Tuesday, June 2, 2009

West Liquidates, East Turns Inward

Nothing shouts "West Liquidates" more loudly than the goings-on at Chrysler and GM. The liquidation of capital assets and labor (i.e. plant, equipment and the jobs that go with them) is a phenomenon that will persist in the so-called developed economies for as long as it takes to wring "excess" activity out of a system which had until now relied on debt-fuelled consumption to an unprecedented degree.

In the US, for example, ever more debt was assumed to generate one more dollar of additional GDP; the ratio of annual debt increase to the increase in GDP reached 6x in 2007-08, from 3x in the 1990's. Household debt soared to 135% of disposable income, from 85% in 1990. Trully, this was an economy based on piling debt upon debt.

Thus, today's "Crisis": What the debt bubble giveth, the debt implosion taketh away - and very swiftly, at that. It is a maxim of financial markets that the downside is much swifter than the long climb up. Likewise for the US economy, which had come to resemble a casino more than anything else: everyone "bet" on fast gains on assets (houses, stocks, credit derivatives, etc.), instead of embarking on the long and arduous process of generating long-lasting income streams (good jobs).

We have now entered the inevitable Liquidation Phase; governments all over the West are furiously working to cushion the blow by transforming private debts into public obligations. In layman's terms, governments are taking defaulted mortgages (and credit card bills, auto loans, tuition loans, etc.) off the banks' hands, replacing them with newly-minted treasury bills. How long can this AAA for D swap last is up for discussion, but it is already raising serious concerns amongst those who regularly fund our debts (the Chinese being a prime example).

There are signs that US creditors are incrementaly moving away from the deposit window: the Chinese, for one, are currently on a commodity and used-cargoship buying spree, choosing to invest their money in hard assets instead of promissory notes. Why? My guess is that they are planning for a long transition period for their economy, away from export-oriented growth and towards domestic development.

For example, they are buying lots of older bulk carriers from the secondary market (66 so far this year vs. a total of 80 in all of 2008), instead of building new ones - even though they possess some of the largest and cheapest shipyards in the world. They will presumably operate these ships for their domestic needs (bulk imports), keeping older tonnage in service that would have otherwise gone to scrap. Global charter rates will remain under pressure, all other things being equal, forcing traditional shipowners (Norwegians, Danes, Greeks) to stop placing newbuilding orders to Chinese shipyards; the Chinese apparently do not care if they go against their best customers' interests. The interpretation is that they see global trade as much less of a factor in their domestic economy, in the future: over-indebted Americans and Europeans will consume less and save more.

This is the question that arises for the future of the global economy, then: will Chinese domestic activity be enough to counterbalance the western implosion and liquidation of capital asset values? I am not talking about the next few months, which is already shaping up as a knee-jerk reaction caused by western inventory rebalancing, plus the Chinese demand described above. Instead, I am looking out a couple of decades, or more.

For this time span, my prediction is this: the Chinese will turn increasingly inward and spend their money at home, creating a more modern state with social services, labor rights and environmental regulations. They will rely on foreign trade to a far lesser degree, with obvious domino effects on the ability of western nations to grow through borrowing Chinese savings.

And will the Chinese consume western goods? Well... like what? Just about everything the average western consumer can afford is already made in China and this is even more so for the average Chinese consumer.

The global economy is going to turn bi-polar: the west will suffer decades of Japanese disease and the Chinese-influenced sphere will grow inwardly. Given current absolute economic sizes (big west, small east) overall global growth will likely stagnatee for a long time.


  1. Some comments on your methods, Hell.
    I seem to remember your mentioning a few posts back that you wanted to keep a few sectors within your binoculars, and look at the evolution of those sectors from a detailed point of view.
    I think that you could probably take almost any individual sector (of the economy), carefully analyze what's going on, and deduce (or induce ? I always get confused on this..) the larger picture. Good thinking.
    Keep your eyes on our spin off.
    As soon as I get some time, (like next week...) I am going to post for our benefit a juicy little tidbit that I received from a local anarchist group about Vaucanson, the Grenoble born granddaddy of engineers, automation, and the destruction of artisanat, i.e., qualified labor which meant INDIVIDUALS, and not interchangeable, anonymous peons in the industrial age.
    He managed to sow the seeds that destroyed the silk trade in France under Louis XV, then Louis XVI.
    You know the old saying, what goes around, comes around, right ?
    Well, what went around in the 18th century has come into home stretch for OUR BENEFIT, right now.
    So... let's not have our eyes TOO trained on 20/30 years when the problems go back SO MUCH FURTHER...

  2. A Japan-style recession will be The Very Best Possible outcome:

    Life is not too bad in japan, crime is extremely low, everyone got access to schools and health care, everyone obey the rules of society - to the point where people starve when they are denied a pension!

    Now, what could *possibly* happen in our multi-cultural-, entitlement-fixated-, "me, me & more me"-society once the funds for police, prisons and massive social security intervention programs runs out?

    Whoopsie - looks more likely that Lebanon is the more probable outcome.

  3. Thee Earl of ObviousJune 2, 2009 at 5:41 PM

    For this time span, my prediction is this: the Chinese will turn increasingly inward and spend their money at home, creating a more modern state with social services, labor rights and environmental regulations. They will rely on foreign trade to a far lesser degree, with obvious domino effects on the ability of western nations to grow through borrowing Chinese savings.

    So you think they are going to move the factories out of the prisons?

    I don't think this is a door that can be opened only a crack. If they attempt such a progession wont they encounter the same barriers to profit that western economies face now ?. I mean if they start paying a fair wage and give benefits and funding social programs the playing field will be leveled and they will have lost their competitive advantage.

  4. Lost their competitive advantage ????
    When they are the ones who STILL have the industrial infrastructures ?
    Our service economy is outside the industrial ball park...
    Isn't that true ?
    Not only do we NOT have industrial infrastructures any more, we also don't have any industrial expertise that will allow us to get to our feet in an industrial world. We have lost knowledge, and important skills.
    But frankly, I'm kind of hoping that the industrial world is going to go down the drain.

  5. re: 'they will have lost their competitive advantage."

    A domestic-oriented economy does not need to be very competitive, since exports are not as big a part.

  6. Thee Earl of ObviousJune 2, 2009 at 10:21 PM


    I am not assuming the industrial template will remain static. Ok so right now they have the newest 20th century manufacturing base. If manufacturing technology evolves then won't countries retooling have the opportunity to invest in what will then be the most modern technology? This is what happened after WWII in Germany and in the 1980's for China. But I also think their rise in wages and benefits AND EXPECTATIONS of workers will increase if they "go domestic" as Hell suggests. All the while, our wages, benefits and expectations will decrease. Soon if our newer technology is factored in to make up for inevitable higher western wages (I don't expect $30 and hour to decrease proportionately to a rise from $50 cents and hour)they meet at an equilibrium and ta dah, a level playing field.


    Even if they adapt a domestic orientation to their economic policy, I think they will continue to demand our biggest export: pop culture. Specifically, immediate gratification. You can already see it in the Chinese countryside: grass huts with T.V. antennas, a water buffalo pulling a cart while the driver is talking on a cell phone. Domestic orientation at the expense of "closing out" the rest of the world won't work even with an iron curtain.

    A rise in the culture of immediate gratification will force them to outsource labor to cheaper markets and thus undermine their domestic focus. Meanwhile we suffer the Yang of this Yin: A reawakening of aggregate delayed gratification (shudder).

  7. I believe the Chinese do have the ability to grow domestically, however the wild card is their politics. Their govt somehow needs to move from a dictatorship to some kind of democracy without a civil war or revolution.

  8. @Hell: How much of what we are seeing in various markets right now do you think can be explained by a dollar carry trade?

    @fajensen- A possibility but only remotely. I think reverse immigration far more likely.

    @Deb, don't confuse industrial production with industrial jobs. The US and Europe are still clearly the world's leading industrial powerhouses, it is just there are not any jobs in those industries. In effect, robots have replaced western industrial workers.

    It may seem crazy but as one simple example, manufacturers often make more profit on (say) complex electronic hospital beds (some can truly be quite complex, such as the Clinitron bed) than they do on (say) cars. Indeed, many of them cost as much or more than cars.

    We all know how expensive health care is, then again so is the cost of healing complex pressure sores that infirm patients get when they lie motionless in bed for many hours at a time.

    Indeed, as but one example, the estimated world wide costs of wounds is something over $20-30 billion/year with lots and lots of people employed/involved).

    I keep sensing Hell is unaware of these kinds of problems in the world, etc... when he makes some of his posts.

    People do not like it when they or their loved ones get nasty wounds and as we are all getting older, and able to care for more and more complex illnesses, these types of problems are getting more and more common.

  9. I'm no China hand but from what I read, it seems that China's biggest challenges will be environmental, especially pollution and water shortages.

  10. Sue, Bingo! Political uncertainties are a big question in China's future.

    Thai, Kudos, l laugh at people who say "America doesn't make anything anymore". Still the largest most diversified economy in the world, on the cutting edge from pharmaceuticals to farming. Never bet against the ability of Norte Americanos to out work almost anyone (to a fault) and make a profit.

  11. I often have to remind myself that economics really isn't that complicated. The west has the exact same problem that Japan had starting 2o years ago. A population that is aging rapidly and needs to sell assets to pay for retirement.

    The average age of Asian countries is around 20 years old. They aren't tied down caring for the old or the very young. A vast amount of our resources goes towards paying and caring for those that can't care for themselves. It's a high price, but one in which I know most people will sacrifice for. In America we have chosen to care for our seniors/parents with good medical care and help pay for their retirements. Asia just doesn't have any of these problems because they don't have a social safety net, and their population is very young.

  12. "I mean if they start paying a fair wage and give benefits and funding social programs the playing field will be leveled and they will have lost their competitive advantage."
    It's a long way from a bowl of rice a day to $30/hr and retirement benefits.
    "America ... Still the largest most diversified economy in the world, on the cutting edge from pharmaceuticals to farming."
    Yes, pharma, airplanes and farming. That's about it. The size of our economy is based on 70% consumption, like selling houses to each other. Don't worry, that will soon be history.
    Over the next 20 years a lot of wealth, economic avtivity and consumption will shift to India, China and Latin America. Given that output of energy, copper, etc. will stay roughly constant (unless we discover an entire new planet like Earth which we can exploit) that means "we" (US, Europe, Japan) will consume less of those resources. We won't we able to borrow from China, Saudi-Arabia or anybody else. We want oil? Better have some goods or services in exchange, and I am not taking your toxic debt either. No more trade deficits that run 7% of GDP. Less resources to consume = lower standard of living. Get used to it. Coming to a paycheck near you.

  13. @Yoski re: "The size of our economy is based on 70% consumption, like selling houses to each other."

    Be careful, I think people ascribe WAY too much meaning to the word consumption. Having spent a fair bit of time on this blog (as have you), I have come to realize we all have very different interpretations of word meaning.

    How do you REALLY define consumption? The use of antibiotics to treat pneumonia is considered consumption; so is the use of artificial skin to heal burns, so is the use of antidepressants to help depression, etc...

    As Deb always reminds us, words carry a lot of subconscious meaning we often forget about.

    There is a lot of consumption in education and health care AND these two sectors are a much larger share of our economy than housing.

    An economy that is 70% consumption may not be nearly as ominous as it sounds at first pass.

  14. Yoski: What an anemic economy that US. A country about 1/4 the population of China has nearly the same exports as China. And is China #1? No Germany:


    "Yes, pharma, airplanes and farming. That's about it."

    Name three high tech industries the US does not excel in. Just off the top of my head manufacturing automation of food consumables, chemicals, building and extraction machinery, energy instrumentation and control, computer technology...

  15. Re: consumption

    This from The Quiet Coup:

    "But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.

    Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent." (emphasis added)

    I think the problem is that there has been too much "consumption" in "financial services." I think the point is that we need to get back to "production."

    I'll get back to my regularly scheduled "vacation" now.

  16. Thai:
    "There is a lot of consumption in education and health care ..."
    In neither we're doing a very good job. We have by far the highest per capita health care cost
    ...but rank 37th in the world in health care quality.
    Something tells me we're not doing a very good job in health care and just about any other area. Again, short term profits for the few get in the way of benefiting the many.
    What I am getting at is that our standard of living is based on the consumption of raw materials. Most of those materials are in short supply (peak everything). So if China or India or who ever consumes one extra barrel of oil that means somebody else will have to consume one barrel less. That's assuming world wide output stays constant which seems to be rather optimistic.
    Since there's no way we can keep the developing world from consuming ever increasing amounts of raw materials (up to some equilibrium point) that means we will have less raw materials to make stuff with. Less stuff we can buy, sell or trade for more raw materials. That means our standard of living will decline for a (long) while until it reaches some equilibirum with the rest of the world. Somewhere between $30/hr + full benefits and a bowl of rice a day with no benefits.

  17. Thanks for the health care link.

    I agree we can do a better job (though this is more complicated than is often made out).

    For your statement "Something tells me we're not doing a very good job in health care and just about any other area" is clearly incorrect.

    In fact, to the extent you have any confusion on your first point, it may be leading you to a wrong conclusion on your second.

    At the most basic level, in order to say we are not doing a very good job you first have to define "from whose point of view?".

    There are many areas where American health care is clearly the best in the world, even for national stats. Most notably, we spend more per person on preventative medicine and public health than any other country in the world (but understand, this INCREASES total costs, it does not decrease it).

    So I completely agree with reformers like Maggie Mahar, who point out the lowest hanging fruit in our system is eliminating "excess".

    Her article is one of the best I have ever read.

    But again, I have found a certain tendency in patients to ask for unnecessary test all the time. Further telling them "no" does not make them very happy. "Doctor shopping" is common. Who is at fault when it is?

    Fwiw, here is another link from the US congress that compares America with almost every other OECD country on many metrics.

    re: your peak thesis.

    I agreed.

    But haven't we really ALWAYS been in a peak world?

    To the extent we use materials more efficiently, we can do much more with the ones we already have.

    But this require brain power and investment (as Hell continuously reminds us).

    And sadly we are spending our money propping up home prices and retirement plans instead of investing in the minds of the people who can dig us out of this mess.

    But it is always like pulling a thread as even this requires a change in mindset, as not all Americans can solve this issue and yet we have the idea that everything and everyone is "equal" (which it is, depending on what we mean).

    How do we have this conversation as a society?

  18. Sorry, I missed posting last link (it is a .pdf file)

    (I am crossing my fingers the link works- it is all you ever want to know on how we compare with other countries). Let me know if it does not.

  19. It didn't.

    If you click on the very fist hyper link in this Google search, it should work (again, fingers crossed).


  20. Sue said, regarding the Chinese,

    "The wild card is their politics."

    I'd say the (not so) wild card is the strained global ecosystem in general and the strained Chinese ecosystem in particular.

    The present global economic retrenchment may simply be part of a much grander, ahem, retrenchment based on sundered resources broadly defined.

  21. Thai said:

    "...it is all you ever want to know on how we compare with other countries)."

    It's all you ever want to know about careless typing; you stuck blogger.com in front of the URL in your failed link; doctors!

  22. The West got itself into this problem, the West will have to dig itself out. China's domestic consumption will not bail out the economic world.