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Nassim Taleb,
author of The Black Swan, co-authored an editorial which appeared in
the July 14th edition of the Financial Times, titled "Time to
tackle the real evil too much debt". The dirty little secret is
that there is no avoiding the necessary pain and sacrifice that must occur in
the aftermath of what can only be described as a period of the greatest
overindulgence in the history of the world. Debt was the drug of choice
and now we will continue to experience the inevitable hangover. Looking
at the two jaw-dropping charts below, it should be quite obvious that it will
take quite some time to burn off the excess debt that was created.
Courtesy: Brian Pretti
"Going with the Flow" http://www.financialsense.com/Market/pretti/2009/0710.html
The western and developed world should
brace itself for an extended period of credit contraction and the road to the
"new normal" could be longer and bumpier than many economists first
thought. Taleb and many others believe "that stimulus packages, in
all their forms, make the same mistakes that got us here." Taleb's
editorial concludes:
"It is sad to see that those who
failed to spot the problem (or helped to cause it) are now in charge of the
remedy. Just as the impending crisis was obvious to those of us who
specialize in complexity and extreme deviations, the solution is plain to
see. We need an aggressive, systematic debt-for-equity conversion."
Ray Dalio, the CEO of Bridgewater
Associates, in a Barron's February 9th
interview who, according to Barron's "began sounding
alarms" early in 2007 "about the dangers of excessive financial
leverage, expresses concerns similar to Taleb's. Falling short of
calling for a conversion of all debt to equity, he tends to concentrate on
further restructurings as a necessary solution:
"They are cutting costs to service
the debt. But they haven't yet done much restructuring. Last year, 2008, was
the year of price declines; 2009 and 2010 will be the years of bankruptcies
and restructurings. Loans will be written down and assets will be sold. It
will be a very difficult time. It is going to surprise a lot of people
because many people figure it is bad but still expect, as in all past
post-World War II periods, we will come out of it OK. A lot of difficult
questions will be asked of policy makers... Only when those debts are
actually written down will we get to the point where we will have credit
growth. There is a mortgage debt piece that will need to be restructured.
There is a giant financial-sector piece -- banks and investment banks and
whatever is left of the financial sector -- that will need to be
restructured. There is a corporate piece that will need to be restructured,
and then there is a commercial-real-estate piece that will need to be
restructured."
The bottom line is that we find
ourselves buried in an avalanche of debt. The following picture which
appeared on the June 13th edition of The Economist
magazine pretty much sums up the situation:
Courtesy: The
Economist
http://www.economist.com/printedition/index.cfm?d=20090613
Multiply that baby by $300 million and
you have a good picture of our predicament.
The deleveraging process is likely to be
every bit as painful going down as is was delightful on the way up. The
question for investors is how in the world do you make money in an economy
saddled with debt? At some point, as the private sector off-loads its
debt to the public sector, the safehaven status of US treasuries becomes
called into question. And American companies are staring down the
barrel indebted consumers whose savings rates are likely to climb possibly
into double digits as they try to restore family balance sheets. Not a
whole lot of potential there except for perhaps investing in publicly-traded
debt collection agencies.
Many strategists and pundits who are
consumed in the "inflation/deflation" debate and who are trying to
time the sequence of when money velocity (M*V=P*Q) will once again rise and
unleash torrent of trillions of dollars of newly minted money (or will the
artful central bankers around the world withdraw the appropriate amounts at
the exact appropriate time and execute the most beautiful and deftly-executed
"exit strategy" of all-time) should consider a more important question...namely,
are emerging markets leaving us in the dust?
Two components are necessary in order
for this to occur. The emerging market countries need to have the
willingness and ability to do so. It was thought that they did back in
2007 when the term "de-coupling" swept the investment world's
stage. The theory was that China and other emerging countries we see
their economies and financial markets move in directions independent of the
US and the developed world. We all know how that turned out.
But much has changed since then.
The Asian-exporting countries, particularly China, are keenly aware of the
charts similar the ones posted at the beginning of this article. When
the Japanese commissioned the Maekawa report in the mid-1980s in an effort to
break their dependence on exports, it was not clear, as it is today, that the
US consumer is "down for the count". They didn't have the
incentive, as the Chinese do today, to make the change.
The recognition by the export-driven
parasites that they need another host country for nourishment will force
economies like Taiwan, Singapore, Hong Kong, Indonesia, South Korea and
others to seek another alternative destinations to deliver their
products. China is a prime candidate. China, while having a huge
trade surplus with the US, has had almost an equally large trading deficit
with its regional partners. This trend should likely reverse with the
US and accelerate with SE Asia and the commodity-producing countries.
Many will correctly point out that China
(and the other BRIC countries) does not yet have the ability to absorb the
loss of consumption that continues to occur in the US and the western
world. This is true. However, the moment that it becomes clear
that the emerging world will in fact supplant the developed world in
consumption, the primary concerns will no longer rest upon how long it will
take the West to deleverage or whether or not money velocity will pick up to
let loose hyperinflation; rather, it will be on how fast investment dollars
flow from the West to the East as investors rush to price in this watershed
event and current and capital accounts surpluses and deficits eventually come
to stage stunning reversals of capital and goods flow.
No sooner did Bloomberg
run and article earlier in the week ("Emerging Markets Priciest Since
2007 When Shares Fell") then did the emerging markets, in true
contrarian fashion, collectively take off again, exceeding the
highly-celebrated weekly gains (once again) experienced in the US market
indices. The article pointed out that the last two times the in which
the valuations of emerging markets were higher than developed markets (2000
and 2007) it marked a major "top" with a crash in all world markets
soon to follow. Will the third time be the charm and will emerging markets
leave us in the dust for good?
The two charts below support just that
possibility. In the first, we see that, for the first time, developing
countries oil consumption has surpassed that of the worlds' top 30 (OECD)
developed countries:
Courtesy: Chris Puplava
"Commodities: Bursting Bubble or Crouching Tiger?"
http://www.financialsense.com/Market/cpuplava/2009/0708.html
The second chart illustrates how motor
vehicle sales in developed economies have fallen below those in emerging
economies:
Courtesy: Dr. Marc Faber Monthly
Market Commentary (July 2009) "The Trouble with Our
Times is that the Future will Not Be what it used to Be"
I think it is safe to conclude that gains
in emerging market "real economies" relative to gains (or
continued losses) in developed countries will continue and will enentually
translate to developing countries capturing a greater share of overall world
stock market capitalization.
I fear that this trend will not stay
under the radar of the world's institutional investor's for much
longer. While the focus for now remains on restoring the economic
vitality of the US and the rest of the in-debted developed world, and on
the impact of the highly-anticipated exit strategy, if it becomes clear
that the the BRIC countries have transitioned from an export-model to more
balanced and domestically-oriented approach, then we might be reading
about a different kind of "exit strategy" -- how to exit capital
investments in the West and to migrate them to the East and the rest of the
developing world.
Kurt Kasun
www.greenfaucet.com
Also
by Kurt Kasun
A contributing
writer to GreenFaucet.com, Kurt Kasun writes a high-end investment timing service, GlobalMacro,
which is focused on identifying opportunities that produce returns in excess
of market with reasonable risk. He is strategically located in Washington,
D.C., a key to maintaining contacts and relationships which help Kurt
understand global policy and economic factors as they emerge. His investment
approach has always been macro in nature largely due to his undergraduate
studies at the U.S. Military Academy at West Point (B. S. National Security,
Public Affairs, 1989) and his graduate studies at George Mason University
(M.A. International Commerce and Policy, 2006).
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