Economic Crash And Crumble 2010
Economics / Recession 2008 - 2010 Jan 22, 2010 - 11:35 AM GMTBy: Andrew_McKillop
ECONOMIC SHOCK
"All you need is $40 oil to bring the economy to a complete standstill. If we have $80 oil we're going to be in the hole," said Adam Sieminski, global oil strategist at Deutsche Bank. (New York Times, 13 Nov 2002)
Comments of this type can still be heard in January 2010, from analysts who produce similar, sometimes absurd offerings on near-term menaces for equities growth but manage to keep their jobs. Nouriel Roubini and Marc Faber keep their jobs by ceaselessly repeating that the end of Boom is nigh, and its name is Doom. In the meantime, the economy steams or lurches forward, but with rising fragility due to real world menaces accumulated through decades.
The possibility of long-term erosion rather than instant and catastrophic slump is usually brushed aside. The job of staying media-friendly pushes analysts to be extreme, needing a liberal treatment of facts when they seem to argue for alternate conclusions. At any one time, outside periods of extreme euphoria or extreme panic, we need to explain how rapid swings of financial market and stock exchange sentiment are generated, starting the index number changes that we later see as long-term trends.
For years the 'oil shock thesis' as recycled by Sieminski, and by a string of finance ministers and central bankers, including Ben Bernanke, was held to be something like a ‘scientific statement’ that if there is an W% rise in oil prices in X months then we get a Y% fall in economic growth over Z months. The bigger the number for percent oil price rise, the higher the Y and longer the Z, but oil shocks like global warming suffer from severe credibility problems when carefully examined. Recent IMF reports show that 'windfall revenue gains' by oil and other raw materials exporter countries since year 2000 are almost completely, and rapidly fed back into the global economy, the process already in fact operating since the 1980s, that I call Petro Keynesian growth.
Economic shock today features the very fast shift from extreme private consumer and corporate debt in most OECD countries, to extreme public debt in an extended range of countries, both lower income and higher income, both developed and developing. Estimates of this mega trend and for the period 2007-2009 extend up to a growth in national or sovereign debt by USD 11 000 billion or more, about 16% of annual total world economic output. At the same time and to be sure, corporate debt is being de-levered, slowly, and private consumer debt has slipped back from its extreme highs of 2007, but this is a long way from 'mission accomplished'. Cumulative private and corporate debt in OECD countries, and in several emerging countries is now so large that estimates for its total in years-equivalent world GDP are very variable - but the only way to treat this hyper-inflation time bomb is economic growth at rates well above 3% annual for the global economy, needing at least 8% or 9% a year growth for China and India, sustained for a decade or more. Austerity cures may seem to be an alternative, but with accumulated debts and unemployment like present, this is a non option.
ECONOMIC SHOCK REVISITED
Since the 2008-2009 recession the only question is how to restore and sustain growth. Turning this question around and asking what happens if strong and sustained global economic growth is not quickly restored, the answer is simple. Continuation of present financial market fear-driven downside volatility is sure and certain, witnessed by the sharp reaction and response to Obama's new strictures about own account trading by commercial and investment banks. Under sufficient stress from serial bad news the newly fragile finance and trading system can rapidly shift to a runaway flight to quality, and massive sell-out of ordinary stock. This would later be called a crash.
Debt overhang is now the legitimate bogeyman, making interest rate hike scenarios instead of oil price rise scenarios the favorite doom trigger: interest rates raised to A% over B months causing a C% increase in debt default and D% fall in economic growth can substitute oil shock. However the number of other trigger factors that can be wheeled on stage are multiple, all of them interpreted by the trading and investor community as affecting the 'visibility' of the global, regional or national economy going forward.
Current fears are generated, unsurprisingly, by a host of powerful financial and fiscal plays going forward. Going back to the first and second Oil Shocks, of 1973-74 and 1979-81 a casual glance at the 50% or 60% falls experienced by most leading stock exchanges over a few months was attributed to the single and sole oil price factor. The 2008-2009 stock market slump was associated with oil prices attaining about USD 145 a barrel in 2008 but was hard to explain away as uniquely due to oil prices - except with central banker hindsight, as demonstrated by remarks by Bernanke and Trichet at the Aug 2009 Woods Hole meeting. At this meeting, Bernanke set a USD 100 a barrel 'red line in the sand' beyond which he could or might raise rates.
The recent and present fall in confidence, and fall in index numbers can also and more easily be explained as due to economic psychology consumer stress, geopolitical uncertainty, and other factors combined with the new and massive public debt overhang. There is plenty of ground for arguing that the 1987 stock market crash – in which worldwide loss of market capitalisation, in dollar value 2009 were about $2000 Billion compared with about $600 Billion for the 1929 crash (both figures being in comparable-value dollars and also very approximate) – was generated by a mix of factors including falling economic growth and rising debt, and certainly not high and rising oil prices, which at the time were trending ever lower.
Another key factor, focused by Roubini and others is prevailing P/E ratios, more simply the ratio of future hope to present reality. The hope is for sustained and strong economic recovery, firstly levered by unsure and opaque mechanisms due to continuing very strong Chinese and Indian economic growth - which in fact can likely accelerate the return of inflation in the OECD countries due to this growth pressuring oil and natural resource prices. Secondly, as underlined and repeated many times by the IMF, continuing Keynesian-style bailouts and injections are needed, underlining that no particular ironclad logic is needed for explaining why 'Chindia' overheating, or a cut-off in Big Government bailouts could at any time drive the downturn in equity trader sentiment, making it spiral. Doom merchants only sometimes underline that preceding a 'surprise correction' or crash, unreasonable optimism spreads through the investor community, just as fast and furiously as the unreasonable pessimism that follows.
ECONOMIC GROWTH REVISITED
The key real world, real economy factor needed for avoiding 'major correction' in stock exchange indexes at this time, is two-word: economic growth. Unfortunately, no spurt of economic growth has happened anywhere in the OECD nations, since midyear 2009 and time is ticking by, as equity values rise with near effortless ease. Weak economic growth has returned, but no growth surge is in prospect - although it is not completely impossible. Relapse to slow or no growth is a continuing threat, easily able to exceed 50/50. Sustained recovery, as the IMF and other sources of conventional and classic logic continue repeating, needs the maintenance of Keynesian-type bailouts and injections.
The logic for this could trace back to previous debt-based bailouts, for example following the October 1987 stock market crash, marked by continuing and vast US federal deficit spending. From the end of the 1980s, de facto Keynesianism has never disappeared despite neoliberal strictures leading to a long interval during which public debt was bad but private debt was good. Following the private debt-driven 2008 crash, we have returned to public debt being good.
New style and massive Keynesian deficit spending can be argued as starting in Japan in the late 1980s following the massive and forced revaluation of the Yen at the 1985 Plaza conference. Continued debt-based government largesse in Europe never went out of fashion, throughout the last 30 years, whatever the neoliberal rhetoric that came and went. The problem therefore is massively accumulated, a long-term backlog of debt, now massively raised through shifting back to public debt, from private and corporate debt. For at least a decade, this somber and fragile structure is impacted from several other converging areas. These include declining consumer confidence partly driven by debt of all kinds, geological depletion and environment stress impacting the supply, and price of energy and natural resources, and to be sure the loss of eminence and power for the OECD economies and countries relative to emerging countries.
NO EASY WAY OUT
What conditions, today, would generate and sustain global economic growth at 3% a year or more ? Through 2004-2007 global growth attained about 4.5% annual but, as we know, this was joined by massive debt growth, record high oil and natural resource prices, high or extreme trade deficits for many OECD countries, constant US dollar devaluation and a long list of other fast growing problems. These related and unrelated stress factors were supposedly joined, until Dec 2009, by imminent or at least certain 'climate catastrophe', but in a fast changing world this meme, in Jan 2010 is already fading from the scene.
We could perhaps imagine that cheap oil, defined these days as less than about USD 60 a barrel, would raise confidence in political and business decider elites, if or when this was joined by fast recovery of economic growth without growing inflation. Achieving these maybe divergent aims is the new quest for central bankers and finance ministers, worldwide.
Like the fragile climate catastrophe theory, oil shock theory is heavily qualified by the real global economy. Oil price fear, today, is a classic case of atavism: oil prices and oil trade deficits are small change relative to the debt overhang and public deficits in the OECD countries. These are vast relative to their oil import bills, and also to deficits in the emerging economy oil importer countries. If we take a figure of about USD 1500 billion as the total for the US Paulson and Geithner 'anti recessionary plans' and 'injections', and do not include TARP financing (for which figures are like estimates for the size of cumulative national debts !), this is equivalent to about 6 years of total US oil import spending at a year average USD 100 a barrel, at current daily import demand rates, recovering slowly towards 12 Mbd.
OECD and emerging economy 'anti crisis' spending, loans and guarantees since late 2008 total more than the total value of world oil trade for decades ahead, at a year average barrel price of USD 100. The oil shock ghost can therefore be laid to rest. Other trigger factors can be identified for the probable, or increasingly possible double dip that would follow a stock market crash. Among these real factors for a real crash, we must underline the rational outlook for non-return of economic growth on a vigorous and sustained basis, especially in the OECD group.
GLOBAL MACRO ECONOMIC PSYCHOLOGY
Economic psychology also features among these trigger factors - several of which are ambiguous or multi-valent and can rapidly flip over from pro-growth to anti-growth for equity values. Stock market traders essentially trade notions of how the economy may or might turn out, sometime in the future. Operators need to get funds from the real economy, so they need to reassure and to exaggerate growth potentials a little, or a lot. They can argue that when or if panic selling is triggered for any reason, this only concerns fictional future value and losing what never existed is hard to call a loss.
Consequently this logic problem, as to what 'loss' means, is closely related to what 'debt' means, a factor heavily impacted by currency values as well as interest rates and economic growth. The notion of 'sovereign' debt relative to other types of debt has since late 2009 began to mutate, with open crises generated by debt linked to, and supposedly guaranteed by states ranging from Dubai and UAE, to Ukraine, Spain, Ireland, the Baltic States, UK and USA, and others. The clearly notional concept of ‘loss’ on equity markets, is now joined by doubt on the firewalls between private, corporate and public debt, able under worst-case scenarios to replicate 1930s-type crises, which as we know were preceded by the 1929 financial crash generating a real economy crash.
One sure indicator of this mega process would be not only a flight from paper equities, but also from paper money. Unfortunately or otherwise, this process of 'restoring strong money' would be a sure and certain failure because of the implied write-down in paper debt value it would generate. This write-down would be so massive the global economy would collapse in weeks, and almost certainly lead to international armed conflict. As we know, only a fraction of all quoted stocks are usually bought and sold on any one day. Devaluing the nominal value of all traded stocks by even 10% in a single day is a crash guarantee. However, devaluing a national money by 25% or 50%, or more overnight is feasible and possible, for example through forcing the passage of a new fiat money, like the Euro in Eurozone countries from 2002. When or if that happens in several countries near simultaneously, with the sole basic objective of dishonouring debt this will surely set the bases of future economic growth - by massively depressing current activity. In the current global macro context, this type of outlook is moving closer to the surface, and will be increasingly commented through 2010.
SHORT TERM RESPITE: PETRO KEYNESIAN GROWTH
Anything can be worked into stock market sentiment. Despite official central bank mythology that high oil prices are bad for growth, equity values cruise upward with oil and resource prices until high or extreme values are reached for both. In the real economy, high oil and resource prices drive global growth many different ways - but as proven in 2007-2008 without any feedback until economic growth is weakened in a process where higher energy and food prices eat into disposable income. The standard mantra of any market analyst will be: higher energy and food prices can only be bad for the bourse, by taking money out of consumers’ pockets but some of that cash will be put into the pockets of oil and energy companies, meriting a re-jig of portfolios, with a higher weighting of Happy Few commodity-linked oil producer, gold mining, alternate energy, resource and utilities companies.
The lengthy, slow motion bourse crash of 1999-2002 is generally agreed to have erased about USD 6000 billion in loss of notional equity value, through Q1 2000 to Q3 2002. Rising oil and energy prices, it can be argued, helped the process of recovery from 2003 in which a new pivotal role was held by the emerging economies, countering the inherent deflationary and recessionary trends of the consumption-dominated ageing societies of the OECD group, where economic psychology, if not the economy, 'can turn on a dime'. Given the revealed wisdom of ex-US Federal Reserve chairman Greenspan, that the dotcom and high tech boom of the 1990s generated vast increases in economic productivity, the economic shock of high oil and resource prices would be a difficult factor to argue as able to generate the constant 18-month run of declining confidence and falling economic growth in the OECD countries.
Petro Keynesian growth driven hard by China and India breaks out of this psychological strait jacket but sets no safety net, and also forces the OECD group into going for growth - or bust. Current equity market fear and hesitation signals that market operators would react with near extreme panic to any perspective of interest rate rises, and extreme euphoria to new and additional 'classic Keynesian' bailouts and cheap loans, or gifts for bank, insurance and finance sector. Adding both types of Keynesian spending together, the ride ahead will be harsh for any countries that fall back into near-zero, or subzero growth.
TOWARDS THE SUSTAINABLE ECONOMY
Coming oil and natural resource shocks, extending across a widening asset space, can be measured in the one-two decade zone, that is 10-20 years before the physical, ecological and environmental bases of the globalized urban-industrial economy will face overwhelming pressures for total restructuring. The so-called 'climate catastrophe' is often added to a list of other and more real limits to growth, these more real limits setting tighter and tighter constraints on creating and operating sustainable asset funds. For 'conventional assets' the resource and energy pinch makes for an investment logic where placements not offering a P/E ratio of below 10 or 15 are more an more unsure. This asset space cap or limit will extend away and outside a small and focused range of specialty activities, concentrated in sustainable energy and real resources.
Whenever oil and energy prices break through a psychological barrier that we can place at around USD 85 to 90 per barrel, close to recent highs in Dec 2009/Jan 2010 finance and bourse strategists will quickly recycle real resource hedging and defensive strategies used as recently as 2008. These will focus plays on oil and gold, fossil energy, strategic metals, arms and defence industries, certain utilities, many agroindustries, biotech and biopharmaceuticals, alternate energy and water, government paper (such as treasury bills), and of course hard cash from a restricted currency range. When or if oil prices continue to rise, with the certitude of this rising sharply through the next 5 year range, this defensive reflex strategy will be forced to grow and develop, to become a fully fledged sustainable investing paradigm and strategy.
Put another way, beyond the 2015 horizon, players ignoring the sustainable investing paradigm will be on the highway towards their final bourse crisis, triggered and sealed by a combination of rising oil prices, geopolitical instability, resource or oil-triggered geopolitical conflict and real but slow climate change impacting agriculture and insurance company earnings. The final bourse crash will sealed also by ever rising unemployment due to inherent deflationary trends and recurring economic slump, and the rapid ageing of populations in the OECD group.
After the failure of 'climate catastrophe' as a rallying call and lever for a near-instant shift to the sustainable economy without harming the OECD's primal role in energy and resource waste, the global economy now driven by Chindia's almost runaway industrial growth is on track to quickly regain 2004-2007 rates of energy and resource demand growth. As little as 2 years of this growth, perhaps less, can lead to Petro Keynesian overshoot. The sustainable economy alternative will return to center stage as an increasing No Alternative, but perhaps not until the current equity cycle reaches a new peak and new decline.
By Andrew McKillop
Project Director, GSO Consulting Associates
Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights
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