Tradesense (a.k.a.Horse Sense)

This Blog was launched on 9th October 2008 just after the beginning of the worst financial crises the world is witnessing and fear seems to be reaching its peak.

Sixthsense investing appears to be the need of the time!! The intention is tickle it every week.


Monday, August 17, 2009

Where is the US consumer crisis heading?

It has been a while since I posted – was caught up in some personal issues and could not put my thoughts down. Having discussed many of the current hot issues including China before, it is becoming difficult to keep turning the same wheel again and again which many seem to be adept in doing. Let’s anyway look at some of the current concerns many of which were discussed earlier and then take a view.

As regards China it was identified in May 09 itself that:

…China doesn’t have the kind of social safety net one sees in the developed world, so it needs to keep its economy going at any cost. Millions of people have migrated to its cities, and now they’re hungry and unemployed. People without food or work tend to riot; to keep that from happening, the government is more than willing to artificially stimulate the economy, in the hopes of buying time until the global system re-stabilizes.

It’s literally forcing banks to lend - which will create a huge pile of horrible loans on top of the ones they’ve originated over the last decade (though of course we can’t see them). Don’t confuse fast growth with sustainable growth. As I’ve discussed in the past, China is suffering from Late Stage Growth Obesity. A not-inconsequential part of the tremendous growth it’s seen over the last 10 years came from lending to the US. Additionally, the quality of late-period growth was, in all likelihood, very poor, and the country now suffers from real overcapacity.

Identifying bubbles is a lot easier that timing their collapse. But as we’ve recently learned, you can defy the laws of financial gravity for only so long. Put simply, mean reversion is a bitch. And the longer inflated prices persist, the harder they fall when financial gravity brings them back to earth.”

It was also noted in early June 09 that:

…However, if there is to be a risk of a credit crisis in the future in China, similar to the one that has unfolded in the United States and Europe, the country would need to lack any other possible engine of growth.

In the United States and Europe, if credit had not outpaced incomes, growth would have been close to potential growth, i.e., in view of productivity gains and growth in the working-age population, around 2.25% in the United States, 1% in the United Kingdom and 1% in the euro zone. Credit was used to ensure more robust growth than would otherwise have been recorded.


In China, the current economic recovery is driven by credit; but there are exceptional circumstances with, for instance, the decline in China’s exports due to the contraction in global trade.

In a normal regime, productivity gains are high and potential growth is robust in China, and this rules out the need for a durable increase in indebtedness to stimulate growth.

However, it may well be that the current vigorous upturn in credit, driven by the government’s instructions, with loans extended at very favorable conditions for borrowers, could lead to the reappearance of non-performing loans in banks’ balance sheets, and the Chinese government will likely have to pay for them in the future as it already has done in the past.

And in January 09 it observed that:

The $584bn.China stimulus is expected to start having some impact from the second quarter. But the main factor would be the expected revival of the western markets after the second quarter which would then give a fillip back to Chinese exports. If this for some reason does not happen or is delayed than we may see some serious dumping by China causing prices worldwide to fall and adding to the deflationary trend. This could lead to protectionist tendencies to increase leading to a global slowdown in trade with attendant political and economic consequences.

As regards the market and FED it was observed in early May 09 that:

…The feel good factor is back. Many experts opine that we have indeed put in a bottom and that with due corrections we shall now march upwards. The fact that most were talking about a recovery that would be shaped L, U, W etc., contrary to the expectations as markets usually do, many experts think the market in its wisdom has sought a V shaped recovery….

…This is not to say that some of the macro parameters have not improved. But this sharp move up of the market has its consequences. The increasing appetite for risk has seen the US 10 year yield move up to 3.2% and the mortgage rates are up from around 4.7% to around 5.2%. And as explained in a previous post sharp up moves in equities is going to make the treasury and the Fed’s trillions of borrowing more expensive pushing up the interest higher which will increase risk for taxpayers and the country dramatically. Hence while printing money the Fed and treasury have to do a fine balancing and that means the interest rates still needs to managed within reasonable levels. This is not going to be easy and is going to be a fine line to tread on, not knowing where the line is.

Now here is the catch. On the one hand this would mean funding the bailouts is going to be more and more difficult and expensive while on the other hand liquidity will find its way to other asset classes. While the short term shift in liquidity to stocks and other assets may move these markets, sooner than later the reality of high interest rates and the inability/difficulty of funding the bailouts other than through FED buying more and more treasuries (printing money or quantitative easing) will become apparent. This we have experienced many a times is a sure shot formula for asset prices to finally form a bubble and lo! we are back to square one.

To me the market players should not get euphoric with current move. The players shifting their liquidity to the market to create such sharp moves would be actually shooting at their own legs. A measured slow consolidation is required and sharp move in asset prices will put the medium to long term sustained recovery in jeopardy. This whole process will be time consuming – running into number of years and the market player’s own action on a collective basis of how they handle this liquidity is going to determine how long the markets may take to make a long term sustainable up move.

On why the seeds decoupling have been sown, it was observed in February 09 that:

…As I see the lessons learnt/being learnt during this severe downturn will have a lasting impact as these Asian countries now re-orient there industrial and fiscal policies to ensure that over dependence on exports is reduced in the years to come. Also trade within the region will now be a much greater focus as two of the most populous countries in the region ‘Chindia’ look to push their growth with policies that are much more domestic investment and consumption oriented. India always was domestic consumption story (save the IT and IT enabled services and Generic Pharmaceutical industry) and now can be regarded as a great advantage.

… the reorientation will be challenging and will take time – a decade or so. But as the US and European consumption story sees its twilight in years to come it is the Asian and some of the resource rich countries such as Brazil that will need to fill-in. And as this re-orientation sees initial success foreign capital (US and European savings) will start seeking these countries and the capital required to sustain a reasonable growth rate will find its way. The seeds for this shift – possibly a power shift too - appears to have been sown.


The point to be understood is that normal downturns/recessions happen due to businesses over investing and generally the interest rates shooting up (through central bank actions) because of inflationary concerns causing demand to ease. The overcapacity brings down prices and as inflationary concerns diminish the interest rate environment softens and we see demand picking up and capacity utilization also move northward indicating revival. The underlying money circulatory system or credit delivery generally remains in reasonable health, although specific concerns may be there.

However the genesis of the current downturn/recession is the failure of this underlying system of credit delivery and money circulation which has its own attendant consequences. The businesses and consumers got into trouble because what they thought was a given (within a certain flexibility band of size or amount and price of credit) suddenly found the ground dry and had to face tight liquidity situation and thereby cut production/purchases etc.

The former situation is akin to an organ or two malfunctioning and with some external medication which can reach the organs through the circulatory system and body’s other organs/systems responding in help, the health can be restored reasonably fast – V shaped recovery. But if the body’s circulatory system is itself damaged and is the cause for other organs malfunctioning it becomes a real challenge to restore the health of the person as the medication has to given directly to the organs in the hope that their improving condition would stimulate the circulatory system and thus the patient’s health can be restored. How this will pan out is difficult to say – L, W, U and hopefully not X.

As Washington Post notes:

“…Growth spurts can emerge, and it appears increasingly likely that the U.S. economy will grow at a solid pace in the second half of the year, as companies restock depleted inventories. But it is unclear what would come after that, given the ongoing restrictions on credit.

U.S. banks have sustained massive losses already, and a wave of soured commercial real estate loans threatens to further limit their ability to lend in the year ahead. A bigger problem looms outside of banks -- in credit markets, which account for vast chunks of mortgage lending, consumer loans and commercial real estate loans. This shadow banking system remains dysfunctional -- notwithstanding a slew of programs the Fed put in place to get it going again -- and no one is sure when or whether it will recover.

All that makes it more expensive for people or businesses to borrow money -- if they can get a loan at all -- which could serve as a powerful brake on any recovery.

"Credit fuels housing. It fuels consumer durable goods. It fuels business investment. It's in every part of the economy," ... "Credit makes recessions after a financial crisis longer, and all the signs are that [it] is happening this time as well."

…The financial crisis and recession are reversing a 30-year trend carrying Americans toward a high point in debt. The ratio of consumer debt to the nation's total economic output rose to 97 percent in the first quarter of this year from 45 percent in 1975.

Currently, Americans are saving more and paying down debt; the savings rate was 1.2 percent of disposable income in early 2008. By the second quarter of this year, that rose to 5.2 percent.

Every dollar that Americans save is one fewer dollar for consumption, which means less economic output. When the savings rate goes up by a percentage point, spending decreases by more than $100 billion…”


So what will bail out American, Chinese and other businesses that are so dependent on the US consumer? The answer to this is the growth of the merging market consumers. As noted above as the US consumer dependant economies focus more on internal consumption and make moves to improve the living standards of their populations through better infrastructure, creating more job opportunities etc., the demand for goods worldwide will start looking up over time. American businesses will have to position themselves to exploit this opportunity.

Remember what the US consumer saves has to find its way to businesses or consumers elsewhere. This capital will flow to where the growth opportunities are – the emerging markets. And as these markets start providing the depth in demand (because of sheer numbers and necessarily due to credit explosion in these countries), American businesses will find its footing in the scale that they were/are used to. This reversal of fortune is going to take a lot of time. US companies already established in these regions will be the first to experience this shift and those focused within the US will have to think globally.

Slowly the cycle will turn, but for now situation seems too challenging for comfort.


Disclosure: No Positions


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