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Wednesday, August 13, 2008

A Very Coordinated Downturn

Japan announced the first estimate of second quarter GDP. On an annualized basis, GDP dropped 2.4% after expanding 3.2% in the first quarter. That's +0.8 > -0.6. No one's being shy any more about the word "recession", and property companies are selling off. There are some job cuts, consumer prices are high, and summer bonuses shrank, so Japan is being hit both by an export slowdown and the domestic economy.

But Japan didn't do that badly. Singapore's second quarter GDP came in at -6.0% annualized. Exports to the US shrank 21% and exports to Europe shrank 12%. Malaysia's economy is slowing, but we'll know more at the end of August. However I think growth is very pressured due to the government's plans to expand control of ports, which likely means the government is trying to expand tax revenue. Thailand's economy is spawning a war between the central bank and the government. The official forecasts are for 5-6% growth this year, but it seems very unlikely.

The theory that Asian growth can continue sharp expansion, absent decent growth in Europe and the Americas, falls on some fundamental facts about average income growth and distribution in "developing" countries. This article provides a major wakeup call with facts, and the facts are ugly. Whereas successful economies achieve healthy dispersion of income gains through a large percentage of their population, too many of the "developing" countries have stayed stuck in highly stratified economies, and this is why growth in those countries has no legs of its own. This is why I have been focusing so much on India, because it had managed to produce dispersion of incomes.

India's industrial growth rate is dropping sharply - down by nearly 50%. Its expected GDP growth rate is substantially below inflation, including producer price inflation, which is going to continue to weaken internal growth impetus. On average, real Indian incomes will fall over the year, which is bad news. Additional bad news is that the off-budget liabilities are still expanding (fuel subsidies are a major portion), which makes for a declining currency, which makes it much harder to control inflation:
The panel said budget deficit targets for 2008/09 would be exceeded and serious fiscal risks were arising from growing off-budget liabilities estimated at 5 percent of GDP.

Hefty fuel subsidies, loan waivers for millions of poor farmers and proposed salary increases for government employees are constraining the country's finances.

"Despite appreciable fiscal consolidation, large and growing off-budget liabilities are however a matter of concern. With these included, the fiscal situation no longer looks stable and sustainable," the panel said.
The Indonesian economy is harder to predict due to the wild variance in recent years between real and nominal growth rates (from 2005, approximately 16%, 15% and 12%). The mood is still optimistic, but Indonesia is running up against infrastructure problems which will tend to restrain growth. The government has to expand fundamental infrastructure investment in a weaker global environment in order to be able to maintain real growth, and this will be an economic challenge. Indonesia has also done well from Japanese investment in industrial plants, so a weakening Japan is not good news.

The three biggest world economies are the US, Japan, and Germany, with China seeking to displace Germany. After that the top ten consists of the UK, France, Italy, Spain, Canada and Brazil. Brazil and China are growing, and Brazil may continue to grow at a close to steady pace. Canada is slowing but growing. Japan, Germany, Italy, Spain, and the UK are all in negative territory, although the UK hasn't figured it out yet. The US and France are still showing growth, although that's not going to continue; both economies should be undebatedly in negative growth later this year. For the US, I feel Q2 GDP will be revised down later (although a weak positive in the second quarter should remain). Germany and Japan contracted somewhat in Q2, although we will not have official German figures until tomorrow. France may have gone mildly negative. All in all, it means the Eurozone probably reports negative GDP growth in Q2.

For Asian economies, the US consumer spending slump which is just about to accelerate sharply will have a major impact.

In the meantime, global steel prices are beginning to drop and while coal demand is increasing, coal prices appear to have topped and be declining as coal becomes unaffordable at some locales for the countries in which it is in great demand. Both China and India are seeking to reopen domestic coal mines closed because of safety concerns. We are on a greased downward slide, and deflation of real estate bubbles around the world is going to add some additional slipperiness in the year to come.

US nominal seasonally-adjusted retail sales dropped slightly, which is no surprise to anyone who has been paying attention, and YTD YoY comparisons show growth much below the inflation rate. There will be further nominal drops in the months ahead, which will accelerate the pressure on Asian countries. Inventory/sales ratios have taken another decisive drop down, showing that the correction is well advanced:

If you look at the dip in 2007, that showed the first economic leg down. The rise beginning at the end of 2007 is a product of the production expansion as that segment of the economy exited trough; the current decline is the next leg down and is the product of consumer weakness, nor do the details of inventory/sales ratios support the idea that we are near the end. It's quite tough to keep running growth on export expansions with the growing weakness globally.

Current world overcapacity looks to be building in some metals and minerals, pharmaceuticals, probably cement and chips. There is strong demand for cheap energy and food, and the need to invest in power plants and the like will support some heavy industry. However growth in consumer discretionary items is likely to be slim in the year ahead. The German grocery WalMart equivalent, Aldi, is making great strides which ought to tell us all something.

Looking at buyout activity, which usually flags cyclical downturns six to twelve months ahead, downturns are ahead for some metals, minerals, coal, some categories of shipping, pharmaceuticals and some types of electronics. It's too soon to tell about the rest, except that the losses are building in natural resources. If you are a contrarian investor, the time to start looking at natural resources companies is about six months to a year from now. The aircraft boom in new orders is nearly over, with only the oil moguls stoking demand.

And so "decoupling" gets exposed as the myth that it always was.
As the news this morning makes clear, we are coupling ever more tightly.

But what did everyone expect from globalization?
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