Changing Investment World: Decoupling is set to become a reality soon

Decoupling is set to become a reality soon

29 Jun 2010, 0920 hrs IST,Aditya Puri,


The world has changed structurally. On the ground, change will require time but the decoupling of the East & West has begun. The financial markets, however, are slow learners, creatures of habit, and therefore, create confusion in the short-term or transition (defined as volatility) period.

Basically, flight to safety still means gold and US dollar. However, we must understand that unless they invest these dollars in the US equity market or actively trade treasuries, there is very little return and the money would have to be returned or invested in growing GDP markets.

Also, the rating agencies (as usual) are behind time, resulting in rating bearing little co-relation to reality which distorts cost of credit. We only need to examine accepted facts to understand where the world is going.

Growth Rate

The forecast GDP growth rate during the next 3-5 years for the following countries are (%): 

• US: 1.8; 
• Europe: 0.8; 
• East Asia: 8; 
• China: 8.5; 
• India: 8. 

This reflects the level of structural adjustments required in the Western countries in terms of asset bubbles, financial contagion, stimulus, exchange rate, etc.

A high GDP growth rate on the other hand indicates that these countries were not structurally affected by the crisis. It also provides the countries with flexibility and time in addressing their problems.

Composition of Trade Between Countries

An examination of the growth/change between regional blocks is illuminating. Basically, the US and Europe, while important, are rapidly reducing as % of total trade while Middle East, Asian and African trade is increasing and also being focused upon strategically India-China trade has grown and will continue to grow exponentially. Political equations will be subject to economic reality.

Asia’s contribution to global merchandise trade has been increasing steadily over the years. In fact, Asia is the second-highest contributor to total global trade flows behind Europe. On the exports front, the Asian region has become the primary exporter to the advanced economies, especially the US region in the pre-crisis period.

However, imports have also started to pick up over the last few years as the Asian region (particularly China) is trying to change its economic structure from being export dependent to consumption driven. Overall, the contribution of Asian trade to total global trade has risen from 18.8% in 1983 to 24.8% in 1993 to 27% in 2008.

Africa’s trade with the rest of the world is also increasing though more moderately than in Asia. Africa’s share increased from 2.6% in 1993 to 3.2% mark in 2008.

There are important changes taking place within China as well. Growth is becoming less dependent on exports and more on internal demand.

Europe’s Govt sector a drag for years to come

The consolidated budget deficit or net borrowings for the eurozone in 2010 is likely to be close to 7% of its GDP. Even in the best case scenario, the net borrowing for the region is likely to remain over 4.5% in 2015. To put this in perspective, the ratio was just 1.2% in 2006. Also, government spending averaged 50% GDP and will not be anywhere close going forward, with resultant impact on the GDP.

Currency and Commodities

Currency and commodity markets will drive Asia’s growth momentum. Strong GDP growth both in China and India will power the demand for commodities. Structural bottlenecks in supply for a whole range of commodities from agricultural to mineral oil mean that prices in the long term are headed northward.

Besides, investors seeking higher returns on their investment will flock to Asia; this will result in a flood of capital and Asian currencies will see a phase of secular rise against their G-7 counterparts. This could erode export competitiveness, and economies within Asia such as India and Indonesia that are more internally focused, will outperform the others.

Unemployment

Employment is known to lag economic recovery and even if the growth cycle were to turn in the US and parts of Europe, it might take 2-3 years for the unemployment rate to go significantly below the current levels of close to 9%. Economies on the periphery of Europe such as Spain, with unemployment of around 25%, have seen permanent damage to their growth model and that will be difficult to repair.

Currency

In the short term, the uncertainty surrounding Europe, the possibility of deflation in China’s housing bubble will see a sustained search for safety. Old habits die hard and despite the US economy’s myriad problems, US treasury bonds remain the preferred safe haven for investors.

Thus, unless sentiment improves significantly and risk-appetite returns, the bid for the dollar will continue. In the longer term, however, America’s structural imbalances (particularly its fiscal overstretch) will catch with the dollar.

Since Europe and the UK find themselves in worse straits, much of the depreciation in the dollar will be vis-à-vis the Asian currencies and not the euro or the pound. The euro will survive but remain sickly in the foreseeable future.

India is destined for big things!!!. The real world is moving and the financial world will recognise events with a Lag.

Decoupling dies as half the globe hits crunch

Decoupling dies as half the globe hits crunch

By Ambrose Evans-Pritchard, International Business EditorLast Updated: 12:33AM GMT 12 Dec 2007

Economists are sceptical that cities such as Shanghai will be enough to offset a US slowdown
The rising economies of Asia are too small and deformed to rescue world growth as America, Britain, Australia, and Club Med face their day of debt reckoning. China may make matters worse, not better.

Read more of Ambrose Evans-Pritchard on the global economy

The seven pillars of global demand over the last year - measured by current account deficits - have been the United States ($793bn) (£388bn), Spain ($126bn), Britain ($87bn), Australian ($50bn) Italy ($48bn), Greece ($42bn), and Turkey ($34bn). Most are facing a housing bust. All are in trouble.

China cannot possibly step into the breach. Jahangir Aziz and Xiangming Li argue in a new IMF paper that China's economy is now so geared to the US and EU markets that a 1pc fall in external demand will lead to a 4.5pc slide in exports and 0.75pc fall in GDP.

Assumptions that it will weather a global shock are "likely to be wrong, perhaps dramatically."
China is indeed gobbling up iron ore, soybeans, and crude oil, but it still makes up less than 4pc of global consumption and is no longer adding to total demand. Imports have been more or less flat since April.

China is boosting GDP at the world's expense, by snatching markets with a cheap yuan. It is beggar-thy-neighbour growth.

Note that Goldman Sachs, Morgan Stanley, and Lehman Brothers, have all begun to tear up the "decoupling" manual. - the pre-crunch script assuring us that the world could get along fine as the US buckled.

"What began as a U.S.-specific shock is morphing into a global shock," said Peter Berezin, a Goldman Sachs strategist.

"There is a clear risk that some of the hot housing markets in Europe and some emerging markets will cool dramatically," he said. The bank has begun "shorting" the Chilean peso. Is the metals boom over?

In Europe, not a single junk bond has been issued since August. Spreads on Euribor - the rate used to price mortgages in Spain, France, Italy, and Ireland - reached 93 basis points last week, a new record. This is tantamount to four rate rises for homeowners.

Thomas Mayer, Europe economist for Deutsche Bank, said the European Central Bank must cut rates immediately, regardless of the lingering inflation threat.

"This could go beyond just a normal recession. It could turn into a real economy-wide crunch that we cannot stop," he said

Four months after the global credit system suffered its August heart attack, nothing has been resolved.

The US market for Asset Backed Commercial Paper (ABCP) shed another $23bn last week. The outstanding volume has fallen for 17 weeks in a row as lenders refuse to roll over loans, cutting off $393bn in funding since August.

For now, consensus has settled on the view that subprime losses will total $500bn, and crimp lending by $2 trillion as bank multiples kick into reverse.

This assumes there are no more shoes to drop. Yet shoes are dangling precariously across the global credit system. We may soon have to add the terms HELOCs and 'monoline insurers' to our crunch lexicon.

HELOCs are home equity loans, the money extracted from houses to pay bills and keep shopping. Many borrowers pushed their debt to 110pc of house values at the top of the bubble.
Moody's says 16.5pc of these loans are in arrears beyond 60 days. The HELOC market is roughly $600bn, so add another $100bn to the funeral pyre. These niches add up.

Monoliners are specialist insurers who earn fees by lending their AAA ratings to US states, counties, and cities for bond issues - the safest corner of the credit industry.

The nasty twist is that most have ventured into mortgage debt to spice returns. They now face enough losses to threaten their AAA standing.

A downgrade means that every bond bearing their guarantee must be downgraded pari passu. Pension funds and institutions will be forced to liquidate sub-AAA holdings. A fresh cascade of distress sales will ravage the $2,400bn 'muni' market.

The unthinkable now looms. Moody's said it was "somewhat likely" that top insurer MBIA would fall below the AAA capital requirement: Fitch warns of a "high probability" that CIFG Guaranty and Financial Guaranty will be placed on negative watch.

Both agencies are poised to issue verdicts. The insurers will then have a month to raise capital, no easy task after a 70pc crash in share prices.

US Treasury Secretary Hank Paulson confronts the very real danger of a credit implosion spiralling into a full-blown depression. Given the risks, he can be forgiven for pushing through a rescue plan last week that amounts to a flagrant abuse of contract law and capitalist principles.
His subprime rate freeze is undoubtedly a stinker. The reckless are bailed-out. Those who scrimped to amass a little equity get stiffed. Moral hazard runs amok. But bankruptcy settlements are always ugly. This differs only in scale.

Mr Paulson's New Deal may at least reduce systemic risk. Frozen rates concentrate losses in the lower tiers of mortgage debt, but rescue the upper tiers, which is where the threat lies for the financial system. Would free marketeers rather see the whole edifice of capitalism burned to the ground to make their point?

The root cause of this staggering debacle lies in errors made long ago by the Federal Reserve and fellow sinners. It was they who inflated the credit bubble by holding interest rates too low for too long. It was they who lulled their nations into suicidal levels of debt.

The strategic failure of a whole generation of economists, bankers, and policy-makers has been so enormous that it may now take a strong draught of socialism to save the Western democracies. We start - but may not end - with the nationalization of Northern Rock.



http://www.telegraph.co.uk/finance/markets/2820887/Decoupling-dies-as-half-the-globe-hits-crunch.html

Asia needs to fully wake up to the scale of the West's economic crisis

Asia needs to fully wake up to the scale of the West's economic crisis
Asia is not going to rescue the world economy.

By Ambrose Evans-Pritchard Last Updated: 10:06AM GMT 04 Jan 2009
Comments 28 Comment on this article

The news from Japan, China, and the Pacific tigers has moved from awful to calamitous since the global industrial system snapped in October.
A raw reality is being laid bare. The mercantilist export model of the East is proving dangerously geared to the debt-driven excesses of the West. As we go down, they go down too. Some are going down even harder.
Japan's industrial output contracted by 16.2pc in November, year-on-year. "For an economy which lives from the prowess of its industrial exports, this is simply earthquake," said Edward Hugh from Japan Economy Watch.
Japanese exports fell 26.7pc. Real wages fell by 3.1pc, the seventh monthly fall. Taken together, the figures are worse than anything during Japan's "Lost Decade". They have a ring of 1931.
The fall-out in Japan has already shattered the authority of premier Taro Aso. His approval rating has dropped to 21pc. The cabinet is in revolt. The world's second biggest economy no longer has a functioning government.
Credit Suisse warns that Japan could slide into deflation of minus 2pc by the autumn. Since interest rates are already near zero, which means that real rates will rise as the slump deepens – the surest path to a liquidity trap.
Kyohei Morita from Barclays Capital estimates that Japan's GDP shrank at an annual rate of 12.2pc in the fourth quarter. "It's shocking," he says. Singapore has already reported. Fourth-quarter GDP contracted at an 12.5pc annual rate.
Taiwan's exports fell 28pc in November. Shipments to China dropped 45pc. Korea's exports dropped 18pc in November and 17pc in December.
"We are looking right in the face of an unprecedented regional depression," said Frank Veneroso, the investment guru.
"If there is one part of the global disaster that is not reflected in today's massacred markets it is this Asian debacle. The source of the collapse appears to be above all a contraction in China."
One has to careful with Chinese figures. When I covered Latin America in the 1980s, veteran analysts watched electricity use to gauge economic growth since they could not trust official data. It is striking that China's power output fell 7pc in November.
Asia has clearly failed to use the fat years to break its dependency on the West. It has stuck doggedly to its export strategy – by holding down currencies, or by subtle policy bias against consumption.
In China's case it has let the wage share of GDP drop from 52pc to 40pc since 1999, according to the World Bank.
The defenders of this dead-end strategy are now coming up with astonishing proposals to put off the day of reckoning. Akio Mikuni, head of Japan's credit agency Mikuni, has called for a "Marshall Plan" to bail out America by cancelling $980bn of US Treasury bonds held by the Japanese state.
This debt jubilee does have the merit of creative thinking, but it is entirely designed to keep the old game going. "US households won't have access to credit they have enjoyed in the past. Their demand for all products, including imports, will suffer unless something is done," he said.
Let me be clear. I make no moral judgment on the "neo-Confucian" model, nor – heaven forbid – do I defend the debt depravity of the West.
A stale debate simmers over whether the Great Bubble was caused by Anglo-Saxon and Club Med hedonism, or by an Asian "Savings Glut" spilling into global bond markets and fuelling asset booms, as Washington claims. It was obviously a mix.
Two cultural systems interacted through globalisation, locking each other into a funeral dance.
The point is that this experiment has now blown up. Whether or not we slam straight into a global depression depends on how we – East, West, all of us – handle this.
The top sources of net global demand as measured by current account deficits over the last 12 months have been the US ($697bn), Spain ($166bn), Italy ($71bn), France ($57bn) Australia ($57bn), Greece (53bn), Turkey ($47bn), and Britain ($46bn).
Most are tightening their belts drastically, and in the case of Britain the shift has been so swift that the arch-sinner may soon be in surplus. If they are draining world demand, then world demand is going to collapse unless others step into the breach.
The surplus states – China ($378bn), Germany ($266bn) Japan ($176bn) – have not yet done so, which is why the global economy went off a cliff in October, November, and December. Beijing is planning a $600bn fiscal blitz.
But how much of it is an unfunded wish-list sent to local party bosses? It will not kick in until the middle of the year, an eternity away.
For now, China is dabbling with protectionism to gain time – a risky move for the top surplus country. It has let the yuan fall to the bottom of its band. Vietnam has devalued. Thailand and Taiwan are buying dollars.
Watching uneasily, the Asian Development Bank has warned against moves to "depreciate domestic currencies".
Anger is mounting in the West. Alstom chief Philippe Mellier has called for a boycott of Chinese trains.
"The Chinese market is gradually shutting down to let the Chinese companies prosper. There's no reciprocity any more," he told the Financial Times. Optimists say the collapse in oil prices will give Asia a shot in the arm. Governments are still flush, with ample scope for fiscal rescues. Asia's central banks are sitting on $4.1 trillion of reserves.
They have the means, perhaps, but do they have the will to act in time? Or do Beijing, Tokyo, Taipei, Kuala Lumpur, – and indeed Berlin – still cling to their assumption that others will spend for them?

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4093676/Asia-needs-to-fully-wake-up-to-the-scale-of-the-Wests-economic-crisis.html


Also read:
Decoupling dies as half the globe hits crunch
http://www.telegraph.co.uk/finance/markets/2820887/Decoupling-dies-as-half-the-globe-hits-crunch.html