Wednesday, May 21, 2008
Weeeell, The Other Shoe Done Dropped
The rupee hovered near 13-month lows on Wednesday as concerns of a widening trade deficit intensified after world oil prices climbed to a record above $130 a barrel.This is a very bad problem which is affecting other countries as well, and inflicting real pain on lower-income consumers in those countries. It certainly affects lower-income cohorts in developed countries as well. It's now mostly about energy import/export balances for many of these countries.
India's oil import bill shot up by more than a third in 2007/08 because of soaring prices, and the trade deficit widened by a similar percentage. Capital flows into the local stock market, a key support for the rupee, have also been eroded after a global financial crisis triggered net outflows of $2.7 billion this year.
In 2007, inflows had hit a record of $17.4 billion.
Another way to look at this is that energy subsidies were in themselves subsidized for a while by capital inflows on expectation of growth, which created additional infrastructure investment which may or may not have been efficient. But as fuel-related worries rise, capital inflow is threatened, and the only cure for some of these countries is to adjust energy subsidies down. This then impacts the population, which tends to suppress purchasing power for parts of the population.
The underlying problem is that demographics alone in many well-developed countries suggest that demand for most consumer goods should be stagnant, and the demand for consumer goods has to be picked up by other classes of countries.
High investments in commodity and fuel production are generally good for the very highly developed countries which manufacture high end stuff like ag machinery, factory machinery and oil drilling equipment. But they are not necessarily good for less-developed countries unless those countries can produce commodities.
As inflation shifts into Asia, it should continue to transmit back to highly developed countries in the form of consumer goods pricing.
The issue is whether there will be a global, extended depression (although milder than most would assume) beginning in 2009 and lasting a few years, probably until 2013 or thereabouts.
On the whole, unless the US has lost all its marbles and refuses to generate power domestically, the US economy will do better than the world.
But the near future of the US economy is dependent on how hard and how lethal the international adjustment is. A bunch of demand for consumer type goods is going to drop out of the equation in Asia and some other recent boom economies.
If these economies adjust energy prices in a somewhat smooth fashion, the impact will be moved forward but lessened. But if these countries don't adjust energy pricing, they will face a hard adjustment late next year, world trade will break, and there will come a 1930-style crash with major overcapacity in quite a few areas.
Paradoxically, the US is in relatively good position. We can generate energy internally, thus redressing most of our trade problems. The shift in investment will be into energy and food production, and our remaining industries are in a better position than most to meet that. The question is whether US politics will see the problem and address it quickly enough. Only dropping the legal and regulatory bars to internal energy production will keep the US from having a depression-type event.
If the US stops being stupid, if the ECB wakes up and realizes that it can do jackshit about current food and energy pricing through monetary policy, if the worldwide wave of protectionism (represented in the west mostly by carbon cap and trade policies)is rebuffed, and if the Asian countries take relatively quick steps to bring energy pricing in line with reality, then the world can get by with a recession. That is a lot of ifs.
The best case scenario is that Germany, Japan and US heavy industry toodle along supplying the heavy equipment needed, that the US consumer support of the economy drops about 5 percentage points, and that growth resumes in 2010.
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