How Many Crises?
02/08/2010 3:25 pm EST
One crisis or two?
How you answer that question will go a long way to determining your investment strategy right now.
If the euro crisis and the bank lending crisis in China are all part of the same crisis, you should stay out of all equity markets until the world works through this mess. (Enjoy your vacation. See you in September.)
If, however, the euro crisis and the bank lending crisis in China are coincidentally, but not causally related—that is, they happen to both be occurring now, but one can be solved without a solution to the other—then you should use the selloff in emerging markets as a buying opportunity somewhere not too far down the road—late March or April, say—even if the euro crisis continues to unfold.
Here are the two ways to view the cause(s) of the current correction.
1) It’s all one crisis. The euro crisis in Europe and the bank lending crisis in China are all part of one big crisis. Both are rooted in the global financial and economic crisis of 2007-2009. European countries such as Greece and Spain are just now paying the price for the debt binge that governments and consumers went on in the run up to that crisis. And these economies are still looking for a way to restore growth and get budgets back in line. The worry is that either governments won’t reduce their deficits because they’re afraid to push their economies into recession, or European governments will cut spending to reduce their deficits, and that will push economies back into recession.
China is in the same boat, according to the “one-crisis” view, just further down the river. In China, the economy is back on the growth track. But much of that growth is a result of government spending and bank lending. And the worry is that China now faces a choice between cutting stimulus and lending and perhaps killing growth or not cutting stimulus and lending and pushing the economy into runaway inflation.
The common worry is that even though the world hasn’t yet managed to create sustainable economic growth, governments now face no choice but to cut spending and monetary stimulus.
2) We’re looking at two different and unrelated crises. Yes, both the euro and the bank lending crisis in China are rooted in the same global financial and economic crisis, but because that crisis played out in very different ways in different parts of the globe, what we’re seeing now in Europe and China are essentially unrelated.
In the euro zone (as in the United Kingdom and the United States), the crisis damaged the structure of financial institutions and governments and undermined faith in the long-term future of many of these economies. In these countries, the real estate and stock market booms covered up a massive loss of global competitiveness that has left many of them, after the boom and bust, trapped in a growth crisis.
With their economies in decline, there’s no way for Greece, Portugal, Spain, and other countries to grow their way out of their budget crisis. And they can’t cut unsustainable levels of spending because that spending kept their economies growing even before the crisis.
The countries inside the common euro currency zone also find themselves with an overvalued currency (from their points of view), because of the strength of the German and French economies that prices their already competitively challenged goods and services out of many markets. And as members of the euro zone, they can’t devalue their own currency to restore global competitiveness.
China’s financial institutions and markets, on the other hand, came out of the crisis relatively unscathed, and on a comparative basis, globally stronger. China’s economy never came close to dipping into an actual recession, with economic growth dropping to a low of 6.1% in the first quarter of 2009 before beginning a recovery. Rather than facing a decline in global competitiveness, China has continued to gobble market share in many markets. And China used a renewed renminbi-dollar peg to keep its currency undervalued and generate a rebound in exports.|pagebreak|
From this point of view, the current crisis in China is largely internal. It matters to real estate and stock market speculators in China’s domestic markets how tough Beijing makes it to get cheap money because real estate and stock prices depend on it. It matters to Chinese exporters and other businesses how tough Beijing makes it to get cheap loans because a high percentage of state-owned companies are dependent on cheap loans for their profits, and indeed for their survival.
But to the Chinese economy as a whole, and to those sectors of the global economy that do business with China, the issue is uncertainty more than anything else. Will Beijing cool economic growth to 10% (from 10.7% growth in the fourth quarter of 2009) or to 9% or to 8% (the official target for 2009)? The answer determines how much demand companies outside of China should plan for. (See this January 28 post for why I think the China crisis is much fear about relatively little.)
So, under the second scenario, problems in Greece, Portugal, even Spain aren’t going to have much effect on the growth rate of the Chinese economy. That growth rate will depend on policies—and policy mistakes—made in Beijing.
In my opinion, the two-crisis model comes a lot closer to describing the state of the global economy right now.
I see the Chinese government ending much of the uncertainty about economic and fiscal policy in the weeks after the March meeting of the National People’s Congress. In roughly the same time period, first-quarter GDP figures—and the reaction to them by the government—will tell investors about how much limits on bank lending put in place in January have slowed economic growth. April’s state visit of Chinese leaders to Washington, DC should also, for better or worse, eliminate some uncertainty about exactly how bad the state of China-US relations are.
Unless Beijing has made a huge policy mistake and tightened loan standards more than it now seems, this time period will put much of what I’m calling the China crisis behind the global economy.
There’s a good chance, however, that the euro crisis will still be unfolding by then. It’s likely to have deepened in a country such as Greece or Spain and to have expanded to include new victims. (I’ve started to hear worries about Belgium and even France.)
Fears that a euro crisis could somehow spread to the rest of the global economy are likely to keep global stock markets in turmoil. But I think in this late-March/April time period, it could become more and more apparent that the China crisis is ending even as the euro crisis continues and perhaps even deepens.
Putting money into emerging markets that might be depressed by a euro crisis that really doesn‘t have much to do with them would make sense in this scenario and on this time frame.
The wild card is the United States. Looking around for a mechanism that could turn a euro crisis into a global crisis, I keep coming back to the US. If a euro crisis gets deep enough to focus investor attention to the size of the US budget deficit, if Washington continues its hapless ways and continues to undermine remaining faith (the triumph of hope over experience?) that someday the US will get its deficit under control, and if the US economy suffers a collapse in growth back below 2% in the first or second quarter, then I think worries about the euro will turn into worries about the US economy and then the global economy.
And then, what are now two unrelated crises would merge into one big global mess again.
Full disclosure: I don’t own shares in any company mentioned in this post.