THE US-Created Global Recession: How Is Everyone Else Doing?

American banks led the world into a credit freeze, and anyone living in the US, Western Europe, or Japan is painfully aware of the resulting global recession. But how about the rest of the world: how is it faring?

 To answer this, consider first the genesis of the global recession:

• after peaking in 2006, real estate prices fell sharply United States, Western Europe and Japan (Developed Countries – DCs), leading to –
• a global credit freeze, followed by –
• stock market and real estate losses of $40 trillion worldwide with 70% of those losses occurring in the DCs, resulting in –
• a dramatic reduction in consumption and investment expenditures in the DCs, resulting in –
• a steep decline in commodity prices and international trade leading into a global recession.

 The first important point about this sequence of events is that it all started in the DCs: they all had housing collapses, and most of their big banks traded in asset-backed securities. It is true that stock markets worldwide went down. But unlike the DCs where 50% of households (http://www.ici.org/pdf/rpt_05_equity_owners.pdf) own stocks, equities are owned primarily by the very wealthy in other nations. In an earlier posting, I compared US total income (wages plus capital gains/losses) in 2003 and 2008. Total income went from $15 trillion in 2003 to less than $2 trillion in 2008.

Table 1. – US Income Losses (in US$ billions)

Americans feel much poorer, and as a consequence, their spending has fallen. This same collapse in income with a resulting fall in spending has occurred in the other DCs.

 Now let’s look at the rest of the world. How were they doing when all of this hit? Most were developing rapidly, bolstered by growing middle classes consuming more, the export of consumer goods to DCs, and rising commodity prices. Because stocks are held primarily by the wealthy in these countries, the vast majority of citizens there did not suffer the same income losses. Consequently, their expenditures did not fall dramatically. And very few banks in these countries had investments in asset-backed securities so they were not involved directly in the credit freeze. In the following table, data on global output/incomes are presented.

Table 2. – IMF World Economic Outlook Projections

(percent change)

Source: http://www.imf.org/external/pubs/ft/weo/2008/update/03/index.htm

 The IMF is estimating a small reduction in import demand from the DCs. However, on March 23^rd, the World Trade Organization estimated that global trade would fall by 9%, significantly more than the IMF estimated in November 2008 (http://www.wto.org/english/news_e/pres09_e/pr554_e.htm). To put this in perspective, consider the following: since the IMF started tabulating global import data in 1986, the average annual percent increase has been 6.6%, and there has never been a decline (the slowest increase was 0.3% in 2001).

 The following table provides information on the leading global traders.

 Table 4. – Trade Data on Selected Countries

 Note that Germany is the leading exporter, followed by China and the United States. For both China and Germany, exports are a very important part of their economy, amounting to 39.8% of GDP and 37.5%, respectively.  The China situation is worth watching. China’s top six trading partners take 70% of its exports and they are all in recession. China’s exports fell 26% in February compared to February 2008, and that was after falling 28% in January. With exports amounting to almost 40% of China’s GDP, such reductions will have a serious impact on China’s growth rate and unemployment situation. Assume that China’s exports fall by 27% for the year. At 40% of the country’s GDP, that would mean a reduction in GDP of approximately 10% for the year. China cannot afford such a reduction: it needs GDP to grow annually at 7-8% to keep the full employment. As a consequence, the China Government acted quickly: it launched a $586 billion stimulus plan last November.

 Germany is in equally serious shape. Its export dependency is slightly greater than China’s and its high-end exports are in steep decline. The German Government has initiated $96 billion stimulus plan consisting of industry support and tax breaks (for more information on stimulus plans , see Kevin Gallagher at http://www.bu.edu/ir/faculty/misc/Survey.xls and Sameer Khatiwada on Dani Rodrik at http://rodrik.typepad.com/dani_rodriks_weblog/2009/03/getting-the-global-stimulus-numbers-right.html). Overall, as I have pointed out in an earlier posting, we would need a stimulus of $7.3 trillion to get us out of this mess. And this will not happen (http://www.morssglobalfinance.com/the-global-recession-what-stimulus-is-needed-for-recovery/).

 Let’s look briefly at global demand. The United States is by far the leading importer: its imports are 14% of world imports, so the impact of a fall in its import demand is felt worldwide. Since July 2008, the WTO reports US import volume has fallen 32%.

Commodity Prices

Over the last few years, there has been a “commodity price bubble” which has greatly benefited oil and other natural resource rich countries. Oil prices reached $140 per barrel just last summer before plunging later in the year. As can be seen in the following graph, other commodities followed the same path.

Graph 2. – Prices of selected primary products,

January 1998 – January 2009

 

Source: IMF International Financial Statistics.

Prices for other primary products, including metals and food, have also fallen from their peaks earlier in 2008. The most important point about these prices is that in recent years, they achieved their highs in part because of considerable speculative money bidding them up. That money is no longer supporting them. And as a consequence, they are probably lower than where supply and demand would dictate they should be, even in this global recession (more on this in my next article on investing in a global recession..

Reduced Capital Flows from DCs

I quote from Roubini:

The reversal of capital inflows due to deleveraging or losses in financial markets has been one of the most significant effects of the financial crisis on emerging and frontier economies. After a period in 2007 and 2008 when many emerging markets faced the problem of dealing with extensive capital inflows, now capital flows have reversed. Private capital flows in 2009 are expected to be less than half of their 2007 levels, posing pressure on emerging market currencies, asset markets and economies. (http://www.rgemonitor.com/roubini).

I would add that with surging US deficits resulting from its stimulus packages, the competition for capital will be severe.

Specific Countries

The Economist recently published an interesting table comparing the problems facing a number of countries. It pointed out that a number of Latin American countries created a stabilization fund during the commodity boom. But even there, the magazine put Mexico, Brazil, Argentina and Venezuela among the nations most likely to fall. These countries either have a high amount of short-term debt as a percentage of their total reserves, or their bank loans as a percentage of total deposits are at a risky level, or both.

Graph 3. – Countries in Trouble

Source: “Domino Theory”, The Economist, Feb. 26, 2009

 China looks quite safe. I remember one of my investment partners was married to a senior official in the Hong Kong office of Barings Bank a decade back. The Barings guy was trying to sell derivatives to the China Government. He made his pitch, and the China official said he would discuss it with his superiors. The next day, the China official reported back that if he agreed to any derivatives investment, he would be fired.

 Summary

The global recession started in US banks that did not believe there was a real estate cycle. And while the recession is global, its effects will be most severe in the United States, Europe, and Japan. Prospects in the rest-of-the-world are more promising than in the DCs.  I conclude with an IMF graph looking ahead.

P.S. In a recent article, I said “Over the last four months, average monthly job losses have been 646,000. At this pace, the unemployment rate will reach 11.5% by August.” The latest US jobs figures for March came out – job losses spiked higher to 742,000.