The next few years are going to be very difficult with high unemployment, possible stagflation and social unrest — as we are seeing in Iceland and some of the Baltic nations. Already we are hearing protectionist voices and the future continuation of globalization could be severely tested. This year will almost certainly see negative growth overall in the G-7 countries and, at best, we will see some stabilization in the second half of the year.
We should, however, be looking for a more L-shaped recovery, rather than a typical V-shaped recovery and there is a very real danger that we could be going to follow a modified Japanese scenario of the 1990s!
The outlook is extremely opaque as we are in the accelerating point of the downturn. While both monetary and fiscal policies have become very relaxed in the US, the UK and elsewhere, funds have mostly been going to recapitalize the banking systems, where they are hoarded rather than re-lent, awaiting the next set of losses and the next recapitalization. US President Barack Obama’s major fiscal stimulus was passed last week and, whilst any tax cuts will have an immediate effect, the spending on infrastructure, etc., will take a considerable time to filter into the economy.
The current economic model, driven by deregulation and the financial markets, will require radical changes. The future model will have to look dramatically different.
Rather than increased bank regulation we need a regulatory agency to control the creation and issuance of financial instruments. This would prevent the introduction of instruments such as financial derivatives and subprime mortgages that do not make any positive economic or financial contribution.
Perhaps what we are seeing is the downside of globalization, where a crisis that began in the United States can infect all of the world’s major economies. It is this dynamic that is having a global impact because the US consumer alone has been accounting for 20 percent of global GDP — twice that of the entire Japanese economy.
Over the past 15 years, businesses in the US, Europe and Japan relocated their manufacturing capacity to places where operating costs were the lowest, for the most part being in the Asian region, especially China, making Asia the manufacturing heartland of the world.
The global banking crisis is now over in the sense that all governments are committed to save depositors, prop-up money markets and, if necessary, nationalize weak banks. What remains, however, is the almost complete lack of new profit opportunities for banks. So banks will have to break up and sell those businesses that are not part of their core competence. At the same time we’ll see much more aggressive consolidation of global banking and finance. How long before a Chinese bank buys a European or American one?
No industry or institution will be spared in the downturn and the biggest impact will be felt by companies in banking, construction, entertainment and the automotive business. Government and central bank action will not be enough to save either the financial system or the global economy. If the crisis was brought on by too much borrowing and spending you can’t solve it by increased government borrowing or by paying off all the bad loans with taxpayer dollars.
Around the world many banks will amalgamate with each other in order to survive. The US dollar will continue to lose its value. The Obama administration’s measures would provide artificial life support for the banks at considerable expense to the taxpayer, but would not provide them the margins and yield curves that enable them to resume lending at competitive rates. Another ceiling on banks’ growth is the danger of excessive regulation due to the large losses suffered by the general public. All this means that financial institutions and banks will be less profitable, and lose their level of importance in the economy.
With the financial system bailouts, US public debt has spiraled. It is expected that at some point in time foreign holders of some $15 trillion to $20 trillion of US paper could start asking questions regarding whether the yield is sufficient to allow for the perceived risks.
Moreover, China, the Middle East and other sovereign wealth funds may have greater priorities in funding and bailing out their own economies than investing in US paper. If these holders do lose their appetite for Treasury paper, US authorities could be forced to raise yields to a substantially high level — in the range of 10 percent or so.
China, for instance, may suffer from a severe drop in trade and foreign capital inflows. Because of its structural over-reliance on exports and manufacturing, China may be required to utilize its extensive stock of international assets to boost domestic demand and this could cause reduction in its purchases of US Treasuries. As a result, foreign demand for US government bonds could shrink drastically as the US requires increased funding for its bailout and stimulus programs. This could lead to extreme downward pressure on the US dollar.
Inasmuch as I try to present a positive outlook today, the realities are different: The economy will continue to slow down; more jobs will be lost, businesses will go bankrupt and real estate fall into foreclosure. It is doubtful that the attempts to stop this momentum will show any signs of success over the next 12 months.
This is a global depression that will touch everyone.
(Habib F. Faris [[email protected]] is CEO & managing director of FinaVestment Ltd., London.)