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“..bringing our (the USA’s) wants and needs into realignment after two decades of narcissistic debt accumulation to finance an unprecedented spending spree on consumer durables (we would add “and housing” – bridport) is going to involve years of savings and frugality”. Thus, Merrill Lynch, elegantly re-expressing the views we have been developing and expressing in our Weekly over the last few years. The key message is that the present economic problems are not just a short-term cyclical setback, they are long term and can only be overcome by the USA adapting its consumption to its production at government, national and household level (we deliberately leave corporations out of this list) |
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May we allow ourselves to remind readers of what we have been saying in support of this pessimistic outlook: |
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- The underlying problems of the USA reflect the historical Greenscam policy of throwing cheap money into circulation to solve threats to growth, thereby countering all economic forces that sought to balance earnings, spending and saving.
- The economic force which first refused to give way to the cheap money policy (which ironically was caused by cheap money) was the bursting of the housing bubble, which both set off the related problems and also prevents their correction until housing turns round
- The credit crisis results from the housing crisis, amplified by the separation of risk from reward (the CDO and off-balance sheet phenomena)
- Tax rebates can delay consumer belt tightening, but cannot stop the inevitable
- Lower spending and higher savings are desirable as a route to sustainable economic growth but are very painful on the way (lower consumer spending means a falling GDP)
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Pimco introduce another consideration, viz. that Keynes recommends increased government spending to offset lower household spending during periods of recession, thereby alleviating the decline in GDP. Pimco therefore applaud the fiscal rebate. The problem is that this approach rather assumes the government has reserves built up during the good times and which can be called upon in the bad. Unfortunately the US Government (and many western Governments) has been at least as prodigal as households, in a sense setting the tone. In the meantime the Chinese hold ponderous amounts of government and agency debt and are not too happy about the continual decline of the USD. They only refrain from selling the lot because that would be shooting themselves in the foot. |
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There is a great temptation to consider the credit squeeze in isolation. Once all the write downs have been taken, will there not be an overshoot, upon which banks will declare that they can write assets back up, start lending again, and get the economy moving? Our answer is “no”, because of the first two causes in our list above (cheap money and housing). The old cheap money policy has run its course. To quote the IMF, “stemming the decline in the US housing market is needed to help both households and financial institutions to recover. (However), at the moment a bottom of the housing market is not visible”. |
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The deflationary environment, the emergence (or recognition) of which we raised a fortnight ago, is gradually overcoming inflationary pressures, with the first signs being the deflation of the commodities bubble. The second sign is the massive discounts being offered by retail stores in many countries (and the closure of some outlets by large retail chains). While we still expect one or two interest rate rises on both sides of the Atlantic, a few doubts are surfacing in our mind even about that. Bond quality and daringly long maturities are the best defence for the expected prolonged period of troubles. |
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Focus |
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(+) Germany: consumer confidence measured by the GFK index declined to 2.1 in August versus 3.6 in July, reaching its lowest level in five years |
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(+) France: household confidence fell by 2 points in July, a new low since 1987 |
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(!) India: the central bank raised its interest rate from 8.5 to 9% to combat 12% inflation |
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(+) USA: two new small banks declared bankruptcy Friday: First National Bank of Nevada and the First Heritage Bank of Newport Beach in California |
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(+) USA: Merrill Lynch announced expected write-downs of USD 5.7 billion, as well as a capital increase of USD 8.5 billion |
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(+) UK: house prices fell by 4.4% in July, the largest drop since the index was created in 2001. |
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(–) Iceland: the krona is the worst-performing emerging-market currency, as the turmoil in global credit markets made it difficult for the island country's banks to refinance debt. |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs the question |
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