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Normally in our Weekly we follow the step-by-step developments of the US economy and its impact on the rest of the world. We identified the sub-prime problem very early this year, specifically when HSBC was the first bank to reveal losses related to sub-prime, and we reasoned that US household spending had to decline if consumers could no longer finance their excess spending by mortgage equity withdrawal. We were less prescient on the associated credit squeeze when mortgaged-backed assets proved so fragile, but so were a number of very senior bank executives! We likened the two themes to the heads of a monster attacking the economic system, and even added a monster’s tail in the form of unravelling the carry trade with subsequent major realignment of interest rates. Our principal observation this week is to emphasise that the monster is far from being slain. The sub-prime knock-on effect on consumer spending, the revelation of more CDO-related losses and the weakening of the USD have much further to run. Last week we surmised that insurance companies might be holding undeclared investment losses. Already, “monoline” insurers, who insure corporate bonds and structured products, look like being the next victims of the sub-prime debacle. |
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This week it seems opportune to step back and view the world’s economy for its mega-trends, and we confess that our attendance last week at the AsiaHedge conference is partly responsible for us adopting this perspective. Viewed from Asia, the growth of housing repossessions in the US and UK, the lack of liquidity in Western inter-bank lending and in bond trading, the pause in mortgage securitisation and the tightening of lending standards, all seem a long way away. Asia is booming. Everyone knows that, but only a visit really brings it home. Emerging markets everywhere are flourishing, and we are gratified to have recommended for many months emerging market bonds in local currencies. It is still difficult to take action on that recommendation for China, but opportunities are gradually emerging. |
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Can the chief mega-trend be summed up in a single phrase? Our proposal: “the relative fall of the USA and the rise of Asia”. The process, which has been underway since the turn of the century, has accelerated as a result of the sub-prime crisis, but will still take many years to work through to a more stable, tri-polar and balanced world economy. What are the symptoms of this mega-trend? |
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- An ever weaker dollar as both cause and effect of the reduction of the US share in the consumption of the world’s production
- Belt-tightening by US households as spending is adjusted down to match (still high) earnings
- Inflation of raw material prices
- A Europe which survives relatively unscathed, owing to its own domestic growth and its participation in the Asian boom, but also because, with the possible exception of the UK, Europe has avoided the temptation to spend more than it has earned at national and household level
- Strengthening economies in almost the entire emerging world, even including Africa
- Sovereign Investment Funds steadily “buying up America and the West“
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We are still wrestling with the question of deflation versus inflation (see Weekly of 17.10). Of this we are sure: the Chinese are basically in charge of the exchange rate of the USD. They are slowing its decline compared with what free markets would decide. We can but regret that the RMB and HKD are not freely convertible and that their exchange rates are controlled. Opening the Chinese economy and financial markets is the single most important change needed to ensure complete rebalancing of the world economy. |
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Focus |
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(!) CDO victims in 3rd Q: Merrill Lynch is going through the worst crisis of its 93-year history. Losses at USD 8.4 billion, up from USD 5.5 first announced, exceed the combined losses of the next four losers. Countrywide lost USD 1.2 billion. UBS lost CHF 4 billion on sub-prime. All are revamping their risk management. |
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(+) Brazil: owing to the outlook of further foreign investments into South America’s largest economy, the Real continues to strengthen, having already doubled against the USD over the last five years |
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(?) Argentina: rumours of manipulation of economic data against the background of the election of Cristina Fernandez de Kouchner |
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(-) Norway: Be aware that some depository banks are already demanding the names of final investors in NOK Government bonds even before this becomes mandatory. No date has been set. |
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(+) positive for bonds (-) negative for bonds (!) watch out (?) begs a question |
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