Morning:
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An alarming parallel can be drawn between what is happening in the world economy today and what happened in the US in the run-up to and immediately after the Wall Street Crash of 1929.
In the 1920s, the mantle of global economic leadership was moving from the UK to the US but the Americans were reluctant to accept the responsibilities that went with the role. Because they failed to realise they were meant to be in charge, the dollar was held down against sterling and no effort was made to recycle the US trade surpluses that built up as a result. Instead, these fuelled the Wall Street boom and the rash of speculative excess that contributed so much to the pain of the ensuing depression and worldwide slump.
Today the fear is that while the world is preoccupied with the credit crunch, the real issue is the transfer of economic power from the US to China, and China's refusal so far to accept the responsibilities of world leadership. Hence the build-up of surpluses in that country, with the increase last year greater than the reserves of Russia.
China's reserves are growing at the rate of $100 billion a month, or $1.3 trillion a year, which is about half of the UK gross domestic product. The global economy grew 4% last year, and a quarter of that growth was attributable to China. In terms of driving the world forward, its growth is twice as important as that of America. Unfortunately, as Charles Dumas of Lombard Street Research said at a seminar yesterday, China does not yet realise it is meant to be in charge. There is a mismatch between its policies and what the world needs to stay on an even keel.
The problem is that with the build-up of reserves in China, there is a deficiency of demand in the rest of the world. Dumas draws an interesting link between the roughly $800 billion US trade deficit and the reduction in equity of the US stock market in the face of the spate of debt-driven private-equity buyouts last year, which for simplicity's sake can be thought of as funds recycled from China and which amounted also to about $800 million.
This was a symptom of the funds being recycled back into the West as debt, but the problem is that the Western economies have reached saturation point and cannot absorb any more debt. That is what the seizing-up of the debt markets and the credit crunch is all about. So if the Chinese are to continue to recycle their funds and keep the global economy turning, they need to switch their focus from debt to equity.
The need is acute because the dryingup of private-equity leverage on its own means there is a $600 billion to $800 billion hole where the buyers' wallet should be. But Chinese buyers are not interested at current equity prices because the gap between junk bond yields and equity returns is simply too great. Unfortunately for stock market investors, the only way it is likely to close is for equity prices to plunge to a level which makes the yields attractive for foreign capital. That is probably about 30% lower.
Dumas says it is in China's interests as well as those of the world to let the yuan appreciate against the dollar and to allow much easier export of capital, preferably by individuals rather than the state through sovereign wealth funds.
The former policy would curb exports, increase imports and slow down the rate of accumulation of surpluses to stop the reserves problem getting even worse. The latter would get the money back into the world economy before it suffered too much deflation. Both would ease the domestic inflationary pressure which threatens to destabilise China from within, and ease the capital markets crisis in the West.
But both these decisions require China to be willing to take on a greater responsibility for what happens to the global economy. Life may well be much more uncomfortable for us if it is not yet ready to take that step.
PEOPLE keep asking if bank shares are cheap - just because they have come down by 30% or more in value and have yields close to double figures.
My view is they probably have a lot further to fall because of the amount of pain still to emerge as the global economy purges itself of debt. Bedlam Asset Management produces some interesting yardsticks in a just-published note.
The first is that bank shares usually touch bottom when their price is between 5% and 10% of deposits. Bank of America, Lloyds TSB and UBS are on 27%, 21% and 12% respectively. A second test is their importance in a given index. Today financials are 22% of the MSCI World index; they were 14% in 1992. A third is the non-performing loans ratio. Three per cent is the number to look for.
But if all this appears a bit technical, Bedlam has one further bit of advice: wait until all the existing management has been defenestrated.
