The World turned upside down
- a changing of the guard?
William R. Thomson
Dec 19, 2008
Revolutionary war history buffs
may recall that as Lord Cornwallis surrendered to George Washington
at the Battle of Yorktown in 1781 his band - the Buckinghamshire
Light Infantry - played "The world turned upside down".
Nothing could be a more apt metaphor for the global financial
markets in the latter half of 2008. The established economic
orthodoxies have been progressively jettisoned as the global
markets entered an unprecedented phase of meltdown and fear drove
out greed as the overriding driving force.
The early years of this century
saw the greatest credit boom in history. Leverage was piled on
leverage through opaque derivatives and for some time the world
has been sailing on the Titanic unaware of the looming icebergs.
That came to an end with the collapse of major US, UK and European
financial giants over the summer and autumn of 2008. One after
another icons disappeared with dizzying rapidity: Bear Stearns,
Fannie Mae, Freddie Mac, Lehman Bros., AIG, Washington Mutual,
Citigroup etc., in the US and Northern Rock and Bradford and
Bingley in the UK all collapsed, were merged or fell into government
ownership. In the space of a few weeks the once proud US investment
banking industry ceased to exist as standalone operations, being
either merged or converted into commercial banks.
The wealth losses from write
downs in property values and stock market capitalisation have
been on an almost unimaginable scale, over US$20 trillion
in the case of the US as compared with a GDP of under US$14 trillion.
Globally, the figures are comparable for stock market losses
of at least US$24 trillion worldwide, including the US, and US$16
trillion excluding. And there is more to come since commercial
property losses, prime loans and credit card losses have yet
to be recognised. It is the first crisis of the globalised era
and as Charlie Bean, the Deputy Governor of the Bank of England
said, perhaps the greatest financial crisis in human history.
(What happened to the famed British understatement?)
The financial collapse has
now morphed into the real economy - especially the automobile
industry in the US - requiring systemic approaches on both a
national and a global perspective to try and mitigate and shorten
a threatened long and debilitating recession/depression. The
banking sectors in the US and the UK have been crippled and despite
frantic efforts to recapitalise they are hoarding liquidity and
showing a great reluctance to lend even to other major institutions.
It is likely we will get more directed lending through so-called
moral suasion from know-it-all politicians who now have the banks
as their play things. Full scale nationalisation into state banks,
which have a truly execrable record world-wide, could even be
on the cards as a lest worst option.
We are now facing a fundamental
crisis of capitalism in its spiritual homeland. The very tenets
of the free market have been junked by a panicked, incompetent
Bush Administration, the most right wing in over 100 years, as
nationalisations, bailouts and new funding initiatives have followed
in rapid succession through either the Treasury or the Federal
Reserve. On December 16th, the Fed lowered interest rates essentially
to zero, we now have the famed ZIRP or zero interest rate policy
that the Japanese were forced to introduce in the 1990s and from
which they were never able to depart fully. Coupled with a policy
of 'quantitative easing', Bernancke is living up to his nickname
of Helicopter Ben.
The most recent estimate by
Bloomberg was that the Administration had committed USD 8 trillion
to the economy since September mostly through the Fed's own balance
sheet. The monetary base, which is the fuel for future money
supply increases, more than doubled in the six weeks after the
collapse of Lehman Brothers in mid September. All pretence about
fiscal prudence has been junked and the US deficit is expected
to exceed 10 percent GDP, perhaps considerably.
The National Bureau of Economic
Research formally announced in December 2008 that the US economy
had been in recession since December 2007 - something most of
us knew already - and unemployment is increasing rapidly - over
2.5 million will be added to the unemployment rolls in 2008 on
the governments low ball estimates. The situation is similar
in the UK and much of continental Europe, especially the extremities
that had property booms based on low Euro interest rates, such
as Ireland, Spain, Portugal and parts of Eastern Europe. Iceland
was the reducio ad absurdum case, with its monumentally
oversized banking sector collapsing and being forced to turn
to the IMF and others for survival. The Russians seem willing
to give a little help, in return, of course, for the use of the
old NATO Keflavik air base.
Bretton Woods II
With the US in meltdown and
suffering an interregnum between the Bush and Obama Administrations
the first ever meeting of the 20 largest economies (G-20) was
called and met in Washington to discuss the way forward. The
meeting was labelled Bretton Woods II, after the meetings in
1944 that established the post World War II by founding the IMF
and the World Bank and the convertibility of the US dollar into
gold as the world's reserve currency. However, whilst Bretton
Woods I had been two years in the making and the meetings lasted
three weeks, BW II had been three weeks in the making and the
meeting lasted a few hours.
Nevertheless, the meeting is
potentially significant. In a real sense it marked a changing
of the guard: the transition from the US as the sole hyper-power
to the first among equals. A few weeks later the National Intelligence
Estimates for the incoming President recognised the probable
slippage in the US' heretofore impregnable position in the coming
years.
The G-20 meeting was not called
by the US but by the Europeans and those restive countries holding
huge levels of dollar reserves, such as the Chinese and the oil
rich Middle Easterners with large sovereign wealth funds. To
help the global economy these sovereign wealth funds must be
mobilized partly through the IMF and World Bank. Unfortunately,
till now the governance of these institutions has reflected the
division of global economic power in 1945 not 2008 and, as a
result, the rising powers - the BRICs, Asia and the Middle East
- are severely underrepresented, whilst the US and Europe, especially,
are hugely overrepresented. In contrast to normal banking practice
the borrowers have been setting the agenda. (That's the polite
way of putting it; one could refer to inmates and asylums.)
Necessity being the mother
of invention, there is now a commitment to a substantial and
timely reform in IMF voting power favouring the emerging powers;
in return for which the IMF would receive greatly increased funding
from the Arabs, the Chinese and the Japanese. In addition, there
was a general consensus (Germany excepted) that most countries
would take fiscal stimulatory measures to mitigate the recession,
even though for some, like the US and UK, it is a bit like giving
an alcoholic another drink. Further, it was agreed that there
needed to be more active regulation of the financial sectors,
nationally and globally and the free trade Doha round should
be expeditiously concluded.
Outlook for 2009
Since the situation keeps changing
that any projections have much greater uncertainty than normal.
On the assumption that the financial sector has been stabilized
by the emergency actions in October and November - and that is
a brave assumption - then the IMF projects, without much confidence,
global growth in 2009 to fall to 2.2 percent from the 5 percent
levels of 2005-7 with the US, Europe, UK and Japan all in recession
throughout 2009. China and India are pencilled in for 8.5 percent
and 6.3 percent respectively, both of which estimates are much
more likely to be on the high rather than the low side, and Brazil
and Russia predicted in the 3 percent range.
It will be a different world
with the Government rampant again everywhere in fiscal and monetary
policy, regulation and nationalisation, for the first time since
the 1970s, with the hope that this activism avoids both the general
stagflation of the 1970s as well as Japan's wasted decade of
the 1990s. These are long odds and will require enormous luck,
since they confound the historical track record, as well as judgement.
Activism could easily lead into a slide towards protectionism
in Congress, although Obama's economic team is opposed to such
slippage. Inflation will not be a problem next year but beyond
that timeframe it could well return as a recovery sets in and
the velocity of circulation picks up. Historically, it has been
seen as the way out of an indebtedness situation. Why should
it be different this time?
For the markets, crisis generates
great opportunities and they are present today in abundance for
those with liquidity and fortitude. 2009 is likely to be the
most challenging year economically in six or seven decades but
could well be more rewarding for both traders and investors than
this year, especially in Asia. Just remember Lord Cornwallis
- his world was turned upside down at Yorktown, but he went on
to fame and fortune in Asia, more specifically India. There may
be a message there for today's investors: Asia remains the growth
opportunity in the world and Asia's favourite commodity - gold
- remains everyone's insurance policy.
Dec 17, 2008
William R. Thomson
email: wrthomson@btconnect.com
William Thomson
is Chairman of Private Capital Ltd. in Hong Kong and an adviser
to Axiom Funds and Finavestment Ltd. in London.
321gold Ltd
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