Money Sage

Since we are chronically skeptical of "miracles," we have long been dubious about the "China miracle," "the Asian miracle," and the "India miracle." Indeed, quite a few months ago we penned an assessment of China stocks which we entitled "Chinese Tulips?" a reference to the tulip mania in Holland in the 17th centruy. We also, about the same time, at the height of the commodities frenzy, penned an analysis of commodities markets which we entitled: "Commodities Crash?"

Now we have observed, over the course of many years, a certain cyclicality which seems inevitably to trump the endless growth stories of the time. Unending, persisting growth for as far out as the eye can see turns out, with the rarest of exceptions, to be a cyclical phenomenon, misidentified during the excitement of a big bull run as a financial fountain of youth. Ponce de Leon, it would seem, was hardly alone in seeking perpetual happiness -- whether it be in the form of a fountain of youth or an endless gusher of money.

Unfortunately, the transmutation of fleeting speculative success -- typically amplified via a spiralling leveraging process which crests at the peak of the market -- proves to be as false as the endless efforts of man to transmute iron into gold.

Even the secular long-term growth stories which do pan out -- the two century plus expansion of American economic production and power, for example -- are marred by somewhat lengthy periods of severe and painful regression, periods historically labelled "depression." Moreover, there is no mystery about why depressions occur, the insistence of erudite economists to the contrary notwithstanding. (This guild of economists reminds us very much of the priesthoods of ancient societies, which maintained a stifling monopoly on literacy in order to preserve the aura of their wisdom and the actual power which sprang from this monopoly on "forecasting" the future).

The story of endless Asian economic growth has been very good copy indeed for American journalists, both print and media. More to the point, it has been extremely lucrative grist for the mill of those who sell, advise, and manage portfolios chock full of Asian stocks, bonds, currencies. It has provided new and virgin fields for the plows of Wall Street to work.

The Asian story, as we see it, has three chapters: the Japan chapter, the China chapter, and the Indian chapter. Japan, in the late 1980s, was the world's ten foot tall economy. The crescendo of blind adulation was reached at the very end of the decade, at the very moment the Japanese economy was poised to fall over the precipice. The cover stories in major American magazines hailing Japan as the economic wonder of the world marked the imminent onset of a two decade period of economic decline and stagnation, which saw Japan's share of the global economy shrink by 50%, her stock market decline by 80%, and real estate prices drop by some 90%.

The China chapter began a while later, as western observers, journalists, and analysts took increasing note of the seemingly endless succession of years of double digit economic growth. This observation generated growing admiration and, in some, fear. The view that China was destined to replace the U.S. as the world's leading economy became a commonplace. China -- and indeed the rest of Asia -- had "decoupled" from the United States economy. A U.S. downturn would not affect China -- indeed, China, and the other developing Asian economic powerhouses -- India, Korea, Thailand etc would PULL US OUT of such a downturn, replacing the U.S. as the engine of global economic growth and prosperity.

The India chapter was really more of a sub-chapter: here was a densely populated country with great potential which was starting to free up this potential and achieve impressive economic growth via de-regulation, curtailment of state monopolies, encouragement of foreign investments, favorable tax treatment for businesses. Moreover, India possessed what China did not have: the stable, democratic and judicial and constitutional institutions and practices which constitute the soundest possible base for future growth and prosperity.

All of these dreams and illusions have been shattered today, of course. The virtual collapse of the American (and now British and European) banking system generated an acute credit contraction, which in turn produced a series of falling financial and economic dominos. This ever-quickening downward spiral -- proceeding without any real stabilization despite unprecedented central bank and government interventions, guarantees, credit backstops, and money printing -- has now succeeded in toppling the biggest domino of them all -- the debt addled American consumer.

The implosion of the over-indebted American consumer, who constitutes more than 20% of the global economy, in turn knocked down the Asian domino. Asia, it seems, depended for its economic growth, prosperity, and accumulation of foreign reserves on the debt-crushed American consumer. The wondrous growth of China, of India, of Taiwan, of Korea, of Singapore, of Thailand -- all had as its dynamic core the endless increase in consumer exports to the good old U.S. of A. When American consumers reduced dramatically their spending -- initially out of necessity, now reinforced by fear and a late-blooming awakening to the financial facts of life -- Asia collapsed. We see the most dramatic, and, let us admit frankly, the most frightening case of this in Japan, whose economy is now contracting at double digit rates, and whose exports have dropped by perhaps 40%. Severe economic contractions, initiated by the plunge in exports to the US and an increasingly stressed Europe, are now underway in the former Asian "Tigers" -- Taiwan, Korea, Singapore, Thailand. And now, wonder of wonders, both China and India are "weakening." (Since we are skeptical about the truthfulness of Chinese economic statistics, it is impossible to guess whether China is even growing currently; we do know that more than 20 million rural Chinese who migrated to the cities where they found work have now lost their jobs and have been forced to return to the countryside).

What is really notable about the severe deterioration in the Chinese economy is that the Chinese financial system and major financial institutions appear to be in relatively good condition. Unlike their European compeers, the Chinese banks did not load up on U.S. real-estate backed securities. Moreover, China holds immense foreign currency reserves -- some $2 trillion at last count. Finally, Chinese households have very large savings, allocated primarily to cash and bank accounts. In other words, they are both LIQUID AND SOLVENT -- in drastic contrast to American households. Yet, despite all this, the Chinese economy is weakening. In the end, it seems, China is a big, developing, but still POOR COUNTRY, which depends on exports to the US, Europe, and Japan for its prosperity and economic growth.

We think that it is the acute implosion of the Japanese economy which constitutes a central threat to global, regional, and national economies and stability. China cannot expect to export much to the US and Europe for the foreseeable future; if it cannot export to Japan, its principal trading partner, or to other imploding Tigers -- Korea, Taiwan, Thailand -- who can it export to?? The din of world pressure on China to increase domestic consumption is all well and good, but this is a very long-term project, which will require drastic and difficult to engineer and implement government and household policies, and altering radically consumer attitudes toward debt, spending, and saving.

Japan remains the world's second largest economy, far larger than China's economy. The apparent political paralysis and ineptitude in Tokyo, the Japanese peoples' long experience with deflation, and the consequent dependence of the Japanese economy on export to debt-laden American and European consumers, rather than consumption by highly liquid, highly solvent, intensely risk-averse Japanese consumers, bodes ill for the global economy, and, in and of itself, is generating powerful contractionary influence in Asia, suggesting that Asia is developing into a secondary but major source of global economic contraction.

Moneysage 2009 - copyright