Singapore Business Times Investment Round Table
Originally published in the Singapore Business Times 8 September 2011
Financial experts present a bleak picture of US and Eurozone economies, and say a recession will impact Asia and other regions
Eisuke Sakakibara: Former Vice-finance Minister for International Affairs of Japan
Robert Lloyd-George: Chairman of Lloyd-George Investment Management, Hong Kong
Ernest Kepper: President of Asia Strategic Investment Associates, Japan
William Thomson: Chairman of Private Capital, Hong Kong, Director of Finavestment, London
Christopher Wood: Managing Director and Chief Strategist of CLSA, Hong Kong
Moderator: Anthony Rowley, Tokyo correspondent for The Business Times
The global economy continues to stumble from one crisis to another. Are we on the road to recovery, or is this just the run-up to a global mega-crisis before a new and more stable economic order comes into view? Can policymakers navigate between the Scylla of fiscal bankruptcy and the Charybdis of economic strangulation? Could another major banking and financial-system crisis be on the cards? The Business Times invited a panel of experts to address these and other key issues.
Anthony Rowley: A warm welcome to our tried and trusted panel. Allow me to "jump in at the deep end" and ask you all what are the dangers of a global recession where both US and Eurozone economies go into recession simultaneously? Professor Sakakibara, your thoughts first.
Eisuke Sakakibara: The centre of gravity of the world economy is shifting from West to East and we have to cope with it. Such a transition is certain to be very difficult. I would say that the 1930s Depression marked the failure of the transition from the UK to the US and the transition this time is much larger than that of the 1930s. (There could be) some kind of simultaneous, worldwide recession, or even a Depression, sooner or later. Look at what is happening to the US economy and the European economy. China and India are not big enough yet to substitute for these.
William Thomson: We are living through a period of enormous uncertainty, volatility and limited visibility. I am assuming there will be no financial crisis in the next six months akin to 2008 even though the odds of a major adverse event have increased substantially in recent months. Much of Europe and the US are especially vulnerable now that they are adopting policies of fiscal austerity, having become hugely indebted after squandering trillions on ill-conceived stimulus programmes. Attempting to balance the budget when the economy is depressed is virtually guaranteed to fail. Fiscal consolidation must be combined with growth strategies but that is proving impossible to implement under the West's present dysfunctional political leadership.
Robert Lloyd-George: I feel we have just gone through what threatened to be a category 3 or category 5 hurricane, and proved to be instead a short-term drenching. This is not yet the real crisis which I anticipate, within three years. It is, of course, possible that both the US and the European Union go into recession, but my hunch is that we will muddle through with low growth in the US at 1.5 per cent this year, and perhaps a little more, 2-2.5 per cent next year, whereas Europe will undoubtedly be slower. If Germany slows then we could see less than one per cent in Europe, but again a slight improvement in 2012. China and India will maintain their 8 per cent growth, but of course their GNP size would not compensate for a real slowdown in the Atlantic economies simultaneously.
Christopher Wood: There is clearly a chance that both the US and Eurozone go into recession. But my view is that German and Eurozone economic data will deteriorate much more dramatically in the next six months than the US.
Rowley: Ernest, I know you have an unusual take on all this.
Ernest Kepper: I believe the global economy is exposed to a run on gold holdings as the amount of paper gold that trades on a daily basis is of an order of magnitude far greater than the amount of physical gold that exists in the world to back it. It is estimated that the gold market is around 100 times the size of the amount of actual underlying metal. Bullion banks are selling what is supposed to be vault gold, but it is really "abstract gold", as it is just a ledger entry if the customer never demands delivery. If someone demands delivery of gold according to their ledger holdings, and a bank can't provide it, the default would trigger the biggest bank run in history.
Rowley: Let's turn to the US economy. How do you rate the chances of a double-dip recession there? Ernest, I know you are bearish. Tell us why.
Kepper: The US is technically bankrupt, and is falling back into recession. There is no economic force in America to carry the country into the next boom. Standard & Poor's downgrading of the US credit rating is just the beginning. The government is over-extended. There is no money left to bail the US out during the next recession. The Federal Reserve has kept the economy alive the past two years by printing dollars. The Fed cannot lower short-term interest rates below zero and the more money the Fed prints, the greater the risk of inflation and the higher long-term interest rates move. I believe we are now facing a new up-cycle in interest rates that will cripple the government and the economy and ultimately send stock prices much lower than they are today. We have about six months left before the next phase of this bear market gets underway, ultimately bringing stock prices below their March 2009 lows. The aftereffects of the next leg of the bear market could be much worse than the Great Depression.
Thomson: If the recent deal on the budget is implemented and there are no growth programmes initiated, then the US faces recession or something close to it. Obama will find it difficult to find money for infrastructure investment because Republicans sense they have a better chance of winning the White House next year if unemployment stays high. It is pure, naked politics. The Fed is limited in what it can do since it is being dragged into the political process. If QE 3 is attempted, we can expect further dumping of the dollar and increased asset inflation.
Lloyd-George: The chances of a double-dip recession are about 30 per cent in the US and I believe that, given that 2012 is an election year, we will have some kind of stimulus or QE 3.
Wood: I think there is a 50 per cent chance of a double dip recession in the US. The alternative is continuing anaemic growth. I continue to expect an announcement from the Fed of a third episode of quantitative easing before the end of this calendar year. I also still expect some move on the fiscal front in the US before the end of this calendar year.
Rowley: What about Europe?
Kepper: Greece is bankrupt - then Spain, then Italy, and austerity measures are difficult to implement in Europe without the use of tear gas as people demonstrate against wage cuts and tax increases. It is only a matter of time before Germany pulls out of the euro. The euro has declined steadily against the dollar. When the richer European countries tire of bailing out the poorer countries, each will just go back to its own currency. Ultimately, the euro will die, and with it the economies of the weaker European countries: Greece, Spain and Italy.
Thomson: Given the current obsession with austerity no pro-growth strategies, Europe will be in or near recession next year. The tables have been turned and the West's future now increasingly seems to emulate Japan's. The West, however, is less stoical than Japan and social unrest is not far below the surface these days. Saving the eurozone will require the German electorate to bear a greater burden of bailouts, something deeply unpopular. So the truth is obscured and we have a series of half measures that are doomed to fail and lead to the next crisis. Eventually reality will have to be faced and that will be a (strengthened) fiscal union combined with debt default, or some countries will leave the eurozone.
Lloyd-George: I think Europe will continue muddling through with intermittent crises, but I would probably venture the forecast that the euro will survive because of the political determination in Paris and Berlin for it to do so.
Wood: There is a higher chance of a renewed recession in eurozone than in America. This will put further pressure on the system. In the meantime, the European Central Bank will sooner or later have to reverse its recent tightening.
Rowley: How would Asia and Latin America fare in the event of a US/European recession?
Lloyd-George: If there is a US and European recession, it will be very quickly felt in both China and the Asian region, as well as in the commodity-producing countries such as Latin America and the Middle East. The price of oil and iron ore and other key industrial commodities would be negatively affected. The linkage of Australia, Brazil and the African economies to China's demand for raw materials is very close, and if the Chinese consumer and the Chinese exporter are both feeling a contraction from Western economies, that linkage will quickly be felt.
Thomson: Asia is better placed than the developed world and should escape recession but with markedly reduced growth rates. Both China and India are combating well-embedded inflationary pressures. China is attempting to reorient its economy away from a reliance on exports towards greater domestic consumption, but that is still very much a work in progress. It will, however, do what it takes to assure a smooth transition to the new leadership that takes over next year.
Rowley: What about the health, or lack of it, among financial institutions - US and European banks especially. Ernest, let's hear the worst from you.
Kepper: The Wall Street bailouts of Bank of America and the other big banks did not fix the sector. Massive injections of liquidity temporarily solved the day-to-day operations of banks, but they did not repair the deeper troubles. Pouring billions of dollars into nearly identical management teams that mismanaged risk, overleveraged exposure and drove banks off the cliff originally is inviting another crisis. Many banks remain severely weakened by holdings that should have been written off. The big US and European banks will very probably move towards crisis and the global banking industry will come to a grinding halt - only maybe then we will see some sensible and drastic steps taken.
Thomson: What did Churchill say about Russia - an enigma wrapped in a mystery? That about sums up the health of Western banks. The elimination of mark-to-market accounting and the extent of toxic waste held off balance sheet means published statements lack transparency and must be viewed with a jaundiced eye. The problems from 2008 were buried rather than eliminated, in the hope that they could grow out of them. Balance sheets have been strengthened more in the US and the UK than in Continental Europe where the most immediate problems exist although regulators and policymakers have had three years to prepare for the next crisis. So I am more relaxed than I was then, about avoiding a systemic breakdown.
Sakakibara: Japan is in no way in a financial crisis and Japanese financial institutions are relatively strong compared to European or even American financial institutions.
Lloyd-George: It is interesting that you make the comparison between Japanese major banks and what the US and European banks are now undergoing because the Japanese banks took about 15 years to bite the bullet, undergo restructuring, mergers and repair of balance sheets after the 1990 stock-market correction. On this basis it may take until 2020 before the major European and American banks are completely recapitalised.
Rowley: Let's look at currencies in this time of extreme turbulence. What is going to happen to the US dollar, the euro and the yen?
Sakakibara: The dollar will continue to weaken although it depends upon how the US economy evolves. The European crisis is spreading, so that both the euro and the dollar are very weak and that implies in relative terms that the yen will strengthen and it will probably break the all-time high of 76.25 fairly quickly and I would not be surprised if the rate went down to the high 60s.
Thomson: Everybody hates the dollar, yet it remains higher than it should be on account of its reserve currency status that most people would like to see changed but there is absolutely no consensus emerging on what to change it to. It is likely we will muddle along as we are for some time while Asian central banks slowly build up their gold reserves and China gradually internationalises the yuan. Eventually, we may move to three reserve currencies:the dollar, the euro and the yuan.
Lloyd-George: I am cautious about all "fiat" currencies, especially the dollar, but I do not see any immediate alternative. The yuan is not ready to step up to the plate. My own view is that we will have to re-establish some link to gold in some form or another within the next three years. The essential problem is the collapse of confidence in the dollar and in all the 66 dollar-linked currencies and the fact that neither the euro nor the yen really commands any confidence either. The gold price has been the only clear indicator of this new trend by global investors, including central banks in Asia, the Opec bloc and now even Venezuela.
Wood: The yen will likely continue to remain strong since it is still 31 per cent below its 1995 peak in real terms. The dollar may bounce in the medium term, most particularly against the euro. But my long assumed endgame remains the collapse of the US dollar paper standard.
Kepper: As the value of the dollar erodes under a mountain of debt and rapid inflation - the result of too many dollars in the financial system - governments and others will move away from a system where the greenback is the official reserve currency. The US dollar will be replaced by a basket of real goods - gold, silver, oil, food - and a couple of currencies such as the Swiss franc, Chinese yuan, Japanese yen and, possibly, Canadian dollar. Rising inflation, a debasing US dollar, out-of-control government spending, and excessive currency printing will continue to push the price of gold higher. I'm expecting gold to trade at US$3,000 (an ounce) within a 12-month period.
Rowley: All comes back to gold in the end it seems. Thank you all.