A friendly client reminded us recently of a statement we had made in the aftermath of China's monetary response to its 2005 yuan appreciation. In order to make sure that a potential export slowdown (which never materialised) did not derail growth, China flooded its economy with money. M2 money supply growth jumped from 14% year-on-year in early 2005 to more than 18% year-on-year in the months following the revaluation. Our comment afterwards was that “we did not foresee how willing the Chinese would be to inflate their system.”
Well, we have suffered from the same lack of foresight again in 2009. While China has been the worst inflation offender, the rest of the world has tried equally hard (and managed some success in asset prices – not Japan, though). The reason we rarely predict this politically engineered frenzy is because we know that it makes no sense and has no lasting real effects. It merely exacerbates imbalances.
We always hope for rational policy-making but, so far, we have always been disappointed. Oh well, at least it makes the job of pinpointing the countries with impending crises easier – in the long run. And 2010 is shaping up to be a long-run year.
The Next 12 Months
Central banks and governments have convinced themselves that they have saved the day (by pouring more money and debt on an over-leverage problem). Their arrogance will ensure that they will begin to test exit strategies in the next few months.
Central banks will be the first to halt quantitative easing strategies (the Fed is particularly adamant that no more is required once the current US$1.75 trillion buying programme runs out). The growth momentum in narrow high-powered money is already slowing sharply. Governments too will attempt to scale back on their budget deficits, mostly by raising taxes.
The result, in our view, will be renewed weakness in asset prices and renewed weakness in economic activity. Far from the crisis being over we expect to see a resumption of major strains in the system. Here are our general predictions for the next 12 months.
- Central banks, led by the US Fed, begin to exit asset purchase programmes. Equity markets immediately relapse and treasuries rally.
- Credit spreads begin to widen in mortgage-backed securities and municipal debt. Risk aversion increases in all credit markets. Emerging-market debt sells off.
- Volatility in markets increases with 2009’s leading asset classes the most vulnerable. Consensus has already bet heavily on continued appreciation of commodities and emerging markets as well as a further fall in the dollar. These are correlated bets. Rising risk aversion equates to a strengthening dollar and a reversal for consensus.
- Problems that have been pushed to the background while cash has been abundant will re-emerge. Residential mortgage defaults will continue to rise, Fannie Mae and Freddie Mac will re-enter crisis. Commercial property defaults in the U.S. will grow to crisis proportions. Eastern Europe currency pegs will come under increased pressure and eventually break. Defaults associated with the shipping industry will increase.
Gold, Unemployment and Inflation
- Gold will increasingly be viewed as a safe haven and a store of value. Despite no emergence of consumer price inflation it will rally hard as physical demand increases and subjective valuations rise. The current system of central banking is fatally flawed and gold is one of the few acceptable prospects as an anchor for a new world financial system.
- Over the next few months, before the financial crisis reasserts itself in a meaningful way, regulators will be busy enforcing costly new prudential regulations and restrictions on banks and financial services companies. Along with the removal of easy money injections these will weigh heavily on bank profitability. Expect a sector de-rating.
- Global growth will disappoint as the private sector in developed and emerging countries does not recover as expected. The weakest link in the demand chain will not be the consumer (who will be subdued) but business investment. Interest-rate signals are too confusing, capacity too plentiful and the outlook too uncertain (both in terms of demand and taxation) for capital spending to revive.
- Unemployment in the U.S. and Europe will continue to rise with the headline rate exceeding 11% by end 2010 in the U.S. Consumer demand in the global economy has reset to much lower levels than pre-crisis.
- Monetary inflation in China will cause major problems in overcapacity and asset prices. Generalised consumer price increases in non-tradable goods and services will rise sharply in 2010. A crackdown in monetary expansion will lead to the re-emergence of recessionary signals in the near term.
- By the end of 2010 world growth will again be contracting as the credit contraction in Western economies intensifies and the Asian domestic demand story disappears. Only India truly has a domestic demand-led economy in the region. Commodity prices (industrial metals in particular) and commodity currencies will be in general retreat as a result.
Global Recession
In short, after eight months of market rallies and the most extraordinary experiment in monetary and fiscal policy ever, we are more concerned about the market and economic growth outlook today than we were 12 months ago.
Could markets hang on in there for another year? Yes, it is possible. However, it is not our central scenario. Markets and taxpayers are pushing central banks and governments to normalise policies. The process of doing so will show the world that we are not even in the third innings of this crisis. Money can paper over the cracks in economies and financial systems for a while but it cannot cure the underlying cause of the malaise: the distortions and misallocations of capital that built up in the preceding boom. These can only be addressed by liquidation and by time.
2009 has been the eye of the storm in the global financial crisis. In 2010 the constraints to public policy will become apparent. We expect global GDP growth of no more than 2% in 2010 – effectively a recession, if we follow the IMF’s definition pre-crisis of global recession as 3% GDP growth.
About the Author
Dr. Jim Walker is founder and managing director of Asianomics Limited, an economic research and consultancy company servicing principally the fund management industry. Formerly chief economist at CLSA Asia-Pacific Markets, he was one of the few economists who correctly predicted the 1997 Asian financial crisis and the current global recession. This article is excerpted from “Green Planet: State of the World,” a 76-page Asianomics report published in December 2009. Asianomics Limited is a subscription only service. For further details please visit the Asianomics website at www.asianom.com.
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