Where is the Economy going?

"This sucker's going down."

George Bush's pithy description of the US economy during the 2008 financial crisis has been lampooned by comedians the world over but the joke may be about to end. Not renowned as being a deep thinker, George Bush was more prescient than he could have realised; it was only the timing he got wrong.

The fundamental economic facts in 2012 have changed little since 2008. The debt overhang and imbalances in the global economy remain huge; such that a major correction is required, somehow, some way. There is a belief that a smooth correction will be possible but for many countries the debt is beyond their ability to pay. The Eurozone in particular has huge internal imbalances which require either the pooling of debt (which the Germans and Finns won’t allow) or break up. There is not a third way ‒ despite the smoke and mirrors that European policy makers are using to uphold the belief that the euro will survive intact.

World leaders and central bankers have worked hard to hold the world economy up over the last four years through pumping in new money and buying up distressed assets. This is like a doctor loading up their patient with increasing doses of anti-depressants despite knowing that withdrawal will be much harder beyond the immediate crisis. Policy is focussed on bolstering confidence and encouraging the belief that all is well.

The point will come when confidence evaporates and a rush into real assets begins. The clever money has already moved, when the rush begins there will be few exits available and the world’s markets will move in unison.

I could be wrong; I hope I am wrong; but reality has to return eventually.  The world economy is more connected, more interdependent, more indebted and more imbalanced than at any previous time in history. Whichever way it goes, we will all go together. Perhaps we are like a cartoon character that has just run off a cliff and is hanging in mid-air, legs still running, defying gravity for as long as possible. The trouble is we don’t live in the fantasy world of international finance; we live in the real world where facts cannot be ignored indefinitely.