How low can global economies go?
Posted on 13 May 2009 with no comments from readers
Dubai Holding has released the conclusions to a report about the global business outlook that it commissioned from the Economist Intelligence Unit based on a survey of 418 senior global executives.
It concludes ‘capitalism is entering a new era of lower risk tolerance, higher regulation and slower growth’. In other words, the debt-driven investment boom is over, government interference in business will grow and economies will not recover quickly from the recent slump in global trade.
Reaching a bottom
However, there is a tacit assumption here that the decline in economic activity has fallen to a market bottom. But do we really have any reason to make this assumption, apart from wishing it to happen? Just how low will economies go before the bounce back starts?
Nobel prize winning economist Paul Kruger yesterday warned against expecting a ‘V’-shaped economic recovery which he deemed ‘highly unlikely’. Billionaire investor George Soros sees an ‘L’-shaped recession that could last for years. Microsoft is planning for something similar, and issuing bonds to cut its capital cost is part of this strategy.
You have to wonder about the UK economists yesterday who greeted the 12.4 per cent fall in 12-month industrial output, the worst since 1968, as marking the bottom of the recession. Or those who noted the 22 per cent fall in Chinese exports in April – the sixth falling month in a row and the biggest decline – and could still smile.
What reason is there to expect a recovery? Where is the recovery coming from? The stimulus packages are clearly softening the blow but can not replace the spending power of the global consumer. The banks are borrowing cheaply but still not lending cheaply nor on any scale.
Indeed, it is hard to see the fountain of global credit becoming more than a trickle. There is still the debt mountain from the boom years to unravel, and banks that have recently been rescued are going to be subject to more regulation to prevent a repeat of recent reckless lending.
Consumer spending
In this climate the consumer is going to stay under pressure for many years. Those who lose their jobs will suffer the biggest contraction in their spending, and those who worry about losing their jobs will be more cautious and save.
There are also clearly a lot more job losses to come as businesses gradually concede, or are forced to appreciate, the need to cut back staff numbers. UK unemployment jumped by 244,000 in the first quarter, the most since 1981; 539,000 Americans lost their jobs last month.
So while the rate of economic decline might have slowed down, and we are no longer falling off a cliff perhaps, global economies will most likely continue to slide downwards for a period before stabilizing at a lower level of output, and then stay at this level for a number of years while debts are repaid and global imbalances adjusted.
no Comments posted by readers:
Peter:
I apologize in advance, for this rather long-winded response!
I always enjoy reading your commentaries; in your recent commentary (How Low can Global Economies Go?), I agree with your analysis and your conclusions, but I believe you’ve overlooked a few very significant events over the past few months that underscore your conclusions. You state that the “consumer is going to stay under pressure for many years.” That is certainly true.
But US corporations are also going to be under pressure for many years; they will find it increasingly difficult to raise capital from both the bond markets as well as the equity markets, for reasons that I outline below. I’m recently retired; yet in my entire life, I’ve never been a pessimist. I say this because what I’m about to write will sound very pessimistic.
The Business Climate Looks Dark and Dismal:
As I ponder the events of the past few months, the outlook for business and investment in the US (and elsewhere in capitalistic countries!) looks rather dark. One of the reasons is because the US Code of Law has changed. So have the investment freedoms which made this country great. In the capitalistic west, there are specific corporate laws and credit contracts that determine how bankruptcy courts distribute a corporation’s assets, and senior bondholders are first in line. In order to ensure the proper functioning of capital markets, this Rule of Law is extremely important. These laws, and the investment “freedoms” related thereto, are a principle reason why capitalistic societies have prospered in the past. If the US deviates from the “normal and expected” rules of capitalism, what does that say about capitalist countries in Europe or Asia?
Simply stated, the landscape has now drastically changed.
A “Black Swan” Event in the Chrysler Deal:
The US government violated (and drastically altered) the US Code of Law pertaining to corporate bankruptcy (e.g. Chrysler). This violation occurred when the Obama administration deliberately coerced the senior bondholders of Chrysler to accept a tiny fraction of their original investment (in order to illegally grant the autoworkers the lion’s share of stock in the “new” Chrysler). This is morally wrong and deeply troubling because this single act has major “unintended” consequences, that impact: a) the freedoms of US citizens (particularly as they pertain to investments), and b) the willingness of Americans to invest capital for corporate growth.
A Few Facts, according to press releases:
1. The US deficit is now four times last year’s deficit, which was a record.
2. The US government will borrow about 50 cents of every dollar it spends in 2009. What does that portend for the 10 year or 20 year US Treasury rate?
3. The P/E ratios of the S&P500 are out of sight in 2009, primarily because of little or no earnings. Bull markets are never born under these conditions.
Inferences from the Factual Data:
With high government bond rates, what does that tell us about corporate bond rates in 2013? And what if you are an investor? If you have the opportunity to buy senior bonds at an attractive interest rate (say 10%) in a corporation, would you be willing to do so, knowing that if that company declares bankruptcy in the future, your government may “intervene” and change the bankruptcy rules, in order to favor another group of individuals over the senior bond holders? If corporations don’t grow, how can their P/E ratios improve?