Saturday, 14 February 2009

The Global Race to the Bottom

Since the financial carnage during late 2008, the real effects of the credit crunch have now started to be fully felt with members of the public now under no illusion of the severity of the situation the world finds itself in. No country has been isolated. The question is, how much worse can it get? Is the world heading towards a path of destruction?

Consumption based economies, resource rich nations, export driven countries - all have been hit hard by the turbulent events we find ourselves in. Since the collapse in commodity prices, after the huge de-leveraging that began in September last year, resource rich nations have come under intense pressure. The Rubble is in dire shape as Russia's Oil and Gas revenues have dried up. Run under a corrupt political system that is trying to keep together its fragmented collection of states by use of oppressive force which now seems unsustainable in the long run. Mexico, whose low cost manufacturing operations have been hollowed out in recent years by the lower Chinese labor costs, has been heavily reliant on it's Oil revenues, however production has been in decline for a good number of years. Along with the collapse in Oil's price, the nations stability has become questionable. The Peso has slid to record lows recently, with the Central Bank trying to stop the slide. Markets always have more money then Central Banks, however authorities always like to waste money to try and prop up their currency as though that changes fundamentals. It's remains to be seen if Venezuela can remain solvent with Oils new low price. Iran faces increasing fiscal pressures, along with other Middle Eastern states in an already unstable region of the world.

The Euro continues to mask the various problematic states that hide behind it. The Mediterranean nations and the Iberian Peninsula, Portugal, Spain, Greece and Italy all with a traditional weak work ethics and a short association with democracy, seem like they could once again fall under a Totalitarian dictatorship once more. Salazar, Franco, Mussolini or the "Junta" - we could well see a new generation of radical political movements. Germany's output has collapsed, as its export market has dried up. Eastern Europe's economic miracle after the break up of the Soviet empire is beginning to unravel. Latvia posted a 10.5% fall in GDP in the last quarter in 2008. After the IMF bailed out Hungary, the government are looking to cut government spending and balance the books further. Meanwhile in Ireland they have begun looking at cutting public pay, in order to keep the illusion of solvency for the time being.

After the surge in the Yen last year, as the unwinding of the Yen carry trade took its course, the BOJ will no doubt try and stem the rise by looking at measures to devalue, as its exports have fallen off a cliff. Many of the other Asian nations have not fared any better. China's exports have also collapsed, but so has their imports by a larger amount putting pressure on resource rich nations in the region such as Australia. China's creditor position, now as cash is king, is finally beginning to buy into the markets it will so desperately need when its rise as world superpower resumes. Layoffs in the urban cities continue to displace people back to the countryside, and its not just China where layoffs are occurring in Asia. Taiwan, South Korea, Vietnam all of these export based nations are suffering.

Back in the UK, Ed Balls, Gordon Browns trusted advisor and friend who recommended granting the BOE independence back when Labour came to power, stated recently that this was the worst financial crisis in 100 years. He also mentioned we could see a rise in extreme right wing politics as unemployment increases. Just like the 1930's another crisis in "Capitalism" has arrived, with worldwide contraction occurring once more. Once more the same mistakes are being committed. The Krona collapsed last year, however this won't be the last currency collapse of the crisis, or for years to come. There will be more that come under pressure. The Forint, Rubble, Dollar, Pound or Euro - no paper currency will be immune to what is happening. Continual debasement will occur and further currency crisis seem inevitable as a race to the bottom takes place.

The US are leading the world with further bailout packages. Obama's recent stimulus plan will soon be in the system. Who will pay for it? Who will pay for the $1Trillion and growing budget deficit? Domestic citizens? Foreigners? In the climate we find ourselves in? Recent losses have been announced at the recently formed giant UK banking group Lloyd's. More pain is yet to come, along with further nationalisation of the UK banking sector. In a post I wrote just before the globe came close to financial collapse, I said there will be a limit to how much Governments will prop up institutions and infuse money into the system. Well it looks like I was wrong on that point as most governments are more incompetent than I gave them credit for.

The 'Fear' Index

Since the Credit Crunch began around 18 months ago, we have seen great volatility in the stock markets and the currency markets. One measure that is used to measure volatility in the S&P 500 stock index is the VIX index, the volatility index, which the below chart illustrates.

The parabolic move, that can be seen in September/October of last year shows how distressed the financial markets became during this period. If we look at the blue line in the middle graph (the 50 day moving average of the index) we can see it has steadily been rising from a low of 0 in October 2007 (Just after the Credit Crunch began), to around 35 currently. Its been on a downtrend for the past couple of months, so does that mean the worst is behind us? Far from it. We are just starting the Bull market in market volatility as the graph illustrates, with further, and in my opinion greater shocks to come. A recent downtrend has emerged but for how long? The Western stock market will not be a place to be for at least the next decade in my opinion. The bailouts, money printing, increased government intervention, currency instability and record low interest rates will ruin the free markets price mechanism and further flatten the production structure. These destructive effects are yet to be felt.

So who will suffer the Worst and who will lead the upturn when it comes?

We are not going to see an upturn in 2009. That's for sure. The exporting giants, such as China, Germany and Japan will suffer a great deal, indeed China should fall into a serve depression if it allows markets to work their magic (I mentioned back in May that this should be expected). Germany and Japan should follow similar fates. In fact nations similar to this will experience as bad downturns if not worse than consumption based nations such as the UK and the US. But some of these nations should lead the world economy out of the downturn when the markets have cleared, along with resource rich nations such as Canada as people will always need materials. They already have the productive capacity or resources when the recovery arrives. The key thing is that they let their domestic markets clear. As Japan illustrated this is not always the case. China will no doubt experience shocks and inevitable set backs (just as the US did back at the turn of the Twentieth Century with the panic of 1907, or the UK did at the turn of the Nineteenth Century with the wars with France), but their leaders are about as Communist as Adam Smith, and have a long term outlook to supplant America as the economic superpower. They are not concerned with short termism, polls, or quarterly GDP figures. They are concerned about building a productive capacity, and becoming the economic engine of the globe. 600 years ago China was the largest economy in the world under the Ming Dynasty. There's no reason why it can't be again. The other Asian giant, India, may well suffer from their larger public sector debt than other countries in the region. For all India's progress, there are still great issues there, whether it is their poor infrastructure (bad roads, frequent power cuts) or the caste system, I still see great potential but it will be limited by these factors.

Nations similar to the UK and US, who have used up most of their natural resources, are running huge deficits, have lost all thrift and have lived on a mirage of debt and cheap goods will be the slowest to recover. Many Western Countries belong in this category. Countries like Italy and Greece, with greater life expectancy, will suffer even worse fates as their vast public sector debt will no doubt drown out any possible recovery. Nations such as Germany may well be hampered by nations such as these as they try to hold the Euro together.

After the fall of the Roman empire, European culture went backwards not forwards. It slipped into what is now known as the dark ages, as the Islamic nations along with the Orient, became the cultural centers of the world, producing goods that fascinated the outmoded Europeans. It wasn't until the fourteenth century that the Renaissance began in Europe, with cities such as Florence and Venice importing goods and ideas from the Orient and the Middle East. The conquests of the Islamic Moors on the Southern Iberian Peninsula further dispensed wisdom and knowledge that spread slowly throughout Europe. The Occident, or what we now refer to as the West, began a long transformation, increasing their material wealth and ideas. Once again, Eurasia finds itself in what seems like a similar junction. Ideas, knowledge and culture are flowing in the reverse, from West to East. In the past it took centuries. This process may well take decades, as technology has increased the ease and speed at which ideas can be spread. The race to the bottom has begun, but who will be the first to resume the race to the top when the recovery arrives?

To fight and conquer in all your battles is not supreme excellence; supreme excellence consists in breaking the enemy's resistance without fighting.
Sun Tzu, The Art of War

By nature, men are nearly alike; by practice, they get to be wide apart.
Confucius, The Confucian Analects

No comments:

Post a Comment