Global Market Brief: A Look Ahead -- The Next Big One
November 09, 2006 23 06 GMT
The U.S. economy is decelerating and will bottom out in the first half of 2007. The dreaded word "recession" might not be appropriate to use, because the United States might not actually meet the technical definition of two consecutive quarters of negative growth.
But a slowdown is clear. The yield curve has been inverted for months (which indicates money is being used irrationally); productivity gains have now fallen below gross domestic product (GDP) growth while labor costs are rising (which indicates the labor market is overheated); and the housing sector -- red hot for nearly a decade -- has finally lost steam.
However, there is no looming disaster about to befall the U.S. economy, or a structural imbalance that will imminently tear the system apart. The trade deficit is not a concern, and the budget deficit is not the monster it once appeared to be turning into. And no matter what one might think of a Republican, Democrat or split Congress, it is a rarity when the legislature's decisions affect the economy on a time frame of less than a year. Every aspect of this slowdown appears to be part and parcel of a normal economic cycle. The fundamentals of the American economy -- cultural, political and financial -- remain sound.
From time to time Stratfor takes the long view, peering ahead to spotlight the development trends that are as critical as they are unavoidable. Now is one of those times.
Money, Money Everywhere
Ultimately, long-term economic trends filter out much of what happens in the day-to-day life of policymakers. Those policymakers can shape the underlying strengths and weaknesses of an economy -- and that is indeed important, as they determine the relative speed of growth that an economy can achieve -- but they have very little control over the macroenvironment that dictates the range of possibilities in which policymakers play.
The macroenvironment of the past 15 years has been remarkably conducive to strong growth in the United States. Do not confuse this with specifics of the U.S. system of mass education, reward for risk, functional bankruptcy laws, a mobile population, enthusiasm for technology, relatively uncorrupt culture or any of the other factors that help spark growth. What is being discussed is the overarching environment in which the United States and the rest of the economies in the world swim.
The single most notable characteristic of that environment has been cheap -- extraordinarily cheap -- credit. Stratfor and others have made much of the idea that the Asian economies function on a system of cheap credit to stimulate their economies. In most Asian states -- with China and Japan atop the list -- the state actively intervenes in the financial system to ensure that anyone who needs cash can get access to loans at well-below-market rates, regardless of the soundness of the borrower's business plan.
In such systems the concern is not for profitability, but instead for market share and mass employment. Consequently, firms that would have been shut down in the United States because they cannot make money (to be more accurate, they bring in plenty of revenues, they just cannot break even) are habitually allowed to continue operating. We will not deal with the consequences of this system here (interested readers can follow these links for Stratfor's take on the situations in China and Japan) but these states do not operate in a vacuum. Their financial choices affect the rest of the planet because their artificially cheap credit does not halt at their borders.
Japan's cheap credit policies have flooded the system with more than $1 trillion in yen as Japanese firms tap that credit for international operations. China's system -- not even touching private or state-firm capital flight -- has resulted in $1 trillion in U.S. Treasury bond purchases. By an extraordinarily conservative measure that does not even take into account Taiwan, South Korea or any of the other Asian states that have modifications on the theme, Asia has added $2 trillion in cheap cash to the system.
And that is the small end of this picture. The real source of cash is not in Asia, but right here in the United States.
Baby Boom Bomb
From a financial viewpoint, people fall into three categories. First are the young workers who are buying homes and raising children. Aside from those lucky enough to have an income that allows it all to be done with cold hard cash, these people have to borrow. They need to get a mortgage, maybe even a second one when it is time to think about college for the kids. Living from paycheck to paycheck -- or credit card statement to credit card statement -- is a way of life. Young workers consume credit, and lots of it.
Second are the mature workers. The mortgage is paid off and their house moves from their debt sheet to their asset list. The kids are moved out and through college. Such workers' debts are paid off and they are preparing for retirement. Money that once went to the children or the mortgage or to interest payments on credit cards now goes into a variety of savings and investments. These mature workers generate the credit the young workers consume.
Finally, there are the retirees who live off of their savings and who want no surprises. They move the vast majority of their investments from the adrenaline-provoking roller coasters that are the stock and private bond markets, and into the sedate world of government Treasury bills. With every year their nest egg shrinks a little bit.
And so the system flows: People turn from ravenous credit consumers to seasoned credit suppliers and eventually withdraw from the system altogether. The system works well so long as the demographic forces remain in balance, so long as there are enough mature workers to support the young workers and so long as the retirees do not pull too much money out of the system.
It is this demographic balance that is shifting.
In the United States the baby boomers are the mature worker generation. They are the largest population cohort that the United States has ever produced (as measured by their percentage of the total population). Beginning in the early 1990s their kids started leaving college, and as of 2006 nearly all of their kids have moved on to their own lives. Some of the older baby boomers are already starting to take early retirement, but the bulk of them will not leave the work force until after 2012. It is the baby boomers who have supplied the bulk of the working capital for the United States for the past 15 years. Their investments -- well out of proportion to what any generation before them has ever been able to provide -- caused the low interest rate environment of the 1990s and 2000s, and single-handedly funded the most expensive and revolutionary transformation the U.S. economy has ever experienced: the computer revolution.
When the baby boomers retire en masse, that surge of capital will simply go away, being poured into government bonds. Replacing them in their role as the country's financiers will be Generation X, the children of today's newest crop of retirees, the war babies. And unlike the baby boomers, there are very few members of Generation X. In fact, they are the smallest population cohort that the country has ever produced (again, as measured by their percentage of the total population). Collectively Generation X cannot hope to hold a candle to the amount of money the baby boomers have proven able to sock away these past 15 years.
Consuming this reduced pool of credit will be another large population cohort, the baby boomers' kids: Generation Y. Often called the echo boomers, Generation Y is nearly as large a population cohort as their parents. And they are about to need loads of credit for their own kids, cars and homes.
Replace the baby boomers with the numerically smaller Xers and add in the demands of the numerically larger Yers, and the United States faces an inversion of the credit environment. Instead of a large generation supplying credit to a small generation, soon a small generation will be supplying credit to a large one.
Getting By With Less
A reduced supply of capital and credit has two implications. First and most obvious, the cost of financing the purchase of anything -- whether a group of aircraft carriers or a staple gun -- will go up. Fewer people and governments will be able to afford the payments that go along with higher interest costs, leading to reduced consumption and slower growth across all sectors and economies. All in all this is horrible news for anyone who is not one of the Generation Xers, who will be able to demand top dollar for their scarce investment dollars.
Second, a smaller pool of anything -- credit, in this instance -- results in a smaller margin for error. Economists have a fancy bit of jargon they use to describe this: volatility. Supply crunches are rare occurrences in well- or over-supplied markets. Lower availability means not only lower growth, but that the swings between booms and busts will be far more rapid and disruptive.
And that is the good news.
Japan had something similar to the U.S. baby boomer bulge, but instead of peaking now, it peaked in 2000. Instead of capitalizing on that population bulge as the United States did with the computer revolution, Japan squandered the opportunity on chronic deficit spending and now faces a national debt that is the largest in human history (and still getting bigger). Japan faces a 20-year dearth of credit as its post-World War II baby bust takes over the reins of capital formation. And after a brief respite from Japan's 1970s baby boom, the country faces a credit collapse.
Europe's demographic scenario is only slightly more cheery than Japan's, but the core problem that each successive generation is smaller than the last is broadly the same. In fact, Europe's demographic decline is in some ways already more serious than the United States', because its average age is already older. In the United States, pension outlays account for some 4.5 percent of GDP; in Italy and Denmark it is already three times that.
Such "population chimneys" -- a term that describes how a population bell hollows out over time because of reductions in the birth rate -- are not limited to the developed countries. Russia's post-Cold War trauma has given it a demographic picture that is worse than even Japan's, and though 60 years of China's one-child policy has indeed slowed population growth to a crawl, it has done so at the expense of unbalancing the country's demographics. On average, every four Chinese grandparents now have but one grandchild. The only major economy in the world that has a "traditional" population bell curve is India, a country that has never been an exporter of capital.
A Bit of Good News
Unlike Japan, Germany or China, the United States has a generation waiting in the wings to take the baton from Generation X. There are a lot of Generation Yers, and when they mature into providers of credit in their own right, the spot that today's baby boomers are just now beginning to step out of, much of this demographic/financial imbroglio will rectify itself. That, however, is some time off; it will not happen until today's college students not only have kids, but have put those kids through college themselves. Until then, the forecast is for more and more expensive credit in the United States and internationally -- for upward of the next 40 years.
CHINA: The Beijing No. 1 Intermediate People's Court on Nov. 6 identified IBM as one of three companies that Zou Jianhua introduced to Chairman Zhang Enzhao of the China Construction Bank Corp. Zou -- who is said to have promoted the use of IBM equipment at the bank -- has been indicted for paying approximately $340,000 in bribes to Zhang, who was sentenced to jail Nov. 2. The court assumes IBM paid $225,000 to Zhang. This is latest in a long series of such cases that have embarrassed China's banking industry. Chinese banks are in the midst of trying to raise foreign capital to modernize operations in preparation for China's December World Trade Organization deadline to open its financial market to foreign competitors. However, these scandals do not seem to have shaken investor enthusiasm for Chinese banks, if the recent successful $9.2 billion initial public offering of China's Construction Bank is any indication.
VIETNAM: The World Trade Organization (WTO) on Nov. 7 formally invited Vietnam to become a member. The invitation comes after more than a decade of entry talks. During that time, Vietnam has gradually reduced tariff levels and agreed to open its banking sector. The country has already successfully completed bilateral trade agreements with the European Union, Japan and Australia. As a WTO member, Vietnam will likely enjoy increased foreign investment and will benefit from the removal of quotas on its textile exports to the United States and Europe. However, Vietnam will be forced to stop giving subsidies and tax breaks to domestic companies and must continue to open its markets to foreign competition. Vietnam's legislative National Assembly must still ratify the conditions of membership, 30 days after which Vietnam will officially become a member.
ARGENTINA/VENEZUELA: Argentina and Venezuela's ministers of finance and economy announced Nov. 8 that they will sell $1 billion in an joint bond issue. The plans were first announced by the two countries in July. The move is unprecedented; joint sovereign bonds have never been issued by any country. The decision to issue a joint bond appears to be politically motivated; Argentina has a close financial relationship with Venezuela, from which it has borrowed more than $3.2 billion in the past year. Both countries have relatively easy access to local capital markets, where the bonds will be issued. However, Argentina remains unable to issue debt in international markets without risking the seizure of funds by holdout investors who did not agree to Argentina's previous debt restructuring and who hold $20 billion in untendered debt.
GULF OF MEXICO: Norwegian oil company Statoil has expanded its drilling in the U.S. sector of the Gulf of Mexico with the acquisition of deepwater stakes from Anadarko Petroleum Corp., representatives from both companies said Nov. 6. Statoil is the world's second-largest subsea operator and has extensive expertise in deepwater extraction.
INDIA: Local police in the Indian capital of New Delhi had to use tear gas and water cannons this week to disperse violent demonstrators who were protesting a government sealing drive against illegally constructed businesses. Protesters blocked traffic, and commercial truckers in the city, who operate more than 80,000 commercial trucks in Delhi every day, have joined in the demonstration to pressure the government to aid the traders in stalling the sealing drive. The truckers have lost a great deal of business from the traders, who have closed their shops in protest. With the truckers on strike, businesses throughout New Delhi have been roped into the conflict. The protesters are also looking to India's well-organized medical and legal associations to join in the demonstrations. The government will most likely be forced to stall the sealing drive once again to bring daily life in the capital back to normal, but in the meantime the protests serve as an example of the difficulties of enforcing controversial legislation in India.
GERMANY: Germany's five "wise men" of independent government-sponsored economics late Nov. 8 issued a damning evaluation of the government's economic plan and inability to overcome political impasses to achieve structural reforms, saying that economic policy was following a "slow-moving zigzag course without a recognizable strategy" and was all the more "disappointing" because "the year 2006 offered not only good political conditions" for decisive reforms "but also the most supportive cyclical environment in years."
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