Reality is always evolving but we humans are reactionary, backward looking creatures. Perhaps to cope with the stress of change, we commonly exert mental gymnastics to justify and bootstrap the status quo. We are all vulnerable in a tendency to see the world as we wish it to be. And so, we can easily see that other people have chubby children, but overlook the poor physical condition of our own. We can see that other cities or countries may have over-valued housing markets, but deny it in our own. We can see in retrospect that tulips and technology were clearly “crazy financial bubbles” and yet argue to justify present day stock and commodity prices. Human behaviour is remarkably consistent in this; has been since time began.
For the past 5 years, much has been celebrated about the incredible connection of our “globalized economy”. Worldwide efforts to jump start consumption were ultimately successful after 9/11, thanks to rate cuts which pushed global borrowing costs to 50-year lows and financial innovation like credit derivatives, and consumer appetite for debt, to multi-decade highs.
Today we are now cleaning up from the spending orgy that was. After years of madness the average consumer is quite literally “spent” and suffering the predictable aftermath. Bankruptcy and foreclosure rates are surging all around the world. Housing values are stagnating and falling all around the world. Economies are slowing and contracting all around the world. Recently the International Monetary Fund (IMF) forecast that global GDP which has grown at a truly awesome 4.9% annually 2002-2007, would fall back in line with its 45-year growth rate of 3.7% in 2008, and bringing the global economy to a .7% hair’s breadth above the 3% needed to avert global recession.
Spurred by voracious, seemingly insatiable, consumption this cycle, commodity prices over the past 8 years have doubled many times over.
But this is all to speak of what has been. A frequently expressed wish today is that global consumption that was once so intensely “coupled” shall henceforth “decouple”. Notwithstanding slowing western consumption, it is argued that commodity prices need not correct meaningfully from here, thanks to on-going growth in the developing world. But to be prepared for the next phase, we must interrupt a fanciful outlook for a glimpse at reality.
Despite strong demand in Asia, particularly over the past three years, the flow-on effects of the housing and economic problems in the US are becoming more and more obvious in the form of reduced Asian exports; declining capital flows; the credit crunch and tightening liquidity; volatile and weakening asset markets; and lower corporate profits. A May 6, 2008 S&P report notes that “domestic growth drivers and increased intra-regional trade will not offset a significant slowdown in exports to the US and Europe.” See Asia’s sovereigns must exercise caution.
Dubbing 2008 “The Year of Recoupling,” Morgan Stanley’s Richard Berner points out that despite the export benefits to US companies of a weaker dollar, the slowdown in US demand brings slowing growth abroad which comes full-circle to hurt US earnings abroad as well as the earnings of foreign companies.
And just as the US government is sacrificing inflation and fiscal prudence to prop its faltering economy in an all important election year, so too is China. “While governments attempt to balance the short-term growth targets against longer-term structural and inflationary challenges, the ratings agency questions the extent to which policymakers will exercise prudence for the sake of longer-term benefits, or implement ill-conceived measures in the hope of gaining support for the upcoming legislative and presidential elections due across the region this year.” Once again, we see that humans are the same everywhere.
What we must see is that millions of people bought homes and other “stuff” with money that they never actually had. Half of all U.S. homeowners who bought at the peak of the real estate bubble in 2006 owe more on their mortgage than their home is worth today, according to real estate Web site Zillow.com. About four out of 10 who bought the year before or the year after are underwater on their mortgages. In Las Vegas, 90% of homeowners who bought in 2006 owe more than their home is worth. In Stockton, Calif., it's 95.8%. See “Your house is so underwater you need a submarine to get in the front door.” And not just in the US, deleveraging is a phenomenon that is now playing out in varying degrees all around the globe. Yes! In our back-yard too!
What many wealthy people (like Wall Street and politicians) may miss, is how utterly soul-destroying it is for regular people to face the loss of their homes, lifestyle and the relative sense of safety that goes with it. Once people have seen and felt this real-life risk to their family, they often have a sentiment shift. Broad-spread in the population, these individual shifts become a societal value shift often lasting many years. If past behaviour is our guide, western consumers will not be bouncing back into zealous consumption-mode again any time soon.
Our imbalance in the western world has been facilitated by great imbalance in the eastern world. It’s as simple as that. Our correction period in the west will be a correction period in the east. To insist that domestic growth in the east will be sufficient to absorb the slack from the fall-off in western consumption, without a downturn in net demand or earnings is surly fantasy. We are all in this together.
Cory’s Chart Corner
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