“A new worry is emerging among economists and policy makers: That economic activity is slowing in sync around the globe and not just in a few markets with their own isolated problems.”  WSJ Europe May 25.

Just realizing that?  We are in a major global collapse, caused by the very bad policy responses to the onset of the Great Recesssion in 2008.  Those bad responses include:

(1) using sovereign debt to bail out banks (except in Iceland, which is now doing fine, thank you), thus hugely increasing sovereign debt while not stimulating the economy, because the banks sat tight to rebuild their balance sheets so they could pay their execs at 2008 levels.  So bankers got a bail out while everyone else got stuck with stagnant wages and high unemployment.

(2) Failure to address the housing market.  In the US, Spain, Ireland, and other countries, the housing market was the center of the crisis.  Yet no strong and persistent measures were taken to move excess property off the market quickly and rebuild effective demand for housing.  So homeowners were stuck with declining assets that were a drag on the economy and still depress consumer spending.

(3) Inadequate stimulus spending.  Countries went head over heels into debt to bail out banks, but resisted borrowing to invest in useful infrastructure and employment measures.  So we got increased debt without growth; the opposite of what we should have had.  The one exception was China, which ramped up state spending on infrastructure to nearly 50% of GDP.  But that was not sustainable.  People mistook that for China’s growth being ‘real’ and able to act as a motor for the global economy.  It was not.  It was the temporary lift China got from being the only country to pursue sensible stimulus policies.  But with the rest of the world, including China’s top customers, strangling their own economies by bad policies, Chinese growth cannot but slow as well.

(4) Adopting austerity policies to depress government spending.  This pro-cyclical action has made recession worse in every country where it was enacted, pushing most of Europe into a double-dip recession, throttling Greece and Spain’s hopes of recovery, and dragging down global growth.  This is a near repeat of one of the biggest blunders of the early period of the Great Depression.

(5) Kicking the can down the road on the imbalances in Europe that threatened the Euro.  For four years, policy makers faced with bankruptcy in Greece and rapidly declining fiscal conditions in Portugal, Spain, Italy, and Ireland did — nothing but scold and insist on counterproductive austerity policies.  These have done a lot to supress growth, but nothing to reduce debts (Greece’s plan to sell state assets to help reduce its debts are now useless, because no one will buy Greek assets at today’s Euro prices fearing a future collapse; this means the plans to reduce Greek debt are essentially junk and there is no way Greece can meet its promised debt reduction targets). The European Central Bank helped stretch things out by lending banks money to buy sovereign debt, thus transferring that debt back to the banks.  However, this has now made things worse because the sovereign debts were not reduced, and the weak banks have traded their troubled private and mortgage debt for even more troubled state debts.  This means the entire European banking system is tied to the risk of sovereign defaults, and will go crashing down if bond rates increase, thanks to mark-to-market rules.

(6) Failure to realize that unlike the period of the Great Depression or any other recession of the last sixty years, we are in a period of labor force contraction in all the advanced economies and China that will be deflationary and restrict demand growth.  There will be no sudden rebound in demand like that which the baby boom provided after 1940 and through all the recessions of the 1970s and 1980s.  So we cannot simply wait out the slump and expect a natural return to growth; it may take exceptional measures to promote and sustain growth in the aging advanced economies of Europe, North America, and East Asia.

It is astounding that sophisticated policy makers in the early 21st century could make so many fatal errors.  But every country apparently assumed that its problems were its own and that growth in other regions would bail it out, if they could just stall and put off complete bankruptcy as long as possible.  These hopes are now being shown to be what they are – naive optimism used as an excuse to avoid difficult policy actions. Yet I still see no sign of more positive policy steps being taken.

Sadly, I see no way out at this point.  The latest data on purchasing indices shows Europe in the sharpest contraction since 2009, with even Germany showing a decline in manufacturing; China’s slowdown is exceeding all expectations with the economy apparently grinding to nearly a complete halt in Q2 2012; India and Brazil are in major slowdowns as well.  Only the U.S. is showing sustained positive growth, but that at a measly 1 to 2 percent; and U.S. policy is headed for a massive fiscal shock of increased taxes and decreased government spending (the ‘fiscal cliff’) after the election that will knock the supports from the sole remaining major economy showing growth.

From Nick Hastings, wsj.com/europedebt:  “Snap! Snap! Snap!  If the Euro were a house on stilts, that would be the sound of its supports snapping.”

Buckle up — it may be a very grim few years ahead….