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Is anyone less thankful this year than last year? It’s probably safe to bet on YES.
I don’t have to run through it all — we’ve been bludgeoned by all that’s bad in the global economy and financial system all year long. And I’m sure there are plenty of individuals out there who aren’t quite in the mood to be thankful — turkey on the table or not.
Last week I discussed the effect of tight coupling on financial markets. I said when the mechanics of some market or some asset of immense complexity becomes loose, it’s liable to create a downward spiral for all the moving parts tightly coupled with it.
That’s exactly what’s happening. And it means …
Assets Collapse, Markets Crumble and
Capital Flow Shifts as We Enter an Ice Age
Governments are taking all kinds of efforts to bailout key institutions and contagious markets.
They understand the severity of the cleansing cycle that’s begun; and are very afraid of what they see.
Eventually though, they’re going to have to take their economies, and the financial system, off life-support. If not, after too long, they may be left with a system incapable of organic growth.
In the meantime, Mr. Consumer is starting to get very worried. His wealth has been hammered by lower housing and stocks, and now his job is either already gone or in jeopardy.
This fear is leading to a major uptick in savings. That means spending takes a back seat. And in the end, global consumption takes a hit.
A very smart guy named Stephen Roach, Chairman of Morgan Stanley Asia, recently commented on the economies of Asia and how they’re faring in this environment. He said:
“[There is] no country in Asia that is either not declining, or in recession, or slowing sharply. No one is spared. [They’re the] most linked region of the world for the rest of the global economy.”
Bingo!
He went on to say China is “slowing very, very sharply.”
You see, China has come to represent a very important middle-man between developed and emerging market economies — in Asia and across the globe. Their low-cost, cheap-labor production model entails gobbling up input products and raw materials from emerging economies in order to satiate the demand from developed economies.
Signs that China is in trouble stem from, among other items, collapsing demand for the stuff they produce. And the ramifications of China slowing down will spread far and wide.
As I discussed at the beginning of this month …
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The New Concern Is Toxic Economies!
Lacking many features of strong, well-rounded economies, emerging markets have put all their chips into their exports sector.
They’ve come to rely almost entirely on neighboring and developed economies buying up cheap goods and raw materials.
And they failed to adequately invest in the domestic side of their economies, leaving them woefully exposed to external demand for growth and foreign investors for funding.
That generous global demand has plunged. Therefore, it’s easy to understand why emerging economies’ stocks and currencies are being hit the hardest.
This is the worst possible environment for emerging economies because they were built for sustained global demand, as far as the eye can see.
So when global capital flow dries up, or reverses course, these emerging economies will struggle to make ends meet.
What’s more, the same foreign investors that quickly backed these countries are now running for cover just as fast.
And in my opinion …
Europe Is the Most Vulnerable to
Emerging Market Defaults
When it comes to emerging markets, Eastern and Central Europe account for $1.6 trillion in loans from G10 countries’ banks. Asia and Latin America are next on the list — recipients of $1.5 trillion and $1 trillion, respectively, according to Morgan Stanley’s Global Economic Forum.
And if you break down the loan originators, Western Europe and the United Kingdom are where roughly 45% of these emerging market loans came from. In contrast, only 9% originated from U.S. or Japanese banks.
Heck, European and U.K. banks are more exposed to emerging economies in Eastern Europe, Asia and Latin America!
Take Ecuador, for example. They recently revealed they’re at risk of defaulting on $4 billion worth of debt. And this is just the tip of the iceberg. Plenty more defaults will likely follow from countries who failed to invest sufficiently in anything but the hope that the global economy would never stop speeding along.
Currencies of emerging markets are no doubt set to suffer as the cycle of leveraging reverses course. But the euro is also hugely vulnerable.
The euro zone is already struggling to defeat the more direct effects of the global financial meltdown. But if a wave of defaults swells up, it’s going to add a huge, additional burden on the banks of Western Europe. Defaults on these loans could mean hundreds of billions — if not trillions — of dollars in writedowns.
Among other things, this means Europe will have a tougher time than the United States in conquering recession.
If recent history is any guide, government and central banks will be as active as ever. More specifically, the European Central Bank will make a concerted effort at saving the economy with interest rate cuts.
When they do, they’ll surely undercut the euro. My first longer-term target will be par with the U.S. dollar. And that could come sooner than the market thinks!
Best wishes,
Jack
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