THE WORLD ECONOMY, 2010 –

Note: This is just an opinion of mine and not based on some economic model, nor is it based on any factual data or figures. Furthermore, I’m no economist, just a regular businessman. I don’t have a degree in Economics either, just plain old fashion common sense.

A few weeks back, my eyes caught on an intriguing title of a magazine cover (either TIME, Newsweek, or Fortune, can’t remember). The catchy title goes like, “Cheap Oil Forever” or something to that effect. Anyway, I was so “stimulated” by the catchy front title that I proceeded to read that particular article on the magazine right on the spot at the bookstore. The central claim of the bold statement is based on a comparison of the oil price behavior made in the previous price cycle during the 1980s oil shock and the current price cycle. According to the article, both cycles though different in their peak prices exhibit similar behavior and from the comparative analysis, the author concluded that the current price cycle has already seen its peak and already went pass of it and the ensuing price trend would only see prices going down if not stabilizing. In short, oil prices is not likely to “skyrocket” in the short term foreseeable future much unlike the price fluctuation seen in the last two years or so. Wow! This is really a bold statement, indeed! Just last week (I think), the IEA, the rich western countries’ energy advisory group, projected a shortage of crude oil production capacity as early as 2011! With shortage as the logic goes, oil prices would revisit that unbelievable price tag of $147 a barrel in the next two years. That assertion though of IEA is hinge upon the complete economic recovery of the US and the OECD economies (the Organisation for Economic Cooperation and Development, the organization for advance economies mainly western countries) by 2011. Contradicting? Yes, absolutely! That the price of oil would buck the established historical trend is both “seemingly anomalous” and unnerving. However, the assertion of full economic recovery by 2011 though is not without basis. The news for the past month or so on the economic front is somewhat optimistic with American authorities claiming to see the “green shoots” of economic recovery based on encouraging economic data so far at hand. In addition to that, China’s economy is coping pretty well with the crisis and it’s export shows signs of improvements as of late. All this fueled market rallies around the globe, reacting in a way that suggests that the end (to the free fall of asset prices and to economic contraction) is already here and that we have already “bottomed out”. The most optimistic in fact, believed that there is nowhere to go from here but up. Pardon me for being a killjoy but I’m still unconvinced that this is the case especially the latter (that there is no way to go but up) though I don’t deny the fact that we had already turned the corner and “bottomed out” but recovery? I felt that assessment is too early to call (and I’m not alone in that assessment). Also last week, the former NEDA director, Cielito Habito, wrote in his column in the Philippine Daily Inquirer about the future economic prospect. Specifically, there is a debate whether economic growth pattern from 2010 onwards would be an “L” (sudden contraction of the economy as seen in 2008 followed by a prolonged recession or at least, an extended period of lethargic growth in the short term), a “V” (a sharp rebound; a momentary “dip” on the economic growth rate followed by an unusually strong recovery), or a “U” (a sudden contraction of the economy followed by a slow recovery). And this is the reason why the magazine article is such a “bold statement” because it presupposes that the global economy will experience a slow recovery or a “U” if not an extended recession, an “L” which goes against the recent raft of evidence of economic optimism. The recent market’s reaction on the other hand assumes a “V” shaped recovery if not at least a short “U” type of recovery. As I explicitly said, I don’t believe that a “V” shaped rebound is in the offing but a prolonged recession (the “L”) seemed to be contrary to what is happening around. Instead, I believe (as a growing number of analysts and economists do) that the world economy will experience a “U” shaped recovery if not an extended period of lethargic growth (or a modified “L”) in the short term. And I had my reasons for believing so. The current economic malady was borne out of the financial meltdown in the US brought about by the overextended debt burden of the typical American household. The debt situation was in turn derived from Americans assuming the mantle of being the “global consumer of the last resort” or being the “consumer of the world” for the last decade or so. This unflattering mantle came about during the last decade of the previous century with the internet boom. As we all know, the Americans have this 301k pension fund, which are heavily invested in securities and with the booming stock market, the value of their future “savings” correspondingly ballooned. Couple this “boom” with easing government restriction on the use of pension fund savings, the average American felt that they are “rich” even if their so – called wealth are in papers only. This “boom” wealth has drastically altered the American psyche and underpinned much of their consequent spending spree. You see, an average person would save a portion of their income as an insurance against future needs but with an extraordinary gain in their “creditable savings” due to the internet boom, most Americans believed that setting aside cash for future needs is no longer necessary and that future pensions and future income streams is as good a substitute to savings. As such, Americans began to spend and spend and spend even more. The internet bubble burst before the turn of the century didn’t give much of a dent on American propensity to spend because the government’s aggressive monetary policies and easing fiscal policies enabled the securities market to continue rolling on. As such, this created an illusion that “good times are here to stay” fueling even more spending spree. Eventually, a point came when this unrelenting spending spree gave rise to a voracious demand for resources that stretch global supply capacities to its limits and by the law of supply and demand, when supply dwindles and demand increases exponentially, exorbitant price increase inevitably follows. Inflation is the end result and we see the $147 a barrel crude oil in the market. As inflation began to bite into the income of the average individual by reducing their buying power, the inflation looks set to spiral out of control and governments worldwide began to drastically change course on their monetary policy from free – wheeling credit to one of restriction. This in turn took the wind out of financial markets resulting into a series of events that led to the current state of things. The current “Great Recession” differs from the previous recession episodes of the 90s and the early part of decade of the 21st century in that American savings are seriously affected. Previously, American savings are “protected” through government’s aggressive monetary policies but the financial meltdown has practically wiped out American savings. This could be gleaned from the news that people are coming out of their retirements to work for a living. And this is exactly my point as to why the current “Great Recession” would drag a bit longer or that recovery would be weak and slow. Americans can no longer spend. They don’t have money to spend. They need to rebuild their savings that they’ve lost. And as Americans were the “consumer of the last resort” or the “consumer of the world” with the American economy contributing a hefty share to the global economy, good times won’t be back for the rest of the world for quite some time. That however, wasn’t the “shocking” part of my “intuitive” assessment. I believed that the current crisis has “shocked” the Americans back to their senses (the common one). From a propensity to spend unleashed in the 90s to a propensity to save, Americans found out that there is no real substitute to savings than putting aside a portion of the hard earned cash in the bank and get this. No amount of government intervention would make people spend again, well, not at least the type of spending that we seen in the last few years. Remember, Economics is not a mathematical science but rather a social science that studies a person’s behavior in allocating resources or in layman’s term, how people spend their money. When people collectively became frugal because they felt they don’t have financial security to spend, no amount of government intervention would force people to spend. They would just save whatever money is thrown at their way. Not even disincentive to save such as zero interest rate on deposits or penalty on savings would force a change in behavior. People would just dug a hole in their backyard and bury their cash. With a much reduced spending resulting into a much reduced overall demand, economic growth would be stagnant, lethargic. The only time would economic growth return to “normalcy” is when spending goes back to “normal” and that can only happen if Americans manages to rebuild their savings or more specifically, when the Americans felt that they are financially secure enough to spend, which could take some time under a “favorable’ economic condition. Just exactly how long would this take? Well, if the 1997 Asian Financial Crisis is any gauge since the severity of the 1997 debacle is as catastrophic to Asian as the current crisis now hounding the Americans, it took some economies several years to recover. Of course, the stronger ones recover first while countries like the Philippine took practically a decade to get out of the rut. And the Asian economies were able to get out of the crisis because of “favorable” conditions. I mean the American economy then is on a bull run and China is equally bullish back then. As of now, there is no economy that is going to pull the world out of the rut. Many pundits are saying that China would save the world economy as its economic stimulus plan is deemed a success and that its domestic consumption is rising. China, however though the world’s third largest economy is far from being the “consumer of the world”. This is because their per capita income (the average income of their citizen) is below par. As such, present global economic recovery could take a much longer time. Speaking of China, the tremendous economic growth of this export juggernaut the past decade has partly contributed to the rising price of commodities of which crude oil count amongst it. What would happen to the crude oil prices if the US economy were to hobble along in a slow recovery while Asia, mainly China’s economy is bustling? Would the scenario of a $147 a barrel oil come back? Well, for one, China’s economy and to a certain extent, Asia’s economies are not as badly affected as that of the US and Europe in this current crisis, which could allow them to recover faster economically compared to the US and Europe and as such, Asian economies could provide some solid demand for commodities like crude oil in the near future and thus, provide support for prices. However, Asian economies and China in particular though big as they are, are merely a fraction of the size of the US economy. Therefore, it is inconceivable that they would be able to absorb the demand slack from the US and thus, tighten supplies and stoke debilitating price increases but nevertheless price increases attributable to China and Asia in general are to be expected. What is more worrisome is the current stimulus package being implemented by the US. The flooding of dollars in the world market serves as a volatile fuel ready to ignite a hyper – inflation in the coming years. This is because prior to the current crisis, the American dollar is trending lower vis – a – vis to the other major currencies around the world such as the Yen and the Euro. In layman’s term, the American dollar is devaluating in the global currency market before 2008. It is due to the crisis that the trend is reverse since the Dollar is the global currency of choice and American Treasuries are a safe haven for Dollar investments. However, as the crisis bottoms out, money would begin to flow out from the low yielding American treasuries and into other markets which offers better yield. Furthermore, recent pronunciations of American policy makers doesn’t really encourage holding onto the Dollar. I mean phrases like “Rebalancing the economies” sounded more like Americans should “sell more and buy less” (which translates to America should export more and import less). Less spending, lower overall demand also support US policy makers’ Dollar depreciation tact. On top of that, we have the flooding of Dollars in the international market. All this doesn’t really augur well with the value of the Dollar. As the value of the Dollar depreciates, prices would correspondingly increase since commodity prices selling in the international are produce locally (as in their respective countries) and as such are priced in local currencies (all production costs are valued in their respective local currency and not in US dollar) and with the fall of the Dollar and the corresponding increase in the value of their local currencies. It would require more dollars to buy the same amount of item even if the value of that item doesn’t change at all in terms of the local currencies. In short, prices would increase and in our case, the prices of crude oil would certainly “jump”. The only question is at what magnitude? This in turn depends on the strength of the underlying demand and the extent of the depreciation of the Dollar. That is a bad news for Dollar and other dollar – linked economies (countries whose currencies are closely peg to the dollar) as they not only have to grapple with slow growth but also with inflationary pressure (for non – dollar linked economies, the net effect could be zero if their currencies correspondingly appreciate against the dollar). This would turn provoke a policy response from the US FED in the form of raising interest rates in order to “mop up” excess dollar liquidity. The net effect would be further slowing of the economic growth and recovery as the economy is starved out of cash in circulation as people prefer to keep their money in banks and earn high interests. With that, we would end up with a classic case of stagflation, stagnant growth and high inflation (if the inflation didn’t subside fast enough), which is about the next worst economic state, next to Depression and /or the Great Recession (another way to “appreciate” what “stagflation” is, is to relate it to income; in stagflation, your income doesn’t improve at all but the cost of living would tremendously increase). Then again, it may not happen since demand may not be present to support stratospheric crude oil prices. But then again, who knows and that is why the “bold statement” magazine article pique my interest.
P.S. I don’t want to be right this time around. I prefer to be proven wrong. After all, I’m just partially correct with my last assessment on China, see “The Coming Collapse?” 9/26/07 (ok, I’m probably way off the mark, which is a good thing). “ )