and a chunk of salt is needed."
He added that while the fiscal stimulus package is likely to boost investment by companies in the short-term, in the long run China needs to increase the incomes of its workers and complete a social welfare system. He kept his forecast at 6.8pc for the year.
The drop in shipments to the US and China, Japan’s two largest markets, slowed.
Federal Reserve Chairman Ben Bernanke said last week the “sharp decline” in the US may be slowing. Goldman Sachs today raised its economic growth forecast for China to 8.3pc this year from 6pc previously, citing Premier Wen Jiabao’s 4 trillion yuan (£400bn) stimulus package.
“It would be premature to celebrate,” said David Cohen, director of Asian economic forecasting at Action Economics in Singapore. “There’s no denying the Japanese economy is in its most severe recession since WWII, but at least it’s not spiraling down any more.”
The casual way the IMF overstated British bank losses by some £60bn, and then retreated after a call from the Treasury, does not inspire much confidence that the fund is ready for its fast-escalating role as the world's monetary overlord.
Jurgen Stark, Germany's man on the European Central Bank, called it "helicopter money" for the globe. "There hasn't been a study to see whether the world needs additional liquidity. In the old days, one would take a long time to explore such a thing."
Some suspect the fund is making up loss figures on the hoof, vying with perma-bears in a Dutch auction of ever grimmer forecasts. Estimated losses have jumped from $1 trillion (£694bn) last year, to $2.2 trillion in October, to $4.1 trillion this week. Western banks must raise $875bn in equity by next year. US Treasury Secretary Tim Geithner replied tartly that the "vast majority" of US banks already have enough capital.
The fund is pushing worldwide fiscal stimulus à l'outrance (2pc GDP) and "bolder steps" to shore the banks, meaning nationalisation. This is not the old IMF. But it is led these days by Dominique Strauss-Kahn, a French socialist.
So is the IMF overplaying its hand as it bids to be the world's saviour? Mr Strauss-Kahn paints in bold colours. He has called this a global "Depression", warning of a spiral into civil strife, revolts, and war if the crisis is mishandled.
If he is right, his leadership is exactly what is needed to shake elites out of complacency, galvanise a global response to avoid a beggar-thy-neighbour replay of the 1930s, and give governments "cover" for emergency action. If wrong, the IMF is hurting confidence and pushing governments into grave policy errors. The jury is out.
Personally, I think he is right, but one wishes the IMF had been more alert – or braver – when global debt was mushrooming out of control. Spain's ex-bank governor, Luis Angel Rojo, said the IMF failed to see the crisis coming, did "nothing" to stop it, and is belatedly kicking the banks when they are down. "For God's sake, just shut up," he said. Many will agree.
Our predicament is desperate but not serious, as they used to say in the Austro-Hungarian Empire. Britain’s budget deficit threatens to hit £175bn this year, or 12pc of GDP.
That is just about the worst performance of any major country at any time in history, during peacetime.
Gordon Brown’s sin as Chancellor was to run a fiscal deficit of 3pc of GDP at the top of the long boom, when other countries were prudently using their windfall tax revenues to build a storm buffer. Many ran surpluses in 2007: Finland (+5.3pc), Denmark (+4.9pc), Sweden (+3.5pc), Spain (+2.2pc), Australia (+1.6pc) and Canada (+1.4pc). Germany was near balance.
The result is that the UK national debt will jump from 44pc of GDP in 2007 to 78pc by the end of next year, according to Fitch Ratings. But at least we have the adult company of the US and Japan in our immediate debacle, and sibling allies in Europe’s Club Med and most of the ex-Soviet bloc.
The US Congressional Budget Office (CBO) expects America to run a deficit of 13pc this year following the US bank rescue and President Obama’s fiscal package. The US national debt will rise from 41pc in 2008 to 65pc next year.
What happens thereafter is the subject of fierce debate in Washington. The CBO fears the debt may ratchet up to 82pc by 2018, with trillion-dollar deficits as far as the eye can see. That gloomy prognosis seems to assume that the US political class lacks the discipline to retrench once the banking crisis passes. This is a matter of political judgment.
The good news is that Britain goes into the slump with a lower level of sovereign debt than some G7 states, thanks to the (now fading) Anglo-Saxon renaissance and the Thatcher reforms. The bad news is that our hard-fought gain has been squandered.
Japan is in a class of its own with debt nearing 200pc of GDP next year, not a happy picture for a country slipping into demographic decline. The working population peaked in 2005. The number of wealth creators needed to finance the debt shrinks year after year.
This curse has already hit Eastern Europe and will soon strike Germany, Italy, Spain and China. Britain’s ageing population crisis is less severe, which has major implications for the sustainability of debt over the long-run. The US and Australia are healthier.
Brian Coulton, head of sovereign ratings at Fitch, said the Anglo-Saxons have another advantage. “While the US and UK are amongst the most directly exposed to the shock, they should bounce back more quickly because they have more flexible product and labour markets,” he said.
Capital Economics fears the slump will do a lot more damage yet. “We think the UK debt could reach 100pc of GDP. Talk of British bankruptcy is over the top but it is going to take a very long time to cut deficit to acceptable levels,” said Jonathan Loynes, their UK strategist.
Marc Ostwald from Monument Securities said it is not yet clear whether investors will recoil from Britain. “The danger is that the gilt market will buckle once the Bank of England has used up its £75bn and there is no longer a backstop buyer. If the Bank throws in another £75bn it will be even harder to unwind. There is no obvious way out of this.”
All we know from a welter of global studies is that a 1pc rise in national debt tends to cause a rise in bond yields by roughly 10 basis points over time. Ergo, the real cost of financing Britain’s debt may jump by 2pc, 3pc, 4pc or even 5pc before this is over. Tighten your belt.