Submerging Markets - Catching Down to the US

Posted by jeff

Thu Jan 15th, 2009 09:44 AM

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Let's take some time out from lamenting the dour economic news at home, the sense of betrayal we all feel by the collective gods of Wall Street, captains of industry and frauds of our country (Madoff, this means you), and take some solace in the fact that we're not the only ones who %&*(#@!^'d up royally.


As I have opined before, unsustainable growth breeds fraud and poor underwriting. I have also written before about the many bubbles that formed around the world as a result of the globalization of capital flows and low interest rate environment that prevailed in many large industrialized nations following the
dot-com crash. In some ways, we are very fortunate that the US was not the only place where a bubble formed. As a result of worldwide deflationary forces, the US dollar and our Treasury securities are being seen as a safe haven by investors worldwide. You can read some of the elements involved in the US becoming the Donald Trump (circa 1990) of the world - we owe so much money other countries can't afford to let us go under - in my prior piece, Devil's Bargain 2.0. The following are some lowlights of economic news around the globe:


Why Spain's Economic Crisis is More Than a Housing Slump - this article discusses the economic downturn that has hit Spain and how the country's rigid union wage policies will make the downturn even more difficult. It also underscores the deflationary pressure caused by collapsing land values as seen in Japan for the last 20 years.

Ireland, in contrast to Spain, is seen as a model of de-regulatory, business-friendly policies. The country embraced foreign investment, chopped import duties, rewired its telecommunications network and invested heavily in education over the last 20+ years. But the good times rocked on a little too hard and long. This recent New York Times article chronicles the troubles of the country's leading real estate mogul.

Another form of capitalism was incubated in Russia - Gangster Capitalism - and despite the cosmetic reforms implemented by the Emperor of Gangster Capitalism himself, Vlad (the impaler) Putin, Russia still seems to be the Wild West of the world. The recent natural gas crisis involving Europe and the Ukraine is just the latest example. This recent article from German Magazine Der Spiegel walks through how the Russian oligarchs lost 180 billion euros in the economic crisis through frivolous behavior and excessive use of leverage. REAGAN FIXED THESE GUYS BUT GOOD; WE BROUGHT THEM CAPITALISM AND DIDN"T GIVE THEM THE INSTRUCTION MANUAL.....HELL, WE SEEM TO HAVE MISPLACED IT OURSELVES.

Fraud goes where the money is, and India certainly has been a nation that was making lots of money in recent years, leveraging off the Y2K software conversion business a highly educated, English-speaking population and relatively low wage rates. The Satyam scandal may be the only malfeasance that took place in India....NOT!, but even if it is, I guarantee you there was a ton of bad risk underwriting involved in the soaring property and stock markets.

Seeking Alpha, a web site targeted at the hedge fund set, gets a decent amount of thoughtful commentary, analysis and research by people with real expertise in various markets 9I say that because I'm a contributor). I love to read everything written on China by Michael Pettis, a professor at Peking University's Guanghua School of Management and ex Wall Street trader. He wrote a piece recently about how the economic implosions worldwide are now catching up with the great producing nations of the world....who in many cases don't have the government debts or consumer debts that the great consuming nations do. His contention is that the surge in unemployment could be even sharper in these nations and could lead to protectionist or economic expansionist policies that could cause a global trade war.

Even Japan, which took very little part in the world's bubbles this time around is taking a significant hit due to its status as one of the great exporters and premier manufacturers of high- quality goods. This recent Bloomberg article highlights that Japanese machine orders fell by a record amount in November.

Stresses on foreign economies are being expressed by increasing prices for debt default protection in the credit default swap market, as noted in this Bloomberg article. The pressure on European economies, particularly those that enjoyed high growth rates previously, like Ireland and Spain, is expected to put downward pressure on the euro for some time to come.

Obviously, as much as it may make us feel better to know we are not alone, the downside of this global economic slowdown is that there is precious little place to hide from an investment standpoint, and few catalysts for future growth. The system needs to be cleansed on a global basis and this will take a long time. More immediately, my guess is that we will see foreign nations catch down and through the US in terms of negative economic developments, starting with banking issues. Away from the European banks and UK banks, there was not much exposure to collateralized debt around the world and the mark-to-market losses had a much less severe impact on these nations' banks. However, we are now in the real economic downturn phase of this crisis where income declines and debt repayment capacity falls. Add to this a rapid decline in consumption of commodities and finished goods, and real economic pain is spread across consuming and producing nations alike. The true delinquency phase, where the market's opinion of defaults as expressed in debt security prices and spreads, is played out in the reality of borrowers failing to pay back debts, is now under way. The bad news on the economy has already been somewhat reflected in U.S. banking system losses due to the prevalence of securitized debt (although actual losses are soon to wreak a second round of havoc here). This is not true of the banks of less developed nations which will soon take huge hits from the real downturns now hitting their economies and the inability of debtors to continue to support their debts. Beware of falling BRICs!