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The Global Bubble Has Reflated

Economics / Global Economy Apr 08, 2010 - 06:21 AM GMT

By: Mike_Stathis


Diamond Rated - Best Financial Markets Analysis ArticleBack in the Spring of 2009, the World Bank forecast that the global economy would contract by 1.7% that year; the first global contraction since the Great Depression (yet another clear indicator we are in a depression).

As it turns out, they were quite conservative (as you would expect). Latest numbers from the World Bank show a decline in global GDP by 2.2% for 2009.

As I have alluded to on numerous occasions, it has been much of the developing world (China, Brazil and India) that have actually helped curtail the global contraction. Without their help, the global economy would have shrunk by around 3% in 2009, maybe more.

In this article, I will present various excerpts from a recent (January 2010) report by the World Bank, while following up with my assessment.

Ultimately, I will make a case that the global bubble is well on its way to reflating, if not already there.

Let’s begin.

According to the World Bank:

“The acute phase of the financial crisis has past and a global economic recovery is underway. However, the recovery remains fragile and is expected to slow in the second half of 2010 as the growth impact of fiscal and monetary measures wane and the current inventory cycle runs its course. While the baseline scenario calls for global growth firming to 2.7 percent in 2010 and 3.2 percent in 2011 after a 2.2 percent decline in 2009, neither a double-dip scenario where growth slows appreciably in 2011, or a strengthening recovery can be ruled out.”

Double-dip? Try quadruple-dip over the next decade.

But you can only have dips if you rebound. And no real rebound is coming, at least in the U.S.; only rebounds fueled by reflation of the global bubble. 

The World bank continues...

However, private sector firms remain shut out from international banking markets. Moreover, the Dubai World event and ripple effects to credit downgrades for Greece and Mexico can be expected to raise concerns about sovereign debt sustainability and will impact risk assessments, capital flows, and financial markets in 2010.”

Private sector financing and investments have rebounded strongly in the emerging markets, setting up bubble conditions.

Could problems in Europe trigger problems for the bubble in Asia?

The World Bank report continues…

“The most marked increases have been in de­veloping East Asia, and reflect, at least partly, the 4 trillion renminbi (or 12 percent of GDP) fiscal stimulus put into place by the Chinese authorities extending through 2010 (roughly half spent). Much of that stimulus has found its way into imported raw commodities and investment goods. Indeed, partly because of restocking, Chinese demand for key metals has been supportive of commodity prices, which have recovered about one-third of their earlier declines.”

This is consistent with what I have been saying, even in America’s Financial Apocalypse in 2006—China is driving the commodities bubble. And China has done more than any nation to temper the effects of the global recession through domestic consumption.

“Although the real-side effects of the crisis have been large and serious, economic activity in most developing countries is recovering and overall growth is expected to pick up from the anemic performance of 1.2 percent in 2009 to 5.2 percent in 2010 and to 5.8 percent in 2011. Although much lower than the 6.9 percent growth rate that developing countries averaged between 2003 and 2008, these rates are well above the 3.3 percent average performance during the 1990s.”

Actually, China and Brazil recovered by early summer 2009.

“Excluding China and India, the remaining developing countries are projected to grow at a 3.3 and 4.0 percent rate in 2010 and 2011, respectively, compared with 5.4 percent growth on average between 2003 and 2008.”

This forecast is only reasonable assuming a best-case, or what the World Bank has labeled a “baseline” scenario. Such a scenario does not account for another wave of bank failures or a catastrophic collapse in Europe.

The chart below shows the IMF’s forecasts for economic growth in Asia. If these forecasts materialize, by 2011 Asia will be back to levels seen at the height of the bubble in 2007.

“Countries in developing Europe and Central Asia have been hardest hit by the crisis and are expected to have the least marked recovery, with GDP expanding by only 2.7 percent in 2010 and by 3.6 percent in 2011.”

This is obvious. What is more relevant is just how bad things are in Europe.

“The combination of the steep decline in activity in 2009 and the relatively weak projected recovery means that developing economies will still be operating about 3 percent below their level of potential output —and unemployment, although on the decline will still be a serious problem.”

I actually discussed this in my newsletter and showed some data to support this for the U.S. I

“Great uncertainty continues to surround future prospects. Even the weak recovery outlined above is not certain. If the private sector continues to save in order to restore balance sheets, a double-dip, characterized by a further slowing of growth in 2011 is entirely possible—especially as the growth impact of fiscal stimulus wanes. A stronger recovery is also possible, if the massive traditional and untraditional monetary stimulus that has been put into place in high-income countries begins to gain traction.”

As I have mentioned many times in the past, for the majority of Americans, there will be no real recovery (see previous issues and online articles). However, there will be a robust recovery most notably for the BRIC nations (Russia is questionable).

“As a result of these and other measures, the freeze-up of financial markets that characterized the autumn of 2008 has eased considerably, and the spreads facing emerging-market borrowers have declined as well, with commercial borrowers able to access funds for a premium of 359 basis points and sovereign borrowers at a premium of about 300 basis points. While these spreads are higher than the pre-Lehman average of about 180 basis points, they remain substantially lower than their long-term averages, the fruit of improved fundamentals of many developing countries and years of policy reform.”

Hang onto your hats because spreads are going to soar; first in Europe and then extend outward. While many will flock to the dollar as they did in late 2008. But the strength in the dollar is likely to be temporary.

“As spreads declined and the acute risk aversion of the immediate post-crisis period eased, investors started moving back some of the money that had been withdrawn from developing-country capital. markets. As a result, beginning roughly in March 2009 developing-country currencies began appreciating against the dollar, their stock markets began rebounding, recovering between one-third and one-half of their initial losses, helping to restore global confidence by restoring some of the wealth initially destroyed in the crisis.”

This  a statement of fact and I discussed it in a previous  issue.

Liquidity in interbank markets has normalized


Text Box:

“The revival in stock market activity has supported new equity placements by emerging economies. Although initial public offering (IPO) activity remained subdued during the first half of 2009, there were signs of a sharp rebound in the third quarter, on the strength of large deals by China, Brazil, and India, which together accounted for about 85 percent of all emerging-market transactions year-to-date, compared with an average share of 65 percent in the five years through 2007. The relatively strong fundamentals in these countries appear to have raised investor preference for these economies.”

This is consistent with my own analysis of China and Brazil.

“Developing countries' access to international capital markets has also revived. Both sovereign and corporate borrowers have benefited from rising global liquidity, improved market conditions, and better long-term fundamentals of emerging economies vis-à-vis advanced economies. The improved bond and equity markets reflect a normalization of financial markets and, to an unknown extent, the opening up of a carry trade precipitated by low real interest rates in high-income countries. Some middle-income countries (notably Chile and Brazil) are attracting very large inflows, which if sustained at 'current rates, pose real policy challenges and could generate significant stress. Some countries have sought to use increased intervention or other measures such as a financial operational tax (Brazil)—even as the effectiveness of these measures is unknown.”

“In stark contrast to the recovery in bond and equity markets, cross-border bank lending remains weak as global banks continue to consolidate and deleverage in an effort to rebuild their balance sheets. Prospects for a resurgence in bank lending in the near term are likely to be muted, especially in regions such as Europe and Central Asia where mounting nonperforming loans and large domestic adjustments are likely to restrain both the demand and supply side for lending. At the same time, lending to natural-resource-rich countries is likely to remain robust.”

I’d like to emphasize that European banks are in worse shape than U.S. banks. Many readers might be surprised to learn that Chinese and Brazilian banks are actually among the world’s strongest in terms of risk and capital reserves. This could become an important point down the road if another wave of financial failures hits the globe.

I find it odd how the World Bank fails to provide a more comprehensive analysis of Euro banks. While they later mention the large pool of toxic assets remaining, I feel the placement and way the material has been laid out (which might be difficult to fully appreciate since I have taken only excerpts from the report) has been done with the intention to downplay the risk remaining in Europe.

Finally, the statement pertaining to the economies of “natural-resource-rich countries likely to remain robust” points to the driver of global growth—China. Oddly, the World Bank made no mention of the real estate bubble that has formed in one of the richest natural resource countries—Australia. The nation “down under” was the first to have raised rates in 2009 as signs of inflation grew. While the rebound in natural resource utilization stemming from developing nations has helped Australia, a severe correction in real estate could create severe economic turmoil.

“In contrast with debt-creating flows, foreign direct investment (FDI) has yet to show signs of rebounding. FDI tends to be the most stable source of international capital, but inflows nevertheless have declined by 40 percent since the first quarter of 2008 and stood at $69 billion in 2009Q3. The recent decisions of the Dubai World holding company to ask its creditors for a six-month standstill on debt payments, and of rating agencies to downgrade Greece and Mexico's credit rating, remind that the echoes of the crisis continue to be felt.”

What they are trying to say is that there is more pain ahead. The agenda of the World Bank precludes them from stating the obvious.

“Global markets have largely been unaffected by these developments and capital flows to emerging markets have strengthened in recent months. So far, these stronger inflows have only partially offset the sharp reduction in flows following the crisis and have not re-created bubble conditions. However, should these strong inflows persist or strengthen, asset bubbles could begin to reinflate, leaving countries vulnerable to a second sudden stop in external finance.”

This is perhaps the most valuable statement made in the report. However, the claim that the reduction in flows “have not re-created bubble conditions” is arguable if one were to examine the effects of a prolonged period of record low global interest rates and massive global stimulus. While these funds have been kept within each nation, the effect is the same.

“After a deep global recession, economic growth has turned positive, as a wide range of policy interventions has supported demand and reduced uncertainty and systemic risk in financial markets. However, the recovery is expected to be slow, as financial markets remain impaired, stimulus measures will need to be withdrawn in the not too distant future, and households in countries that suffered asset-price busts are forced to rebuild savings while struggling with high unemployment. Although global growth is expected to return to positive territory in 2010, the pace of the recovery will be slow and subject to uncertainty. After falling by an estimated 2.2 percent in 2009, global output is projected to grow 2.7 and 3.2 percent in 2010 and 2011, respectively (-1.0, 3.5, and 4.0 percent when aggregated using purchasing­power-parity weights). The main drag on global growth is coming from the high-income countries, whose economies are expected to have contracted by 3.3 percent in 2009.”

Once again, you see a cheerleading organization warning of a “slow or weak recovery.” That should tell you that there will be no real recovery for some nations; namely the U.S. As you will see on the next page, the World Bank later asserts that a “pronounced growth rebound is under way.”

Japan, which felt the consequences of the global crisis more severely than other high-income countries, experienced the sharpest growth contraction (-5.4 percent).”

I showed this in my January newsletter. Remember, Japan is still in the middle of a two-decade long period of misery, yet it appears as if the worst is to come. While Japan’s debt-to-GDP is around 200%, keep in mind that unlike the U.S., which relies primarily on foreign investors (China, Japan, UK) to fund its deficits, Japan relies mainly on domestic sources. This implies that Japan actually has a better ability to fund its debt without threat of conflicts in foreign trade policy.

“Growth rates of 2.5 and 2.9 percent are expected in 2010 for the United States and for high-income countries that are not members of the Organisation for Economic Co-operation and Develop­ment (OECD), respectively.”

These are la-la land forecasts, built upon the presumption of continued record deficits. These GDP forecasts, if they materialize, will not be real.

“Among developing-country regions, economies in Europe and Central Asia were hit hardest by the crisis, with GDP falling 6.2 percent (with the Russian Federation contracting 8.7 percent). The main causes were lower oil prices (Russia) and difficulties in funding large current account deficits in a risk-adverse environment.”

This is true. What was not mentioned of course were the political issues underlying the tug-of-war between the U.S. (and it’s allies in the Middle East—Israel, as well as Iraq) and Russia (along with its allies in the Middle East—Iran, as well as China). 

The signing of the Balkan pipeline deal (after many years of dispute) with Bulgaria, Albania, Macedonia and Greece has enabled Russia to become the largest supplier of oil to Europe. What you will never hear mention in U.S. media is the fact that one of the primary reasons the U.S. invaded Iraq was for access to its rich oil reserves. Furthermore, the ONLY reason the U.S. invaded Afghanistan was to clear the path for a pipeline from the Caspian Sea in order to supply Europe with crude.

“Moreover, the impacts on poverty and human suffering in these countries will be very real. Some 30,000-50,000 additional children may have died of malnutrition in 2009 because of the crisis (UNSCN 2009; Friedman and Schady 2009), and by the end of 2010, 90 million more people are expected to be living in poverty than would have been the case without the crisis.”

This is a key finding. Note that China and Brazil have funneled large amounts of their stimulus with the intent to actually raise the living standards of the most impoverished segments of their population.

“Growth in the East Asia and Pacific region (particularly in China) as well as in South Asia (particularly India) has been resilient, buoyed by a massive fiscal stimulus package in China and by India's skillful macroeconomic management. Between 2008 and 2009, growth in the East Asia and Pacific region is estimated to have eased by only 1.2 percentage points to 6.8 per­cent, while South Asian growth has remained stable at 5.7 percent. GDP growth in China is estimated to have slowed from 9 percent in 2008 to 8.4 percent in 2009, but is expected to recover toward 9 percent over the remainder of the forecast period.”

I have discussed this on numerous occasions in my newsletter.

“These developments have also been reflected in global industrial production, which declined sharply in the aftermath of the global financial crisis. In February 2009, world industrial produc­tion was falling at a 27 percent annualized pace, but by the beginning of April/May, production began recovering, initially led by accelerating growth in China following the implementation of the $575 billion (over five quarters) fiscal stimulus package. Increased import demand from China quickly spread to other countries, with industrial production registering positive growth in emerging countries (excluding China) by March 2009 and high-income countries by May 2009.”

Also discussed in the January issue.

“Output among high-income economies in 2009 is estimated to have contracted by 3.3 percent, the first time since 1960 that the aggregate GDP of these countries has declined. Industrial production and trade flows among high-income countries were particularly distressed, with the former registering peak-to­trough declines in excess of 20 percent in countries such as the United States, the United Kingdom, Germany, and Japan.”

This is not something that will rebound anytime soon, and certainly not without a continuation of bubble-like conditions. Recall I discussed this towards the beginning of this report (Economics: GDP). This is precisely the reason why investors must remain very cautious with investments in developed nations. On the other hand, investments in developing nations are much more volatile. I prefer to buy into developing markets like China and Brazil after global sell-offs.

“A pronounced growth rebound is under way. The initial turnaround was driven by an investment rebound in developing countries, particularly China and the newly industrialized economies of East Asia, which has spread to high-income capital-equipment-exporting countries such as Germany and Japan. High-income countries have now started making larger contributions to world output and trade growth, as the effects of stimulus measures bear fruit in fostering domestic demand and imports, and a turn in the inventory cycle un­derpins production gains.”

This is not at all true. A small degree of stabilization has occurred for high-income nations, but mainly due to stimulus packages, and only when compared to metrics from 2008. Any stabilization is relative. As well, any injection of stimulus is temporary and will come at a high price down the road because, as discussed in the January issue, at least in the case of the U.S., the fundamental issues are not being addressed.

“The growth rebound in high-income countries is projected to remain relatively strong over the next several months but should lose strength during the course of 2010 as the growth impact of stimulus measures and the rebuilding of depleted inventories cease to bolster growth. In the United States, notwithstanding the recovery of growth in the second half, whole year GDP is estimated to have declined by 2.5 percent in 2009. The recovery is expected to continue into 2010, supported by the inventory cycle, the bottoming out of the housing sector downturn, and fiscal and monetary stimulus.”

I somewhat agree with this, although the World Bank is too optimistic. Moreover, the World Bank has made the error in forecasting based on the economic cycle. What we are seeing fits no cycle. It is off the charts.

“However, the pace of recovery should slow toward the middle of 2010 as the growth impact of these forces wanes and as banking sector balance sheet consolidation, and still large negative wealth effects weigh on domestic demand. Overall, growth is projected to come in at 2.5 percent in 2010 and stabilize at a relatively modest 2.7 percent in 2011.”

I feel this is a fair assessment, although once again, I do not think they have summed up just how bad things could get. Timing is uncertain, but I am quite certain that the second half of 2010 will look much worse that the first half.

“The IMF estimates that even though global bank write-downs amounted to $1.3 trillion through the first half of 2009, further write-downs of some $1.5 trillion may be required as U.S.-domiciled banks have recognized only about 60 percent of anticipated write-downs.”

It would appear as if the IMF was assessing only the write-downs from only a portion of the U.S. financial system. We cannot forget about approximately $2.0 trillion off-balance from Citigroup, Bank of America and others, as well as the trillions of dollars of toxic assets held by Fannie and Freddie, of which the Federal Reserve is in the process of soaking $1.25 trillion up. Globally, I would expect at minimum, another $3 trillion of write-downs over the next 3-4 years. On the high end, the number could go as high as $6 trillion, depending on what happens in Europe.

“In high-income Europe, GDP is expected to decline by 3.9 percent in 2009 and to increase by only 1.0 percent in 2010. However, ongoing balance-sheet problems of Euro Area banks are likely to remain a drag on financing conditions. So far, commercial banks have made little use of the governments' rescue packages, and governments have yet to amend rescue plans. As a result lending restrictions are likely to remain a drag for capital expenditure. According to the latest ECB Financial Stability Review (2009) only two-thirds of potential losses in major European banks have been provisioned or written off so far, with some 187 billion euros of potential losses still remaining.”

That is my point exactly.

Prospects for developing economies                  

“Most developing countries were not directly involved in the risky behaviors that precipitated the financial crisis, and the banking systems in most regions carried only limited exposure to subprime loans. Nonetheless, economic activity in virtually all countries were sharply affected. By the first quarter of 2009, 25 of 31 developing countries (for which quarterly national account data are available) had reported negative growth rates. Domestic demand in developing countries was particularly affected by the sharp slowdown in fixed investment growth, which fell from 13.4 percent in 2007 to 8.5 percent in 2008 and to an estimated 1.3 percent in 2009. In response to falling domestic and external demand, industrial production came under pressure. By the end of the first quarter of 2009, industrial production was down by 12.9 percent from its level a year earlier, the volume and value of developing-country exports had declined by 30.2 percent and 17.6 percent, respectively, and the commodity prices that had supported growth in the boom years in many countries had fallen sharply. Moreover, the freezing of capital flows in high-income countries and increased borrowing costs generated a huge $690 billion financing gap that had to be met by reduced imports, layoffs, and in some instances substantial injections of foreign capital through official agencies such as the IMF, World Bank and various regional development banks.”

This is more of a statement for the history books. However, I will point out that this reality served to thwart those who held the view that China was decoupled from the U.S. economy. While I warned in America’s Financial Apocalypse of China’s growing ability to self-sustain, you will note that I also warned of a large correction in the commodities bubble, which would severely (although temporarily affect China).

“As a result, GDP growth in developing countries decelerated sharply, coming in at only 1.2 percent for the year as a whole. Developing Europe and Central Asia, which went into the crisis period with large current account deficits due to a consumption boom financed by international credit and FDI was hardest hit. GDP there fell an estimated 6.2 percent in 2009. Excluding these countries and China and India, which were able to weather the worst effects of the turmoil through large fiscal and monetary stimulus packages, GDP in the remaining developing countries fell by an estimated 2.2 percent in 2009—well below the 3 percent trend growth rate of these countries going into the crisis.”

The problem is that the GDP has not come down sufficiently to unwind the leveraged credit created within the global bubble. With U.S. Q4 2009 GDP coming in at 5.7%, that should tell you that the bubble is already being reflated without ever having been sufficiently deflated.

“Unemployment is rising, an additional 90 million people are expected to remain in poverty (less than $1 a day) by the end of 2010 as a result of the slower growth, and as many as 30-50 thousand additional children are expected to have died of malnutrition in 2009 (Friedman and Schady 2009).”

The global bubble is reflating while a large segment of the world is becoming more impoverished. Unemployment remains high, while new jobs are scarce. This implies that the stimulus funds are not working in high-income and many developing nations. Thus, another collapse (which can’t be ruled out) could be much worse.

“As emphasized above the economic rebound that is currently under way is likely to continue for several months, supporting relatively rapid growth. However, a great deal of uncertainty clouds the outlook for the second half of 2010 and beyond. The waning growth impact of the fiscal stimulus, a progressive end to the inventory cycle, uncertainty about the extent to which private sector confidence will step in and sustain the recovery, and the possibility of a second round of bank failures either in developed or developing countries are among the factors that could contribute to a more pronounced slowdown of growth in the second half of 2010 and into 2011-potentially yielding a double-dip growth recession.”

The above statement (I bold-faced) should be taken as more of a warning than a random myriad of possibilities.

“On the upside, if private sector confidence does return, there is a risk that the huge traditional and nontraditional monetary stimulus that has been put into place will begin to gain traction, potentially reflating some of the bubbles that have only recently burst. Indeed, some (Roubini 2009) are already arguing that very loose monetary policy in high-income countries has produced a carry-trade opportunity that is underpinning in an unsustainable manner the resurgence of capital flows to developing countries, which may ultimately regenerate the kind of global imbalances that precipitated the crisis in the first place.”

Notice the World Bank references their buddy, Roubini. Roubini was formerly employed by the World Bank. You should also note that he is one of the extremists with a profit-power agenda which the media is fueling. He has one of the worst track records of anyone. If you do not believe me, I encourage you to research his track record over the past few years. This is a man who has NO IDEA about the capital markets, while his economic forecasts should always be discounted, as you might expect from any extremist.

Finally, I want to point out that all of this rhetoric you have been hearing about the carry trade by the media and the financial “experts” and bloggers is without merit. They are all followers. Once they hear it a few places, they all jump on the band wagon. The fact is that the carry trade is not really offering any real arbitrage situation because it comes with the price of higher risk.  Currency/interest rate spreads exist for a good reason. And while some may think they present opportunities to make easy money, the fact is that eventually, the market is always right. The market eventually displays the reality, or for many investors, it reveals the true level of risk.

A more buoyant private sector reaction

“The reaction of the private sector to the recov­ery is one of the major uncertainties underlying the outlook. In the baseline scenario, the negative wealth effect from the crash plus the indebtedness incurred during the boom period are expected to dampen consumer demand for several years. In addition, the weakened banking sector is not expected to be able to support the kind of investment rebound that normally follows a serious recession.”

Some of you might recall that I warned of the “Poor Effect” that would materialize after the implosion of the real estate bubble in America’s Financial Apocalypse and Cashing in on the Real Estate Bubble.

You should also note that the World Bank has once again waffled on its previous claims (pg.62) of “pronounced growth rebound.” Now, the WB is stating that the weakened banking sector is incapable of supporting the type of recovery that follows a major recession. This also supports my premise that you cannot make forecasts based upon the economic cycle as the World Bank has done, because what we are seeing does not fit within the economic cycle.

Policy implications for developing countries

“Although the financial crisis has passed and the global economic recovery seems to be under way, many challenges for policy makers and international financial institutions remain. Paramount among these is the management of the unwinding of the fiscal and monetary stimulus that has played such a critical role in avoiding a much more serious downturn. Timing the tightening of fiscal and monetary policy to avoid killing off the recovery is one clear consideration. But so too is the risk that the very loose monetary and fiscal conditions in high-income countries could create dangerous conditions for developing countries. Already very low interest rates in high-income countries are promoting carry trades that may be promoting destabilizing capital inflows into developing countries that could create new asset bubbles and the potential for future crises. For developing countries, the management of the recovery in capital flows is a critical challenge. Warding off new asset price bubbles may call for greater exchange rate flexibility. If these inflows are enduring and effectively channeled into productive investment, they could present a major boon to developing countries.”

First, while the previous financial crisis has passed, there is still a reasonable risk that we may experience another financial crisis. While I agree that there is a possibility of danger to developing nations, the reasons for my agreement differ. Once again, this carry trade talk is bologna. Carry trade, when done the right way is short-term. You won’t see the carry trade result in the accumulation of assets as in the case of long-term investments unless you are dealing with complete bozos.

“Government policies should focus on productivity-enhancing growth strategies (for developing nations). For low-income countries, these strategies may involve simultaneously addressing underlying structural problems such as the quality of institutions, regulatory reform, and openness all critical factors in promoting faster productivity growth.”

This might well be the most ludicrous statement in the entire report. It is much more important for high-income nations such as the U.S. and nations in Western Europe to create quality financial institutions and move forward with financial regulatory reform.

The following table shows the results of the World Bank’s global economic forecast, through 2011. 

Global Economic Prospects 2010: Forecast summary 2007-2011

Percentage change from previous year, except interest rates and oil prices.

Source: World Bank.
Note: PPP = purchasing power parity; h = estimate; i = forecast.
a. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
b. In local currency, aggregated using 2005 GDP Weights.
c. Simple average of Dubai, Brent, and West Texas Intermediate.
d. Unit value index of manufactured exports from major economies, expressed in USD.
e. Aggregate growth rates calculated using constant 2005 U.S. dollar GDP weights.
f. Calculated using 2005 PPP weights. 

g. In keeping with national practice, data for Egypt, Iran, India, Pakistan and Bangladesh are reported on a fiscal year basis. Expressed on a calendar year basis, GDP growth in these countries is as in the table on the right.

I added some additional data which highlights growing concerns I have regarding reflation of the global asset bubble. For most of the nations I have shown, interest rates collapsed since 2006-2007, where they currently remain very low.

Note that while inflation appears to be contained (except for India and the UAE) it is nowhere near previous levels.

However, with the global stimulus and an extended period of near-zero interest rates (except for Brazil, China, Russia and Australia), a huge global inflationary force is being created. Based on what I see today, I would expect India and Australia to serve as leading indicators of global inflation. 

Next, I show GDP per capita in terms of purchase price parity (in order to adjust for currency exchange rates).

For the first 6 nations shown, the GDP per capita increased by about 3.5% annually (compounded). However, for Russia, the increase was about 9% annually, 6% for Brazil, 11% for China, and 7% for India.

What does this mean? 

Well, it’s the same thing I have been saying all along—the developed world (mainly the U.S.) has transferred wealth and incomes to developing nations, and it has done so as it’s only way to create robust growth in the U.S.

The problem is that it has created a global bubble, which has still not deflated completely. What we are seeing now is a reflation of this bubble. It is likely to swell beyond its previous massive size. 

Below, you can see that U.S. household net worth has began to rebound, despite that fact that it never corrected fully. As you can imagine, this rebound was led by the 65% rebound in the stock market in 2009. This alone has implications for the stock market.


The next chart shows world growth set to rebound to pre-collapse range by the end of 2010, perhaps 2011 (data not shown).  It has been a rebound too fast and without sufficient de-leveraging.

Figure 1 provides a nice summary of global historical GDP as well as forecasts through 2011. Here, I want you to first focus on the World GDP forecasts.

As you can see, GDP is expected to rebound to levels similar to the period prior to the global collapse. You should find this is troubling. It reaffirms my suspicion that indeed the global bubble is reflating, or has already reflated.

But recall that most of the gains in GDP growth are expected to come from emerging nations as Figure 1 shows. Make no mistake, as strong as the economies of China, India and Brazil are, they are being propped up by the global bubble.

Figure 2 shows industrial production and exports have already reached (and in the case of advanced nations they have actually surpassed) pre-collapse levels).

Where is all of this commerce coming from when employment around the globe is so high? 

In part, it’s coming from each nation’s economic stimulus plans.  While China, Brazil and other developing nations have the cash for these plans, many advanced economies (such as the U.S., Japan, UK and others) do not. 

Figure 3 shows global inflation to be in check. However, I would not expect this to persist for long. With little doubt, inflation will create many difficulties throughout the globe.

Finally, although I do not have time to get into the details, you should note the presence of a housing bubble in Canada, and especially Australia. One could also argue there is a housing bubble in China. Although China’s surge in real estate is backed more by its economic gains, it is still a bubble.

Keep in mind that bubbles can persist for many years. However, they are always implode due to large events. Any significant global event could spread to these bubbles, which would have multiplier effects.

I have posted an excerpt of one of an interview transcription in November 2009.

In order to understand these economic trends, you need to remember that over a short period of time, wealth is relatively finite. That is, you can only create a certain amount of wealth over a given time frame. Generally, this wealth creation is similar to global population growth - about 1.5%. This is also similar to the median economic growth of the world historically, roughly speaking.

Now these numbers don’t always match up one-for-one, because you do have things that add to productivity per capita like high-tech innovations. But the correlation between population growth and global GDP under normal (non-bubble conditions) are close. You might see the global GDP a percentage point higher than the population growth due to these innovations, but that’s about it. Anything above that over an extended period indicates signs of a global bubble.

The reason for these relationships is simple. It takes people to create goods and services.

As I mentioned, there are things that increase productivity per person. But that productivity reaches a limit because it also takes people to consume goods and services. And there’s only one thing that can enable people to consume goods and services beyond their normal capacity; open access to credit.

But if credit expansion occurs unhindered over an extended duration, you will have a bubble. And eventually, all asset bubbles burst. This is exactly what we have seen over and over throughout history.

If U.S. corporations have been more profitable than since the post-war period, (they were from 2003 to 2007) and if developing nations have been delivering 6 to 11% economic growth annually, (they have for many years) that wealth has to come from somewhere. So where has it come from? Working-class Americans. They have had their incomes partially transferred to developing nations in the form of lost jobs, declining job quality, and poor wage growth.

But we also had massive credit expansion because that was needed to fuel the consumption binge in America which led to demand for goods and services in these emerging markets.

Notably, the past decade, the average global GDP has been much higher than the population growth, implying the existence of a global bubble.

These trends account for the growth of developing nations like China, Brazil, India and others, as well as the record profitability of U.S. corporations, who benefit from cheap labor overseas.

Everyone has benefited except working-class Americans; the engine behind the U.S. economy. But since there was also a bubble component to this, that is why the emerging markets felt the effects when the U.S. economy cratered. Without the effects of these bubbles, China, India and Brazil would not have grown nearly as much as they have.

So it’s been a symbiotic relationship. But U.S. workers are at the bottom of this economic food chain. These are the things that I addressed in my book. The data is very clear. And these relationships have not changed.

I don’t expect them to change based upon what I see happening politically in this country, which is an entirely different topic.

There are so many problems. It's going to be a domino effect. I just don't think we are going to see a real recovery because our leaders keep playing the same games, reflating these bubbles, trying to cheat the system, instead of taking a hard beating and starting fresh.

You can’t cheat the system. You can’t keep printing money thinking that it will restore productivity. It’s a very destructive strategy.

The only wake up call might be when some of these countries decide to dump the dollar. If that happens, it's going to be a big, big problem.

America has been exporting inflation for many years. And the countries that receive a big part of our inflation – our trading partners, Asia, Europe and the Middle East – they realize it.

We’ve only been able to export inflation because the world is dependent on the dollar. The dollar is the universal currency because of the dollar-oil link. That means you must have the dollar to buy oil anywhere in the world. It enables us to export inflation.

But OPEC doesn’t like it one bit, and they’re in a unique position to fight back. How do they fight back? They make sure oil prices go up when the dollar goes down to off-set the dollar’s weakness.

If the dollar-oil link is destroyed, you’re going to see unthinkable levels of inflation in this country, which is why I think that any threat to the dollar-oil link will result in a major war.

Of course, Iran is a big part of the picture because Iran has been selling oil on its own oil exchange for the euro. And on many occasions they’ve encouraged OPEC to do the same. This is really the main issue you don’t hear about from Washington, the media or anywhere else. It's the dollar-oil link that enables America to run an economy that's kind of like a Ponzi scheme. This is what most people don’t realize.

It’s all about the dollar-oil link. That’s why Washington has suppressed alternative energy development for decades.

I know for a fact that a good deal of the research and technology for alternative energy innovations you’re just now starting to hear about have been around for at least two decades.

Washington knows they can’t delay alternative energy development much longer, so I’d say they’re trying to figure something out (carbon tax credits) before the world’s dependence on oil moves to other sources.

The dollar-oil link also explains the mysterious “good” relations we’ve maintained with the Saudis since the 1970s, despite their involvement in terrorism, human rights violations and many other things that would lead to economic sanctions. 

These “good” relations with the Saudis are only due to the dollar-oil link established by President Nixon in the early 70s. Back then, Nixon promised military and diplomatic support for the Royal Saudi Family in exchange for selling oil for dollars.

Shortly thereafter, OPEC followed suit. Since then, America has been able to export inflation throughout the world since you must have dollars to buy oil.

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By Mike Stathis

Copyright © 2009. All Rights Reserved. Mike Stathis.

Mike Stathis is the Managing Principal of Apex Venture Advisors , a business and investment intelligence firm serving the needs of venture firms, corporations and hedge funds on a variety of projects. Mike's work in the private markets includes valuation analysis, deal structuring, and business strategy. In the public markets he has assisted hedge funds with investment strategy, valuation analysis, market forecasting, risk management, and distressed securities analysis. Prior to Apex Advisors, Mike worked at UBS and Bear Stearns, focusing on asset management and merchant banking.

The accuracy of his predictions and insights detailed in the 2006 release of America's Financial Apocalypse and Cashing in on the Real Estate Bubble have positioned him as one of America's most insightful and creative financial minds. These books serve as proof that he remains well ahead of the curve, as he continues to position his clients with a unique competitive advantage. His first book, The Startup Company Bible for Entrepreneurs has become required reading for high-tech entrepreneurs, and is used in several business schools as a required text for completion of the MBA program.

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