The U.S. Looks Ugly Indeed, But It's All Relative

There are major imbalances across the global economy … Some countries save too much, others borrow and spend too much. These imbalances go back and forth as economies rebalance themselves.

The gut wrenching credit crunch of 2008 is a symptom of global rebalancing. And there’s no reason why it won’t continue well into 2009.

The Act of Rebalancing Is About To Get Real Nasty
For Export-Model And Oil Exporter Countries …

My outlook for 2009 is this: The U.S. economy could get a lot uglier. But the pain of rebalancing will be even more severe in Europe, Asia, and Latin America. And it will hit those economies a whole lot harder than is now priced into the market.

I think Treasury Secretary Paulson nailed it in his recent comments to The Financial Times:

“In the years leading up to the crisis, super-abundant savings from fast-growing emerging nations such as China and oil exporters — at a time of low inflation and booming trade and capital flows — put downward pressure on yields and risk spreads everywhere.

“This laid the seeds of a global credit bubble that extended far beyond the U.S. sub-prime mortgage market and has now burst with devastating consequences worldwide.

“Excesses built up for a long time, [with] investors looking for yield, mis-pricing risk. It could take different forms. For some of the European banks it was Eastern Europe. Spain and the UK were much more like the U.S. with housing being the biggest bubble. With Japan it may be banks continuing to invest in equities.”

Put another way, the U.S. financial system became saturated trying to absorb all the excess savings from the export-model and oil exporting countries.

These countries lacked internal investment alternatives and decided not to invest into their own economies. This created virtually “free-money” for the birth of massive levels of new, exotic derivatives and one of the core reasons for the lack of U.S. consumer savings.

The Cash Cow Has Dried Up …

In short, the U.S. isn’t recycling excess savings from China and oil exporters any longer because China’s exports and oil prices have plummeted.

U.S. consumers are starting to save again. And this has reduced spending on products from developing countries.

Many pundits imply that this is very bad for the U.S. But these same commentators fail to mention this situation is much worse for economies dependent on creating wealth through exports.

This category includes:

• China,

• Energy exporters (Middle-East, Russia, and Latin America), and

• Emerging markets dependent upon foreign bank funding.

The U.S is at the core of this rebalancing because it is no longer providing the funding …

U.S. consumers were saving with rip-roaring home prices and a booming stock market. But then — housing and stocks — got hammered. Now guess what: The U.S. consumer is saving again and U.S. institutions are deleveraging!

So, the pool of savings being created by U.S. consumers will help replace much of the lost reinvestment from outside.

U.S. institutional deleveraging is painful. Nevertheless, the process of cleaning away dead wood for potential future growth is continuing. And remember, the U.S. has funding mechanisms others don’t have — deep capital markets and a flexible fiscal and monetary policy.

A Major Shift Going Forward …

Chinese workers are feeling the pinch as factories close and unemployment rises.

If I’m right about a major sentiment shift of debt and risk-taking going forward, the process in many other countries will be much more painful and take much longer than it will in the U.S.

These countries will have to make major changes to their export-export-export model. This means developing a viable domestic market. That means transferring economic and political power. And that means a lot of social unrest could be in the cards in 2009.

Consider …

• Emerging markets of all stripes have been cut-off from their funding sources. They’re unable to make it up through exports in a world where consumer demand may have changed for some time.

• Russia’s pure, energy-dependent economy is imploding and unrest is rising; some believe the Putin regime is in trouble of being toppled. This adds to the potential that Russia will lash out in order to whip up nationalist frenzy to divert attention from dwindling economic alternatives and freedoms.

• Social unrest in Russia will add to the riskiness of investing in Eastern and Central Europe, increasing the chances of country defaults in the region — Ukraine is already teetering! This will also add to Western Europe’s banking woes since they are hugely exposed to emerging markets in Europe and elsewhere.

• Rising tensions across the Eurozone increase the rising risk within the system as Greece’s and Italy’s fiscal status deteriorates by the day. Unrest in Greece among youth and anarchists could be the tip of the iceberg for broader unrest across the Eurozone as unemployment rises.

• Global demand for exports has evaporated. And China, the world’s biggest exporter, is feeling the pain in a big way. Factories across China are closing, unemployment is soaring, and social tensions are rising. This is a real wildcard. China knows its dependence on exports is coming around to bite them. Transition from an export-oriented to a consumer-driven economy doesn’t happen overnight. China was already moving down the path of consumerism. But in the foreseeable future rising unemployment, falling reserves, and dwindling corporate profits will likely crush China’s expected consumer growth in 2009.

• Latin America is highly dependent on rising commodity prices and exports. Already, Ecuador has defaulted on its bonds because of falling revenues as oil prices tumbled. And the prospect for a big rebound in commodity prices looks dim because global demand continues to weaken. Tensions are rising across the region, too.

So, yes, the U.S. economy is in trouble. And it could get much worse for the U.S. as unemployment seems set to shoot higher. But, it’s all relative. And relative to the potential for a lot more pain elsewhere, U.S. financial assets could surprise investors.

That’s why I remain bullish on the U.S. dollar.

Best wishes,

Jack

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