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February 18, 2011

The Merry-Go-Round

By Spear's

The global economy continues through 2011 with the widespread belief that the worst of Global Crunch has passed and that a slow recovery is in prospect. Would that it were so

The global economy continues through 2011 with the widespread belief that the worst of Global Crunch has passed and that a slow recovery is in prospect. Would that it were so. The storm clouds of global inflation, high unemployment, illiquid banks, sovereign debts and currency wars are all still with us. Let’s survey the scene.

America is in a debt-strapped economic mess. President Obama doesn’t do economics, and so the federal deficit marches on past $14 trillion while stalemate has taken over Capitol Hill until the next presidency in 2013. So Bernanke’s Fed has no option but to continue with QE to fund the deficit; more than half of the states, municipalities and cities are also bust, led by California; wider unemployment is 16 per cent; the housing market is still stuck in the doldrums; and the only coherent policy is for The Fed to create inflation by loose monetary policy, to inflate away America’s huge debts, and hope nobody else cottons on. Bernanke, however, has already been spotted moving into an offside position: every dose of US QE, you see, gives another upward twist to Chinese inflation.

This brings us to the second-largest economy, which has funded American profligacy for the past decade. The unspoken quid pro quo is that China pegged the renminbi to the dollar, so its exports to the US gave the dollars that the Chinese then loaned back, creating the deficit. This high-wire tension act could obviously not continue forever, and the forces and imbalances revealed by Global Crunch are stretching the elastic to its limit. America is determined to bust the peg and, like a giant crocodile, is determined to grab hold of China and wrestle it until the peg is loosened by rising Chinese wages.

China does not want to be crocodiled just at the moment, thank you, as it grapples with an economy that must grow by 8-10 per cent pa. The trouble is that China’s super-growth has been created by its own exceedingly loose monetary stance, which is about to blow the lid off its own property boom and let rip domestic inflation, too, so interest rates have to rise, not just in China, but globally.

Meanwhile, the debt problems of the eurozone, the world’s biggest market but far from being a single economy, have been exposed for all to see. The only solution, however, has been for more money to be thrown at the very same PIGS who got into trouble because their debts were too high in the first place. Some solution indeed!

Now Germany sees that the euro was a trap of its own making as they must now either underwrite the entire euro-system and import inflation or call off the experiment altogether. The break-up of the current eurozone structure looks set to be caused by indecision, vacillation, the markets and civil disobedience. This process is already in the works — just watch Ireland — and 2011 will be a watershed year.

Stock markets seem to have largely shrugged the macro-economic risks and problems aside, as corporate profits have recovered, other than at the busted banks still reporting losses from continuing bad debts. Nevertheless, stock markets are in for a bumpy ride, which may present good opportunities for the bold, but gold will end the year higher, potentially much higher.

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None of this should surprise regular readers of our leader column: ever since July 2007 we’ve been ahead of the curve, and called the UK double-dip back last summer. The problems faced by the BoE’s MPC are now acute: try to look across the inflation valley and keep interest rates low, and risk ending up behind the curve? Or hike interest rates in mid-2011 and risk curtailing the anaemic recovery? Either way, the re-emergence of inflation is pointing to a long period of stagflation, not just in the UK, but across the eurozone and America as well. It’s time to head East.

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