A few days ago, Merrill Lynch and Co.’s North American economist, David Rosenberg, became the first mainstream pundit to say that the US has already entered a depression. He points out that even after unprecedented action by governments and central banks, there is no end in sight for the contraction in credit, bear market in financial stocks, or decline in real economic activity.
But won’t the measures taken by governments finally lead to a recovery by the end of the year? Unlike the majority of economists, Rosenberg doesn’t think so. He underlines the huge build-up of credit in the last few years and the need for it to be unwound.
He writes: “Considering that total private sector credit market debt relative to national income is still near a record high of 140% versus a long-run norm of 80%, the mean reversion process suggests that before we can even consider embarking on a fresh credit cycle, more than $6 trillion (Rs292.8 trillion now) of excess household and corporate debt has to be eliminated.”
His advice to investors: “Investors looking for growth should look beyond the American consumer and housing market. These areas of the economy, even after they stabilize, are unlikely to be the leaders in the next economic expansion or bull market. Investors are advised to seek out the countries, most of them in the emerging market world, who have the cash, the surpluses and the savings rates that can liberate consumers on the other side of the ocean. The global economy has relied for far too long on the American consumer for growth, but that well has run dry—and this time, for good.”
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There are two big themes in Rosenberg’s analysis—one, the decline of the US; and the second is the rise of the emerging markets. Let us take a look at the US decline theme first.
As I have said in this column before, the American state at present continues to be the big hope, not only for its citizens, but for international capital. But if, as more and more voices are arguing, the outcome of the crisis is a depression and if it leads to a fundamental change in the way the global economy has been arranged for the last quarter of a century, there could be huge tensions building up within the US.
The social compact there has been one where Wall Street makes huge profits from financial activities, its companies increasingly offshore their operations in places such as China and India, while Main Street prosperity is fuelled by debt and rising asset values. This system was engineered during the 1980s as a reaction to the Keynesian, social-democratic model that dominated most of the Western world until the 1970s. It revived growth, but also had the added advantage of disciplining labour, as a result of which the share of labour in national income in the US went down strikingly.
The problem is that it is not possible to get back to the world of the 1950s, a world in which there was no global production system.
As Morgan Stanley’s Stephen Roach pointed out years ago—first in manufacturing and now in services, the global labour arbitrage has been unrelenting in pushing US pay rates down to international norms. That effect has so far been camouflaged by the explosion of consumer debt in the US and the wealth effect created by rising asset prices as pension funds were freed to invest in the stock market.
But that harsh truth is now in the open. As Russian Prime Minister Vladimir Putin put it at the World Economic Forum at Davos, the explosion of debt “set the pace for rapidly growing personal consumption standards, primarily in the industrial world. We must openly admit that such growth was not backed by a real potential. This amounted to unearned wealth, a loan that will have to be repaid by future generations”. Perhaps it’s time the West stopped bothering about the impact of the crisis on China and started worrying about what it will do to its own societies.
As for investors putting their money in emerging markets, the summing up is best left to investment guru Jeremy Grantham. In an interview with Steve Forbes, he said: “We’re simply getting more mature, and all the other developed countries are doing the same thing. But emerging has not fallen off its trend line, and has a lot of people coming into the workforce and a huge savings rate. I think it will do very well. Put it this way, it will appeal to investors. It may not make any more earnings per share, in other words. I’m not talking about true fundamental value. I’m talking about how people buy stocks. They love topline growth. If they’re going to grow at four-and-a-half and we’re going to slow down to two-and-a-half, it’s going to look like a no-brainer. So, I think the next big event in emerging will be that they will sell it at a big P/E (price to earnings) premium over us developed countries, who are suffering from a terminal case of middle-aged spread, I think.”
I doubt if it is going to be so easy. The stresses and strains on Western societies with the shift to a new model may be enormous. Globalization will be under tremendous strain. The last time the world had a depression, it was followed by the rise of Nazism and World War II.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org