Charles Dumas, chief economist at Lombard Street Research, says he finds himself in an unusual position; he's not as pessimistic as most people. "I'm less pessimistic than the consensus regarding the United States," he said at the AsianInvestor and FinanceAsia-sponsored conference on Distressed & Troubled Asset Investing last week.
Dumas has been a proponent since 2004 of the argument that excess savings in China, Japan, Germany and other countries played a direct role in the financial bubble of the US and Britain. Without the 'savings glut' there would have been no extravagant consumption binge, because US interest rates and spreads on Treasuries would have soared.
"Excess savings caused the trouble, and now savings glut countries are suffering the most because of deficient demand," Dumas says.
Important trends in the current economy include the massive rise of US government debt as a proportion to GDP, which he calculates to be about 250%, including bailouts, bank guarantees and so on. They also include the reversal of three decades of leveraging, a shrinkage in Asian and European excess savings, and the emergence of China as the world's biggest source of economic growth.
Dumas says the global recession could have been healed if savings-glut countries had consumed more; instead, their incomes have collapsed because their exporters have lost their customers. Policy blunders in the US made things worse, in particular the Fed's initial moves to cut interest rates. These had no impact on mortgage rates, for example, and led instead to inflation, notably in commodity prices. This turned a downturn into outright recession in early 2008.
The collapse of Lehman Brothers meant that inflation was no longer a threat, and since then US policy has improved, Dumas says. Falling oil prices and reduced consumption means US real incomes have risen, and US savings rates have gone from zero to about 4%. That's not enough to address the global imbalances, but Dumas says the inability of households to borrow will continue to force US savings rates closer to 8-9%. The fiscal stimulus package will also improve American's income, and the Fed's subsequent quantitative easing provides a floor on prices. (The timing for interest rate cuts had changed.)
Dumas is less impressed with the Geithner plan for rejuvenating interbank lending. The stress test and the public/private investment partnership for toxic assets don't require banks to value the dodgy CDOs on their books. He says it is a conflict of interest for Geithner as the regulator to encourage banks to sell assets to private/public JVs co-owned by Geithner -- although US taxpayers may not see the problem with a Fed-owned JV making lots of money.
The upshot, however, is that Dumas predicts the US economy is likely to recover first, and its real financial assets are already attracting investor interest. Corporate profits ex-financials are making modest gains -- and he's not too bothered if the banks' profits lead to consolidation, "as we need fewer banksters". He says there is good money in both investment-grade and high-yield credit.
The problem with this outlook is Asia, and China in particular. Export growth rates in China, Japan and Germany have turned negative, dropping 20-40%, which creates GDP losses of 7-10%. Japan and Germany will experience worse recessions than America and Britain. China's fiscal stimulus has smoothed its fall, but Dumas warns the country is storing up future trouble by relying on infrastructure investment rather than boosting consumption. He doesn't think the Chinese economy can recover without US consumption improving first, particularly if China ends up building its own 'bridges to nowhere'.
Dumas says as long as Germany sticks to budget balancing, it will not enjoy real growth for several years. Moreover, all exporting/savings nations are vulnerable to the rise of protectionism in America. "China's recovery is temporary and the others are dead in the water," Dumas says. "The crisis will resume because the imbalances in savings-glut countries are not being addressed."