Tuesday, 24 May 2011

Economic fire or ice

Business Mirror

Perhaps, you have known a person whom doctors described as “terminally ill,” or sick to the point that death was inevitable and would come sooner than later. “But I just saw him a few months ago, and everything seemed fine.” While sudden, brutal deaths receive the headlines, death for most is a process—going from healthy to sick, ill, then terminally ill.

In a sense, we are better-equipped psychologically to deal with sudden disasters than with a slow, creeping catastrophe. The ancient Roman city of Pompeii was destroyed by a volcanic eruption that lasted two days. The ancient Greek city of Ephesus in Turkey was founded in 6000 B.C., becoming one of the most important ports on the Aegean Sea. By A.D.1090, it was nothing more than a small village. Silting and sedimentation of the seaport by the Cayster River over 1, 000 years eventually moved the ocean more than 5 miles away from the original city. The “instant” disasters are easier to take, for we console ourselves with the idea that there was nothing that we could have done to prevent the problem.

Pompeii died violently, almost instantly in fire; Ephesus died slowly as its life-giving river stagnated. However, both cities were terminally ill for centuries as the pressures that led to their deaths built up. Make no mistake. The global economy is in intensive care, if not terminally ill.

This is the big picture. The Economic Cycle Research Institute (Ecri) reports that its long leading indicator of global industrial growth is at 0.1, near the lowest level since January 1980. By comparison, January 2009, the number was 0.8 and in mid-2010, it stood at 0.7. From Investor’s Daily: “There’s a downturn in global industrial growth in clear sight, said Ecri managing director Lakshman Achuthan. Output has already started to decelerate in the US, Europe and key emerging-market countries such as China that have driven the global economic recovery.”

I am sorry, but any talk of a global economic recovery is a fantasy. You cannot have economic growth when the lifeblood of the economic system, the financial sector, is in desperate trouble.

Europe’s debt problems were supposed to have been solved with the bailout of Greece. Now Greece is ready to default, closer to financial Armageddon than before the $145-billion rescue. Ireland fell next with $125 billion and the most recent, Portugal, is getting $37 billion. Now Spain is ready to fall, and could need $250 billion.

The US continues to fall. That economy survives on consumer purchases and US consumers have not been this worried (and reducing spending) since October 2009, during the depth of the Great Recession.

Forget about China saving the world. Their main market, the US, cannot buy enough goods for China to be the financial rescuer. And China has other problems. From Bloomberg: “China faces the worst power shortage in seven years as the economy grows faster than forecast and some utilities cut production or shut.” China’s growth does not translate into global growth, as China is less than 10 percent of global economic activity; the US accounts for over 30 percent.

The Philadelphia Federal Reserve Bank just released its May 2011 survey. This is the reaction to the housing and business activity numbers in that report. Eric Green, chief economist, TD Securities, New York: “It’s pretty ugly. The Philly Fed index was a lot weaker than expected.” Kathy Lien, director of Currency Research, GFT, New York: “All the numbers that we just saw were extremely, extremely bad.” Tom Porcelli, US economist, RBC Capital Markets, New York: “It was, I think, in a word, pretty ugly.”

One of two scenarios will play out in the next 12 to 18 months: fire or ice. Put in simple terms we can all appreciate: very high inflation with crude oil priced at $250 per barrel or stagnated economic activity, deflation, and $25 for that same barrel. Fire puts gold at $2,000; ice drops the price to $200.

Those seeing near-hyper inflation are worried about the fate of the dollar with the US Federal Reserve creating money from thin air at an unprecedented rate. John Williams at Shadowstats.com: “The US economic and systemic-solvency crises of the last four years only have been precursors to the coming Great Collapse: a hyperinflationary great depression. Prerequisites to the crisis unfolding include the Federal Reserve moving to monetize US Treasury debt; the US dollar losing its traditional safe-haven status; the US dollar losing its reserve status; the federal budget deficit and Treasury funding needs spiraling out of control.” Too much “funny money”—US dollars in circulation cause prices to skyrocket as the value of dollars in terms of the goods it buys goes down. The other side, the “deflationists,” believe the views of financial author Harry S. Dent and stock-market analyst Robert Prechter. Allow me to say that I think both Dent’s and Prechter’s market analysis is not just wrong but often foolish. Perhaps, I am just jealous since they have published 20 books and I have more than 20 rejection letters. Nonetheless, deflation is a real possibility and deserves an understanding of the arguments.

Deflation occurs when prices fall as demand weakens. In this case, demand weakens because people in countries like the US are becoming poorer. No jobs, no money, no consumer buying, no economic activity, no demand. As demand falls, prices go down because no one can afford to buy. Dent sees this happening; commodity prices collapsing and a rising dollar. Dent “argues that the collapse of asset bubbles will bring a multiyear bull market for the greenback that could take us up 40 percent from here. Debt defaults not only create bond shortages, they foster dollar shortages, as well.”

In effect, the “inflationists” see debt default forcing the need for printing more dollars and resulting inflation. All prices rise, including stock prices. The “deflationists” see default as creating demand for dollars, which reduces printing but creates economic stagnation. Stock markets crash along with other asset prices.

We will continue this on Thursday with the implications of both for the Philippines.

E-mail comments to mangun@gmail.com. PSE stock-market information and technical analysis tools provided by CitisecOnline.com Inc.

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