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Urbanization in the USA: a driver for global growth?

2012/04/17 in macro trends

An important global trend is “urbanization“.  But, while we often think of  the rapid urbanization of the developing world, we often forget of the importance of urbanization on the developed one.  Case in point is the recent article posted online by the consulting company McKinsey looking at the impact of urbanization of the US economy on global growth:

Exploring urban America’s economic clout

In a world of rising urbanization, the degree of economic vigor the US economy derives from its cities is unmatched by any other region of the globe. Over the next 15 years, large US cities are expected to generate more than 10 percent of global GDP growth—a bigger share than all their peers in other developed countries combined. McKinsey Global Institute’s new report, Urban America: US cities in the global economy, profiles their dominant role in US economic life and gauges how large they loom in the urban world overall. Read the report on mckinsey.com.

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Three trends for the next decade

2012/03/20 in macro trends, political economy, Rebalancing Global Finance

We just finished reading one of the most thought-provoking and interesting articles related to Global Trends.  It was written by Louis Gave of @GaveKal Research titled “Weeks When Decades Happen“.   I originally found this article posted on John Mauldin’s Outside the Box newsletter.  We recommend taking a serious look at these predictions of future trends.  A brief summary of the main points are highlighted below…

The three big events of 2001 were:

  • The terrorist attacks of 9/11. This unleashed a decade of bi-partisan “guns and butter”policies in the US and produced a structurally weaker dollar.
  • China joined the WTO in December 2001. China’s full entry into the global trading system signaled a re-organization of global production lines and China’s emergence as a major exporter. Export earnings were recycled into the mother of all investment booms, which drove a surge in commodity demand and a wider boom in emerging markets.
  • The introduction of euro banknotes. The introduction of the common currency unleashed a decade of excess consumption in southern Europe, financed unwittingly by northern Europe through large bank and insurance purchases of government debt.

     

All three trends have ended.

For the future, he indicates the following three important trends:

Instead of lamenting over the past, investors should be coming to grips with the trends of the future: 

  1. the internationalization of the RMB, 
  2. the rise of cheaper and more flexible automation, 
  3. dramatically cheaper energy in the US.

Why these three trends are significant was very well presented in his article.  We suggest reading the article in full here:  ”Weeks When Decades Happen“.  Some interesting comments are highlighted here:

  • “the creation of the offshore RMB bond market in Hong Kong, a development which may go down as the most important financial event of 2011.”
  • “ yesterday China’s trade mostly took place with developed markets, was comprised of low-valued-added goods, and was priced in dollars. Tomorrow, China’s trade will be oriented towards emerging markets, focused on higher value-added goods, and priced in RMB.”
  • Over the coming decade, cheap labor may not be the comparative advantage it was in the previous decade, simply because the cost of automation is now falling fast “
  • “one aspect of policymaking which makes China unique: the country’s leaders wake up every morning pondering how to return China to being the world’s number one economy and a geopolitical superpower in its own right (few other world leaders harbor such thoughts).”
  • Hence we are convinced Beijing will eventually bite the financial reform bullet, and RMB internationalization is the leading edge of that reform. In that light, the creation of the RMB offshore bond market is an event of much greater significance than is currently acknowledged by the general consensus.”
  • “This does not make for a stable situation. And given that the RMB is unlikely to replace the dollar as the principal global trading currency for many years to come (see History Lessons and the Offshore RMB), the likely combination of expanding global trade and a shrinking US trade deficit should mean that either the dollar will have to rise, or US assets will outperform non-US assets to the point where valuation differnces make it attractive for US investors to deploy dollars abroad (since US consumers won’t). “
  • “The internationalization of the RMB and the birth of the RMB bond market is likely to be one of the most important developments of the decade. The closest analogy is the creation of the junk bond market by Michael Milken in the 1980s. Interestingly, just as in the early 1980s, few people are taking the time to work through the ramifications of this momentous event. Understanding this new market will prove essential to understanding the world of tomorrow.”
  • “The likely evolution of the US from record high twin deficits to much smaller budget and trade deficits should help push the dollar higher over the coming years. And this in turn will have broad ramifications for a number of asset prices.” 

 

 

Top trends for 2012 (economic, political)

2012/02/23 in Europe, Great Debate - Economics, macro trends, political economy, Rebalancing Global Finance

2012 Trends

In no particular order, here are the global macro trends that we think will be most significant in the current year (2012):

Continue reading here: Visit our Wiki to see the rest of this article.  Community involvement:  This document is dynamic, so any of our community is welcome to contribute, and to help shape our views of these important developments.  Please log in to our wiki, and feel free to comment…

See also: Top Trends for 2009

 

The “savings glut” that may be to blame…

2009/02/10 in credit crisis, macro trends

The “savings glut” theory is one of the two main competing theories to explain some of the bigger mysteries of global finance in recent years (including the credit crisis of 2007 ).  The basis of this theory is that there are underlying fundamental “global imbalances” which are causing all of the trouble (and which need to be fixed in order for the crises to stop).  In this blog post, Im going to quickly outline “savings glut” theory…

The other theory (money glut)

The more popular (and easier to understand) theory (which Im not going to cover in this blog) is called the “money glut” theory…which basically says that American Central Bank kept interest rates too low for too long, which led to too much money, too much credit and encouraged too much risk taking by banks and greedy people on wall street.  This is the popular version of the story that most people hear every night from their local news commentator.  This is NOT the theory that Im going to review in this blog posting.

Savings glut (summarized)

The less well known (and more difficult to understand) theory of what-went-wrong…is the  “savings glut theory”….which basically says that the root of the problem lies not within the US, but with the fundamental imbalance of international finance.

While finance is risky (borrow short, lend long), it is even more risky when it crosses borders.  Countries in Asia and Latin America learned the lesson not to accept deficits after punishing recessions in the 1990′s and early 2000′s.  Since then, nearly all emerging nations (and most developed ones, minus USA) have fought hard to keep current account surpluses.   In an effort to keep away from risky deficits, many central banks (especially in emerging Asia) have purposefully chosen to (a) keep their currencies undervalued, and (b) to accumulate foreign exchange reserves to buffer against potential shocks.  Note that the countries with large reserves in 2009 are the ones most likely to survive this latest crisis with their economies in tact.   After seeing the prescriptions given by the IMF after the last round of crises, most emerging countries said “no thanks” to foreign capital, and instead have chosen to run massive surpluses.

The key to understanding the “savings glut” theory is to first understand that the nations “balance of payments“, by definition, must BALANCE.  That means that if a country chooses not to accept foreign capital, and therefore if they choose to run a capital account deficit…then they must by definition also run a current account surplus (the current account is physical goods exports).  That means that in order to export capital, they must also export products (I know, it gets a bit confusing, sorry).  The net result = they must keep the currency undervalued for this to work.  And the currency of choice = the US dollar (as a target peg).

“Ok, so what is the problem?” you might ask…

Well, due to the rules of global accounting…if one country runs a current account surplus, then others must run a current account deficit.  That part is easy to understand….if one country exports, another must import.  Ok, but what is less obvious is that if one country runs a capital account surplus (think China), then another MUST run a capital account surplus (think USA).  This is the root of the “savings glut” theory…

The savings glut theory states that sometime in the late 1990′s to early 2000′s…there was a massive amount of countries that all decided “thats enough”…no more foreign capital can come in.  It was too risky, and led to too many crises.  As Martin Wolf says, they chose to “smoke, but not inhale” from international finance…and so began a massive financial recycling program, whereby money that came in quickly was sent back to sender.  Money no longer flowed from rich countries to poor ones…instead money was borrowed on a massive scale from poor ones to rich ones.

Why did this happen?  The theory is that international finance proved to be too risky, and so developing countries almost unanimously chose to reject international finance and send it back.   (the only emerging markets that did not follow this prescription seems to have been the emerging Eastern European nations, many of which are now facing crisis…on a much deeper scale than emerging Asia).

Enter the “borrower of last resort”

But, with all of these emerging countries sending money back, unfortunately, there was only ONE country on the planet that was willing and able to accept it:  the USA.  (note that economists that subscribe to this theory are extremely critical of Germany / Japan and other developed nations that did not take some of this capital that was flooding the USA).

The US, as the theory goes, was uniquely capable to absorb this flood of “savings” because the US dollar was the global reserve currency, and the US could borrow in its own currency on a massive scale (with no chance of foreign exchange crisis).

economist-image

Who Believes this theory?

Surprisingly, the “savings glut” theory has some pretty impressive followers…

  • the list goes on and on….

Who is to right?  Who is to blame?

The reality is that both “savings glut” theorists and “money glut” practitioners are probably each 1/2 right. I read somewhere…”the Chinese may have supplied the noose, but it was the US that strangled themselves”…Thats probably the most accurate way of reconciling the “savings glut” vs “money glut” theories…

More on the “Savings Glut”

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Financial de-globalization (a real trend?)

2009/02/06 in credit crisis, macro trends

There has been lots of talk lately of “deglobalization“…especially since Gordon Brown (Prime Minister of the UK) mentioned these words at Davos, a little over a week ago.  But what does it mean?  Are we really de-globalizing?  In this article, I will argue that while the treats of protectionism are real…it’s still a bit too soon to call “deglobalization” a trend (no matter how good this may sound in headlines).

A second concept that I will present … is that (a) trade protectionism is indeed a threat, but one that politicians ultimately have control over.   On the other hand (b) financial de-globalization is an area which is less understood, and much harder to control.  Financial deglobalization works in reverse….politicians want money to be spent at home….as opposed to “product” globalization where it’s in the interest of home politicians who want their products sold overseas.

Clearly the treat of protectionism is real, but I will argue that we are still a long ways from actually seeing “deglobalization” as an actual trend.

Deglobalization of trade (products)?

Nationalistic tendencies are on the rise.  We have seen labor strikes in France, UK and others…demanding local jobs.  We have seen the US congress propose “buy American” rules…and, we have seen protectionist actions from Switzerland and maybe even China.    In Malaysia there is a proposal to “layoff  foreigners nationals first” in order to protect local jobs.

“Protectionism” is clearly on the march…but is this really “deglobalization”?  I dont think so.  The threat of protectionism is not the same thing as “deglobalization”.  Rather, they should be seen as two distinct steps.  First comes protectionism…then, maybe (if we are unlucky) comes deglobalization.  Im not saying that it wont happen, Im just saying we arent there yet.

Politicians still have a choice.  This was clearly on display when Obama pleasantly surprised me and pulled the improbable “free trade” move by actively denouncing the “buy American” rules proposed in the stimulus package. He showed that clear-headed leaders have a choice about our path, and can choose to keep borders open to trade.

“Obama for the first time yesterday said he opposed language in the bill that would require steel and other goods used in infrastructure projects to be made in the U.S., saying such protectionism may trigger a trade war America.”  source:  Bloomberg

Political decision

What is interesting about this move (beyond just being a huge relief to all free traders)…is that it clearly shows that protectionism / vs free-trade is a political decision, and one that democratically elected officials have control over…. the process of deciding to try and protect local jobs is a political decision, and as long as cooler heads prevail, free trade in goods and services will continue.   (sure, there will be HUGE pressure from trade unions to “keep” local jobs, but the ultimate decision to close or open borders to trade is a decision that our leaders can make).

Exports are desirable for the US.  So, it makes sense to keep globalization of products alive-and-well.  Free trade of goods and services are clearly in everyones best interest (mosts economists agree that free and open trade is preferable to trade barriers).

But, the same can not be said of financial globalization.  Economists are much more divided about the positive impact of globalized finance on economic development.  Its not that they think its bad (although its clearly risky), the trouble is that there is much less consensus among respected economists about the benefits of globalized finance.

Who decides to (or not to) deglobalize finance?

Politicians can choose to have flexible exchange rates, and they can choose to allow capital to flow freely.  Politicians, however, can NOT oblige banks to lend money overseas.  In fact, its probably in the politicians interests to NOT lend money overseas (but rather at home to local companies).

Bank nationalizations will only increase the pressure to lend at home (rather than overseas).  As banks get nationalized (as they surely will, or already have been)…there will be increased pressure to lend at home (at the expense of lending abroad).

“The fact that the financial sector now depends on a government backstop may have prompted the banks to pull back more from foreign markets than their home markets, though they are clearly doing both.  Deglobalization – particularly financial deglobalization – isn’t going to be pretty.”   Brad Setser blog

And, even if the banks dont get officially nationalized (which I believe is highly unlikely)…the process of financial deglobalization will be hard to slow down…

There is “growing pressure on banks and financial institutions to retreat from international business and concentrate on domestic markets. Trevor Manuel, South Africa’s finance minister, captured the fears of many when he warned that his country and other emerging markets were in danger of being crowded out of international capital markets and of “decoupling, derailment and abandonment”.

Financial protectionism is driven by the logic of the market and political pressure. Banks that have lost confidence and capital in the credit crunch are retreating to the home markets they know best. And because so many banks have been bailed out by national taxpayers, they are also coming under political pressure to lend at home rather than abroad.   source:  Financial times blog

But, will finance get “deglobalized”?

No, I think not.   Currency markets trade 100′s of Trillions of dollars per year.  The sheer size of international financial markets ($140 trillion in promises 2005) makes it highly unlikely that finance will actually be “deglobalized” (see data below).  While the size of the pie may shrink, I dont see that as the same thing as deglobalization (elimination of the pie all together).

Again, I think that this term of “deglobalization” is a bit overused in the press, and has a shock value, but not much else.  Its important to realize that deleveraging of capital markets is going to happen (which means there will be less credit around for everybody).  Its also important to realize that capital will flow to the safety of the US when emerging markets seem too risky, but it will flow in reverse when volatility subsides.  Local banks may lend less overseas, and nationalized banks may be pressured to lend at home.  But, this is NOT deglobalizaton of finance.

As long as barriers are not erected to keep local capital at home (as is the case in countries such as China with capital controls), then global financial capital will flow freely.  As long as exchange rates remain flexible (in most of the major trading economies of the globe), then financial globalization will continue.

The economists will still debate about whether that is a good thing or not.  But, for now anyways…I dont see “deglobalization” as a trend.   The threat of protectionism is…deglobalization is clearly not.

Wiki:  Read more & contribute in our GloboTrends Wiki:

Data

Size of the Financial sector:

1.  USA:

  • household & non profit:
    • total assets = $64.4 trillion assets owned  (5x USA GDP)
    • total debts =  $11.9 trillion
    • total balance:  $52.5 trillion
      • of this $52.5 trillion…the breakdown was as follows:
        • $25.6 trillion = tangible, mostly property
        • $38.7 trillion = financial assets
          • $6.1 trillion in deposits
          • $3.1 trillion in credit market instruments
          • $5.7 trillion in direct corporate equity
          • $8.9 trillion in indirect corporate equity, of which…
            • $1.1 trillion in life insurance
            • $3.0 trillion claims on pension funds
            • $1.9 trillion claims on gov’t retirement funds
            • $2.9 trillion mutual funds

So, total US financial assets in 2005 was as follows…

  • Household & non profit sector (data from above):
    • financial assets:  $38.7 trillion
  • Business sector -  Non-farm, non-financial corporate sector
    • financial assets:  $10.9 trillion
  • Business sector -  Non-farm, non-corporate sector
    • financial assets:  $2.3 trillion
  • TOTAL US private sector Financial Assets:
    • $52 trillion USD (approx. in 2005)….obviously it grew more till 2008 (especially housing bubble), before falling…

Financial assets globally…

Compare this with world (in 2005):  source : McKinsey report 2005, “Mapping the global capital market

  • USA (private sector only):  $52 trillion  =  37%  (rounded)
  • Eurozone (all):  $30 trillion                  =  21%
  • Japan  (all):  $19.5 trillion                    =  14%
  • UK (all):  $8 trillion                             =   5.7%
  • Top 4 total $109.5 trillion / 140           =  almost 80% world total !!
  • World total (all, including private + govt + business):  $140 trillion….owned of financial assets

How this $140 trillion breaks down…

  • $44 trillion was equities      =  31.4%
  • $35 trillion was private debt securities   =  25%
  • $23 trillion was government debt securities   =  16.4%
  • $38 trillion was bank deposits                        =  27.2%…….down from 42% in 1980 (shift away from simple deposits to more indirect banking)
  • $140 total

How has it grown? As a % of GDP…

  • $140 trillion was = 3.16 x total world GDP in 2005….up from 2.18 times in 1995,  and from 1.09x in 1980
  • Regional trends from 1995 to 2005
    • UK: rose from 2.78x to 3.59x GDP
    • USA  from 3.03x to 4.05x GDP
    • Eurozone: from 1.80x to 3.03x GDP

* data from McKinsey report 2005, “Mapping the global capital market“  and http://www.federalreserve.gov/releases/

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credit crisis…a symptom, not the cause of global imbalances

2009/01/17 in BRIC - emerging markets, credit crisis, currency, macro trends

What is often considered to be an American-led banking crisis should really be considered just a symptom of global imbalances (and not the cause of them).   Rather than seeing this credit crisis (turned banking crisis, turned global economic crisis) as the result of US financial greed, innovation or stupidity…its more accurate to look at this recent crisis as just one of a string of bubbles that burst as a RESULT of global imbalances in international finance.

The global imbalance that I’m talking about is the role that the US has been forced to assume as the absorber of surpluses from many exporting countries (especially emerging economies of China, east Asian nations, and oil exporters).

Remember, if one country (or a bloc of nations) runs a current account surplus, then some other country by definition, must be running a deficit.  But when countries such as China, Japan, South Korea, Taiwan, etc make it their policy to control their exchange rates vs. the US dollar, and to drive their economies with export-driven growth, then by definition, there must be some other country running a surplus.

The lessons of the 80´s – 90´s taught most emerging nations the dangers of running current account deficits.  They learned mostly through experience the brutal dangers of accepting capital from foreigners (Mexico in 94, SE Asia in 97-98, Russia in 98, Brazil in 99, Argentina 2001-02).   So, as a result of learning these lessons the hard way, almost every emerging economy chose to build up `reserves´ of US dollars, and to run surpluses rather than deficits.

reserves

China and others purposely decided to ´smoke but not inhale` from global finance.  They would do everything in their power to recycle the incoming dollars, and send them back outside of the country.  This process of dollar recycling guaranteed that the money earned from exports would be sent back out of the country as US treasury purchases.

The more China exported, the more they were forced to purchase US treasuries to keep their undervalued currency undervalued, so that the machine could continue.  But, the more they exported capital, the more that global finance became flooded with cheap credit and easy money.  This should have fueled inflation, but cheap Chinese products and labor kept a lid consumer products and drove down labor costs around the globe.  In this new world, the central bankers in the US and Europe were able to keep interest  rates at all time lows without running the risk of inflation.

The only problem was the (string of) asset bubbles that followed…

A series of bubbles…

In response to a flood of cheap credit on tap from Asia, China, and oil exporters…we saw a series of bubbles build up in assets starting in the late 1990´s.  First was the internet bubble,then Telecom bubble, then real estate bubble, then commodities bubble…all the while there was a credit-bubble building and building and then finally popped.

Each of these asset bubbles built up as a direct result of cheap credit on tap from countries that were unwilling (or unable) to absorb incoming capital from global finance, and instead chose to force that capital back on the only country willing and able to absorb excess savings abroad: the USA.

The key question now that the credit bubble burst is:  what´s next?  If you assume that the credit bubble was just the result of American´s choosing to spend more than their income (and poor regulation in the USA), then you might be inclined to believe that this would be over once the credit crisis were over.  But, if you believe (like I do), that this credit crisis was just a symptom rather than the root cause of the recent pain…then you would have to wonder like I do: what´s next?

Note: Morgan Stanley highlights the fact that there will likely be another bubble in their recent article A New Global Liquidity Cycle, where they say `It’s time to get ready for the new global liquidity cycle.`

The only way that this series of crises will end is for the underlying imbalances in global finance to be corrected.  In order for this to happen, then countries like China (Japan, S Korea, Taiwan,etc) will need to stop targeting undervalued exchange rates by selling local currency and buying US dollars.  The only way out is for global finance to be restructured in a way that emerging markets would not be afraid of accepting capital from developed economies, and would be willing to run deficits without the fear of punishing deficit and currency crises.

In an ideal world (or one that makes sense), capital would flow from the rich developed nations to the rapidly developing ones (where opportunities to invest that capital was greater).

For now, we live in a strange world in which money flows on a massive scale from the worlds poor developing nations to the developed rich ones.  And, as a result of this perverse capial flow, we will continue witnessing bubbles that will continue bursting until we fix the underlying causes of these problems.

Please add your comments to our forum here:

Related blog posts:

  1. What is causing the commodities bubble?
  2. Series of bubbles
  3. USA credit crisis – what caused it to happen?

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