Regular FT Alphaville readers will be familiar with Albert Edwards’ post bubble Ice Age thesis of Japanese style deflation writ large across the globe.

In this week’s Strategy Weekly, Edwards looks at the end game for his theory and it’s pretty apocalyptic stuff (again).

Think monetary debasement, competitive devaluation and a trade war. (And curiously some of themes were touched upon by Bank of England governor Mervyn King in a recent speech.)

A staggering 42 million people, more than one in eight Americans, are now on food stamps. Poverty and inequality in the US are at an all-time high. Almost half these unemployed have been jobless more than six months. This is, by any standards, still a crisis. Meanwhile, just as we are on the cusp of US unemployment rising again, trade imbalances with China are reaching new records. With China’s refusal to revalue, across-the-board tariffs beckon.

An extremely lacklustre US recovery is now being followed by a cyclical slowdown. Although it is my view that we will slide all the way back into recession, one does not have to be this gloomy to see an intolerable strain being put upon the fabric of US society where the populous is now in open political revolt. This would happen in any nation where a vision of prosperity has been shown to be a Ponzi sham, engineered by the authorities to help disguise the fact that the rich have been getting a whole lot richer. In the absence of any alternative, a desperate Fed continues these same ruinous policies. No-one should be surprised that Bernanke is trashing the dollar. We quoted him recently openly boasting in November 2002 that this is what he would do to avoid Japanese-style deflation.

Meanwhile Chinese foreign exchange reserves are rising at a record pace in order to maintain the yuan/US dollar peg… meanwhile the US is now running a record deficit with China on the latest data (see chart below we run the data through Datastream’s seasonal adjustment and the story is the same) … and meanwhile Chinese Premier Wen is warning that a 20% yuan rise would bankrupt Chinese companies and sharply rising unemployment would cause a major social upheaval (i.e. exactly what is happening in the US).

The end game for the Ice Age was always going to be monetary debasement, competitive devaluation and a trade war. As US unemployment begins to rise, do not be surprised when across-the-board tariffs are implemented if China does not revalue.

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And here is what King had to say on protectionism on Tuesday night in a speech to business leaders in the West Midlands (emphasis ours):

The international monetary system today has become distorted. The major surplus and deficit countries are pursuing economic strategies that are in direct conflict. And there are some innocent victims. Those emerging market economies which have adopted floating currencies are now suffering from the attempts of other countries to hold down their exchange rates, and are experiencing uncomfortable rates of capital inflows and currency appreciation. So there is more to this issue than a bilateral conflict between China and the United States.

At the G7 meeting in October 2008, I was part of the group of ministers and central bank governors who threw away the prepared communiqué, and replaced it by a bold short statement of our determination to work together. That spirit, so strong then, has ebbed away. Current exchange rate tensions illustrate the resistance to the relative price 6 changes that are necessary for a successful rebalancing. The need to act in the collective interest has yet to be recognised, and, unless it is, it will be only a matter of time before one or more countries resort to trade protectionism as the only domestic instrument to support a necessary rebalancing. That could, as it did in the 1930s, lead to a disastrous collapse in activity around the world. Every country would suffer ruinous consequences – including our own. But, to borrow a phrase, in order to be tough on protectionism, we need also to be tough on the causes of protectionism.

Who would have thought King and Edwards would have so much in common?

Related link:
Let the equity bear market resume – FT Alphaville
The descent into global C-H-A-O-S – FT Alphaville

This entry was posted by Neil Hume on Wednesday, October 20th, 2010 at 11:00 and is filed under Capital markets, People. Tagged with albert edwards, ben bernanke, china, federal reserve, Ice Age, japan, mervyn king. Edit this entry.