After a gruelling year, it is natural to hope that better times are around the corner. True, it is difficult to believe that the markets are going to get better right away and that we are going to see anything more than a bear market rally, but most experts are predicting things will look up in the second half of the year.
Is that likely?
After the dot-com bust, it took three years before the equity markets started to move out of a trading range. The Sensex peak of 6,150 reached in February 2000 was crossed only in November 2004, four-and-a-half years after the bust started. And yet—in spite of everybody saying the current bust is the worst since the Great Depression—we seem to be assuming the markets will recover much earlier than they did during the dot-com bust.
The reason for this optimism is that governments and central banks around the world have been very swift in providing both monetary and fiscal stimulus, which is why the hope is that recovery will be more rapid than usual.
But what exactly do we mean by usual? Does it make any sense to compare the current global crisis with previous ones? Even a Japan mired in a long-drawn-out recession had the option of sustaining its economy by exporting more to the rest of the world.
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If CLSA economist Eric Fishwick is right and the “shadow banking system” of derivatives and securitized debt makes up 93% of global liquidity, then the destruction of the credit derivative market and cutbacks in issuances of other types of derivatives and securitized paper will be certain to suck out huge amounts of liquidity from the system. Despite the best efforts of central banks, they will not be in a position to supplant all the liquidity that has evaporated as a result of the contraction of the shadow banking system. Once the excessive amounts of leverage in the system are wound down, liquidity too will fall.
A report by Nomura Securities Co. Ltd points out, “Our basic view is that any look at equities or other assets in 2009 must be through the prism of a capital shortage. Our numbers show that either the system must raise more than $1 trillion (Rs48.7 trillion) in new capital or else reduce assets by $14 trillion to achieve a leverage level of about 15x.”
The report finds that the forces of debt deflation resulting from deleveraging are far more potent than the forces of economic stimulation, because while 1% extra growth adds $140 billion to US gross domestic product (GDP), a 1% deleveraging subtracts $350 billion from US GDP.
And the global move towards closer regulation of the banking system means that the carefree days of casino capitalism are finished. The upshot: liquidity in the system may never be the same again.
Now consider liquidity from the point of view of the so-called global imbalances.
Japanese exports dropped at their fastest rate on record in November. China’s famed export machine is now working in reverse gear. That means the export surpluses of these countries are going to decline, which means, in turn, that they will have less surplus with which to buy US treasurys.
The global economy is, willy-nilly, being rebalanced.
Moreover, faced with job losses and with banks having tightened their lending standards, US consumers have little choice but to save. Personal savings as a percentage of disposable income in the US has risen from zero last April to 2.8% in November. And the more they save, the less they consume and import.
Andrew Sheng, former head of Hong Kong’s Securities and Futures Commission, writes in the Chinese magazine Caijing that if the US current account deficit (currently 4.8% of GDP) were to adjust back to 3% of GDP, it would cut back exports to the US to the order of roughly $320 billion annually, or roughly 13.5% in imports. This will seriously impact Asian economies.
That’s not all. Oil exporters such as the Gulf states and Russia, which too have built up sizeable surpluses, have also been hard hit by the fall in the price of oil.
All this will mean that the US may not be able to rely much longer on the kindness of foreigners. The US government will then have to rely on higher US savings to sell treasury bills at home or start printing money.
As CLSA consultant Russell Napier says, “When China succeeds in shifting to a consumer-driven growth model, it will clearly provide the key marginal demand for most global consumer goods. This will further reduce the need for the current export-oriented growth countries to manage their currencies relative to the US dollar in pursuit of export growth to the USA. The fewer countries that pursue such a policy, the less foreign support there will be for the US federal debt market.”
A report by Merrill Lynch and Co. economist Alex Patelis points out, “We suspect that markets and policymakers, in 2009, will come against…limits and side effects to stimulus. We believe that global rebalancing—the need for the US consumer to shrink and domestic demand elsewhere to expand—will be forced onto the global economy by the markets whether policymakers like it or not.”
The process will be far from painless.
Despite our best hopes, the world is unlikely to go back to “business as usual” for a very long time.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org