Saturday, November 22, 2008

The Great Chimerica Depression

Inspired from several articles (Washington Post, Bloomberg, China Financial Markets and Naked Capitalism), there is a history lesson from the great depression that we can learn from given the current credit crisis.

Bottom line: The US is deleveraging from a private consumption-based economy to a more publically financed economy, just as the Europeans did during the 1930s; and, China is subsidizing its export overcapacity in order to prop-up its government's primary objection: sustained growth - just as the US did in the 1930s.

At the heart of this crisis is the huge imbalance between the United States, with its current account deficit in excess of 1 percent of world gross domestic product, and the surplus countries that finance it: the oil exporters, Japan and emerging Asia. Of these, the relationship between China and America has become the crucial one. More than anything else, it has been China's strategy of dollar reserve accumulation that has financed America's debt habit. Chinese savings were a key reason U.S. long-term interest rates stayed low and the borrowing binge kept going. Now that the age of leverage is over, "Chimerica" -- the partnership between the big saver and the big spender -- is key.
From Bloomberg:
China is struggling to stave off the effects of a worldwide economic downturn with 4 trillion yuan ($585 billion) in stimulus spending on new roads, railways, airports and low-rent housing. Asia's second-biggest economy grew 9 percent in the three months from July to September, the slowest pace since mid- 2003, threatening the expansion to which the Communist Party has pegged the credibility of its one-party rule.
From China Financial Markets:

If unemployment is rising, however, it does mean that there will be serious pressure to do whatever it takes to support employment growth. One thing that I am worried about (and this was the subject of the “longish writing commitment” I mentioned above) is that it puts pressure on the government to engineer measures to expand export growth. For example I suspect that the fight over whether or not to continue appreciating, and even depreciate, the RMB is intense. 
But if you think of China’s role within the global balance of payments, it seems to me that this is little more that a form of Smoot-Hawley-with-Chinese-characteristics. Global demand is slowing, just as it did in the 1930s, and China as the leading source of global overcapacity is trying to address its global demand problem by shifting the burden abroad.
In the 1930 it was the US who had huge overcapacity which it exported abroad (via huge trade surpluses) and it was Europeans who were over-consuming, financed by capital exports from the US.  When the credit crunch came it was unreasonable, as Keynes argued bitterly, to expect the rest of the world to continue demanding US goods, especially since the financing of their consumption had been interrupted.  Since US production significantly exceeded US consumption (with the balance consisting of course of the trade surplus), the need for demand creation most logically rested in the US.
Today it is China who is exporting overcapacity and it is the US who is consuming too much, fed by Chinese financing.   With the collapse of bank intermediation US households and businesses are cutting consumption and raising savings.  This is a necessary adjustment. Calling on the US government to engage in massive fiscal expansion to replace lost private demand is crazy.  It means that we should continue the current game that has led us into so much trouble, but instead of having US over-consumption and rising debt at the private level we must have it at the public level.
This can’t work for long.  The world has excess production and there is a need for the US to reduce its demand and increase its savings. The only proper place for new demand to originate is, once again as in the 1930s, from current account surplus countries.  They should be engaged in demand creation, not supply creation.  If they continue trying to export their way out of a slowdown, there will almost certainly be a trade war, as in the 1930s, and the full force of the adjustment will be borne by the current account surplus countries, again as in the 1930s. Remember that back then the current account deficit countries, like Germany after 1932, found it relatively easy to limit the impact of the crisis by forcing balanced trade — which has the effect of increasing demand (domestic) and reducing supply (foreign). 
[remembering that Germany, France and England defaulted on its debts - Germany suffered a tremendous GDP collapse (-40%) between 1929 and 1933. Germany unemployment in the years following 1929 reached over 30% (more than USA) (data from Findlay - O’Rourcke - Power and Plenty - Ch.8).This level of unemplyment was one of the reason that pushed Hitler to power in 1933.It is not nice to say but was Hitler Economic Policy, with substancial deficit spending (to build arms and highways), to reach full employment again in 1937. On my opinion that was one of the reason of the substancial support of German people toward Hitler in the following years (1938-1945).This is a reminder that substancial financial and economic crisis have strong political implications.]
From Naked Capitalism:

Note the Chinese have a problem that probably did not obtain in the US during the Depression: a huge disparity in living standards between the exporter and importers. Remember, there was still a great deal of international labor mobility in the early 20th century, and that helped dampen wage differentials between countries. Presumably, many of the goods the US exported in the 1920s would have been the sort that US consumers would buy. By contrast. a lot of the goods made for export to the US would not appeal to the mass market in China. I do not know how specialized manufacturing is and how hard it would be to reorient production for the domestic market. But American like to overconsume in quantity as well as type (when I lived in Australia, I was struck by how much smaller their closets are than ours. It was refreshing, in a way).

Monday, November 17, 2008

Market Links - 11/17/08

Umpqua chief sees federal cash leading to fewer, stronger banks

Friday, November 7, 2008

Capital Market News

§  Dems crafting $100B stimulus plan, tax-cut package
Democrats began work Thursday on a second economic-stimulus package. The plan could include $100 billion in stimulus spending, as well as middle-class tax cuts that could be implemented as early as next year. President-elect Barack Obama is expected to discuss the plan today in his first news conference since the election. The Washington Post (11/7)

§  Real estate funds go after capital despite down economy
Opportunistic real estate investment managers are still attracting capital, even as the credit crisis continues and economic growth falters. Research from real estate fund of funds manager Clerestory Capital Partners shows that 187 funds were seeking about $155 billion in the third quarter. "Lots of real estate fund managers see potential once-in-a-lifetime investment opportunities coming," Clerestory principal and co-founder Tommy Brown said. Europe Real Estate (11/7)

§  Fed pumps additional $100 billion into commercial-paper market
The Fed's program to bring liquidity back into short-term corporate lending is showing results, with lending under the Commercial Paper Funding Facility increasing to $243 billion over the past week, from $144 billion a week earlier. Businesses and financial institutions were forced to look to the Federal Reserve for help after the traditional sources of debt, including commercial paper, dried up in the wake of the Lehman Brothers collapse. One analyst said the Fed "is tapping all the keys on the keyboard, and it does seem to be helping." (11/6)

Fed's balance sheet expands to record $2 trillion
For the first time, the Federal Reserve's balance sheet exceeds $2 trillion as the central bank continues to lend huge sums of cash to financial institutions to keep short-term funding markets alive. The Fed's balance sheet grew from $1.953 trillion Oct. 29 to $2.058 trillion on Wednesday. Banks pulled back on direct borrowing from the Fed's discount window, but the industry remains dependent on the lender of last resort. CNBC/The Associated Press (11/6)

Wednesday, November 5, 2008

Latest Construction News

§  With loan delinquencies up 10%, projects spawn liens, suits
With construction loan delinquencies jumping to an estimated 10% in the third quarter, an increasing number of commercial construction projects are being slapped with liens or ending up in litigation. The Granby Tower project in Norfolk, Va., has sparked four lawsuits since construction ended last year, and the Spire condominium project in Chicago has collected several liens before construction has even begun. "The magnitude of the crisis is historic," said Ted Novak, a Chicago real estate attorney in practice for 30 years. "Activity has stopped." (11/3) , (11/3)

§  Cost of construction materials rises in September
Construction materials cost 0.5% more in September than they did in August and 12.7% more than they did a year earlier. One of the largest increases, 6%, was for asphalt and asphalt roofing. Commodity prices in general are expected to weaken into winter because of surplus materials and lower fuel costs. Reed/ACP Construction Data (10/31)

Testing the fire resistance of HOW joints
Requirements for fire-resistant walls have brought up questions about the state of head of wall (HOW) joints in Type IIB structures, so the Metal Building Manufacturers Association and Hughes Associates tested the joints. They found that HOW joints between a fire-resistant wall and a roof assembly meet the one-hour fire assembly ratings criteria. Three new UL assembly listings were issued as a result. GoStructural.Com (10/31)