The return of IKGW
Today is the day Israelis dread, when “after the chagim” actually arrives, when the holidays are over and there is no choice anymore but to face reality. So to for the entire world: it is no longer possible, given the news flow of economic, financial and market developments in recent days and weeks, to ignore what has happened and is happening. IKGW is back.
Veteran readers of this column may remember IKGW, albeit not fondly. During the financial crisis of 2007-2009, the clumsy but accurate slogan of IKGW — “it keeps getting worse” — was my guideline for tracking and explaining what was going on, and why.
However, for five years beginning in March 2009, it stopped getting worse. Most global stock markets bottomed that month, although the crisis in the real economy deepened until mid-year. But if we use the financial system as an indicator of the health of the overall economic system, then the crisis started in July 2007 and ended in March 2009. The real economy always lags behind the financial one when changes of direction occur, so that the recession in the US, for example, only started in December 2007 and in Europe even later.
Those five years were seemingly very good ones. If your measuring rod is the stock market, then they were extremely good — the S&P 500 index, to take just one prominent example, tripled from its nadir of 666 to over 2000 at its recent peak last month. However, this boom was not widely felt or widely shared. Rather it was an artificial one, engineered by the world’s major central banks, to achieve specific policy goals: first and foremost, to stop the collapse of the global economy during the crisis (check that box); then to provide a monetary stimulus to facilitate making reforms in the financial system and real economy (half a tick, at best); extending liquidity to banks to begin lending again to small businesses and households (a fraction of a tick, at the very most); and, ultimately, a mechanism to prevent markets from sagging or crashing.
The last goal was achieved by buying government bonds and thereby pushing investors — institutions and individuals — into riskier investments. Although the proclaimed aim was to stimulate consumption, employment and ultimately real investment, it has long been obvious to most economists, even in the official sector, that this strategy is not working. Instead, it has created phony wealth which accrues almost entirely to the rich. In fact, so far from providing an opportunity for governments to address deep-seated structural problems, central bank intervention has actually provided an excuse for them to do little or nothing, whilst pretending that all is well or, at least, getting better.
Nevertheless, the strategy has enabled the façade to be maintained for over five years. Along the way, a massive crisis almost destroyed the euro and threatened the EU — but it, too, was papered over with printed money, promises and make-believe. The extreme example was when Mario Draghi, the President of the European Central Bank, ended the entire euro crisis by simply declaring that the ECB was ready to do “whatever it takes”. The program he announced in August 2012 has not merely yet to be implemented, it doesn’t even exist on paper. But the ploy worked: Eurozone countries that were effectively bankrupt and unable to borrow in the international markets, such as Ireland, Portugal and Greece, have seen their interest rates plunge and their recent bond issues snapped up, as if they were strong and solvent.
However, during this five-year hiatus, almost nothing important was truly fixed, while many aspects of national and global economies fell deeper into disrepair. By way of generalization it is fair — if not entirely accurate — to say that the state of the world economy today is worse than it was in 2007. Two aspects are sufficient to justify that sweeping allegation: first, the Chinese miracle is over and China is not only unable to save the world, as it did in 2008-09 (yes, and to a greater extent than did the US) but is itself a major part of the problem; secondly, the central banks have exhausted their single most important asset, namely credibility and so cannot reprise their role in any future crisis.
That next crisis is no longer a future event. It is here, now, and hence the resurrection of IKGW is, if anything, belated. IKGW is not a prediction, it is rather a comment on where we currently stand, as well as a summary of the past 6-12 months. What is truly amazing is how much worse ‘things’ are now than they were a year ago — and these are the things that really matter, the ‘geo-politics’ of war, insurgency and domestic unrest, and other systemic risks, notably in the area of health.
As for the financial sector, there has been a sudden and belated awakening from the fantasy. In the four weeks from September 19, when many share indices hit record highs, sentiment has swung everywhere from blind complacency to concern. But in the weeks and months ahead it will keep on getting worse, because IKGW is back.