Saturday, October 25, 2008

Economic Reality Bites Back!

The crisis has, in many respects, followed the course that I predicted. Economic reality intruded on the fragile (false) restoration of confidence that followed the bailout. In the UK, the economy contracted by 0.5% in the last quarter, which will come as no surprise to regular readers here, and Mervyn King has now warned of a recession. The result was carnage for the £sterling which suffered massive falls. Meanwhile around the world stock markets plunged in a state of panic. From the US there is an endless stream of bad news, an example of which is that General Motors and Chrysler are now heading fast towards bankruptcy, and the once mighty Ford is in deep trouble too. These once unstoppable behemoths are symbolic of the underlying problems that are seeing the Western economies contract. Meanwhile, US house prices continue to slump.....

So far, all of this has played to the script that I have been writing for a long time. However, not all has followed the script. The $US should also be plunging, but instead is strengthening as funds are pulled from investments in emerging economies, seeking 'safety' in the $US and Yen. As the article I have linked to points out, there is outright panic driving such moves. An analogy that might explain this is a person running from an angry bear, only to seek safety in the Bear's cave.....where mother bear and her cubs are waiting, and where father bear will soon return. The result of the flight to illusory safety has rocked the world with for example, Russia at risk of sovereign default. Once again, this is not following my script, but any script can not account for panic and emotion driven decision making. In other words, the world financial system has left rationality behind. As with the return to panic, at some point soon, events must return to the script, as there is an underlying economic reality driving events. An explanation of that reality can be found here.

As if there were not enough problems, OPEC is seeking to reverse the one positive in the crisis, the drop in the price of oil. I predicted a long time ago that oil would fall to $60 per barrel, though not as quickly as has happened. I saw the drop in commodity prices as one of the elements in eventual recovery from the crisis. I have previously described how commodity supply is at the heart of the current world rebalancing (and crisis), and in order for the world economy to return to growth it is necessary to increase supply of commodities. As such, OPEC cuts in production are just the opposite of what is needed.

Another worry is that China is now feeling the pain of the crisis. I have always considered that China is on a knife edge, that it was uncertain how the country would ride out the storm. One of the positives that I identified is that China's huge reserves would allow them to cushion the impact, and the Chinese government has duly announced massive infrastructure spending to ameliorate the impact of the world slump. In other words, the money put away for a rainy day is already being utilised. Whether this will be enough to ensure stability in China remains to be seen, but they are in a position of having significant resource at their disposal, even if the value of that resource is heavily weighted in high risk $US. This reminds me of a comment / question that I received as follows:
Following on from Lemming regarding China stopping lending, surely the consequences for them will be a lot worse if they do suddenly stop? Your link points to an article that indicates that the Chinese authorities are trying to stimulate exports by increasing export tax rebates; surely if the West's economies & currencies collapsed it would make it even more difficult for China to compete in the world markets, as well as destroying their potential markets for an even longer period?

Like a bank lending to a business, I can see that it's in their interest long-term to stop lending so much to the West but surely it would be in their own interest to stop lending gradually, rather than suddenly, so they can recoup at least a portion of their previous lending?
As I have previously discussed, economies such as China which have been financing Western economies have a dilemma. If they stop lending, then the value of their holdings will collapse, along with Western economies. However, they must realise that any continued lending will throw good money after bad. My feeling is that the comment is very sensible, but China will need to utilise the resources at its disposal in the support of its own economy. They are, in effect, between a rock and a hard place. If they divert their surplus to the US and Western economies, they will help avoid a general collapse, but at the risk of a collapse in their own economy. In addition, such a diversion will only delay the onset of the rebalancing of economies. It may be possible that they can balance both internal and external problems, but I am not sure that they have enough resource to manage both. Do they have the will to do so? Recent news suggests that they do, but it is difficult to be sure.

As I have discussed before, at this point in the crisis, it is increasingly the decisions of individuals driving events, and how China acts in the crisis will be driven by a few leaders at the head of the CCP. Perhaps the most telling article in the latest round on the financial crisis is an article on the 43-nation Asia-Europe Meeting, in which the following was said:
Mr Miliband said the meeting had highlighted the significant shift in economic power towards the east but also how interlocked everybody's interests were in tackling "deep imbalances" in the system.

"I don't think it's just the fact that we are meeting in The Great Hall of the People and we listened to the general secretary of the Chinese Communist Party talking about the need to prop up global capital markets that brings home to one that there is this big shift in economic power," he said.
This has been the point at the heart of this blog. World economic power had shifted to the East, and now we are witnessing the global rebalancing. Bailouts, international talks, action plans and all of the rest of activity of Western politicians directed towards saving the Western economies are fighting against this shift. In other words, all of the activity to 'save' the economies is entirely pointless.

As I have long, and consistently argued, the only thing that will save the Western economies is reform that will allow them to compete with the emerging economies. Bailouts, more borrowing, Keynesian boosts to economies will only serve to make the economies more debt laden, and less able to adapt to the economic reality that wealth has moved East. Still, despite this reality, the politicians and economists are scurrying around, scrabbling for solutions, and imagining that there are magic wands that can change reality.

Note for new readers: I strongly recommend that you take a look at the links at the top left hand of the page. These will explain why it is that the world has changed, and why the change has led to this crisis. As far as I know, this is the only place that has a comprehensive explanation of the underlying roots of this crisis that actually explains the question of 'why?' I would expect that, if you read the explanation, you will understand my pessimism. You may want to start here....

Note: I have had a very pleasant comment (see below). However, I would caution readers to read other opinions before making investment decisions. Whilst to date my track record of predicting the economy has been extremely good I am, like anyone, fallible. As such, I would suggest looking at a variety of sources. I am personally very confident that I have understood the situation more clearly than many economists, but my views would be contested by any number of economic 'experts'. I will add this warning to each of the pages in the blog.


  1. Hi CE,

    Just found your blog and your deep thoughts chime with my fears that have been building since summer '07.

    I deeply thank you taking the time to explain how you see what is happening.

    I am very worried for Britain and on Monday I will transfer all my capital into Yen, Euros, Oz, Canada, Norway. I am going to buy short dated government bonds from each country.

    I was going to do it last week but the pound collapsed. The market is moving very quickly and if you dither... There has been a dead cat bounce.

    I totally see Britain going bust.

    I envisage rioting pensioners outside Downing Street.

    Blair and Brown may have to eventually leave the country for their own safety as the masses come out of the bubble and see the economic destruction.

    This could be the end of the Labour Party.

    I'm just going to sit back and watch it unfold.

    I will be using your blog as way to deepen my understanding.

    Keep rocking matey!!!

  2. Hi CE

    Don't be concerned I would never base my judgement on any one view.

    Since the Crunch began I've been following Satyajit Das and his writings.

    I also follow Nouriel Roubini.

    Here's a couple of crackers:

    1. The guy who wrote the Final Crash is a hedgie. He explained what would happen in the book. His hedge fund has lost 20% in the past six months. Obviously didn't believe his own book.

    2. The guys who wrote Wake Up! called it beautifully. This summer they said RBS was a good buy at £1.85.

    Even the hardcore bears/doomsters are having trouble in believing what they really think.

    My postman went bankrupt with 26K in credit card debt. Teh falt underneath is owned by a BTL guy who has three others, his own home and a pad in spain. Debt c.1million.

    It is totally insane that these Debt Junkies got such credit.

    Death to Bubble Addicts!

  3. Mark,

    This will interest you: IMF may have to print more money

  4. Hi CE.

    Out of interest, if you had savings currently in a UK bank, what would you do? (Savings are a deposit for when I get back onto the property ladder - sold to rent 1 year ago.)



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