``Get your facts straight, apply them to the current valuation of the market, take decisive action, and then hold on for dear life as the mob hopefully comes to the same conclusion a little way down the road.”-William Gross, 2+2=4
The highly reputed Bond King PIMCO’s William Gross suggests that the global investment climate have radically been transforming where ``future of the global economy will likely be dominated by delevering, deglobalization, and reregulating”, from which the investment sphere would lead ``to slow global growth, a heightened risk aversion, a distrust of conventional investment model portfolios, and a greater emphasis on surviving as opposed to thriving.” (bold highlights mine)
Protectionism From Reregulation
Seen from a general sense, the idea seems true. For instance, aside from a sharp drop in global trade and investment flows as a consequence to the near US banking collapse last year, recent signs of deglobalization include the steep decline in migration trends especially from the corridor of Mexico to the US (New York Times) or the emergence of protectionism from policies aimed at “protecting ” locals-interest groups and not the local population-and the subsequent trade frictions in reaction to these policies such as the recent escalating row between the US and Canada over pipe fittings (Washington Post).
However, the chaotic reregulation in the misguided and the convoluted premise of the market’s inability to self-regulate is likely to spawn an even deadlier backlash.
Policy measures, which piggybacks on noble sounding myopic populism, have immediate beneficial solitary effects but at the expense of long term and far larger and wider damage to the system. And in the case of the pipe fittings, the political boomerang appears to have generated a greater impact than from the immediate intended benefits for the privileged groups.
And as the Washington post aptly reports, ``With countries worldwide desperately trying to keep and create jobs in the midst of a global recession, the spat between the United States and its normally friendly northern neighbor underscores what is emerging as the biggest threat to open commerce during the economic crisis.”
``Rather than merely raising taxes on imported goods -- acts that are subject to international treaties -- nations including the United States are finding creative ways to engage in protectionism through domestic policy decisions that are largely not governed by international law. Unlike a classic trade war, there is little chance of containment through, for example, arbitration at the World Trade Organization in Geneva. Additionally, such moves are more likely to have unintended consequences or even backfire on the stated desire to create domestic jobs.” (emphasis added mine)
Yet, this may serve as a casus belli for a global trade war which requires our vigilance. So reregulation seems to be inspiring more of “risk aversion” than containing it-again another unintended consequence.
Delevering Isn’t Equal
However where we depart with Mr. Gross’ outlook is on the premise of delevering.
The notion of delevering implies of a world, including the Philippines, equally swamped by an ocean of debt.
In the Philippines, it is the public sector and NOT the private sector (household or corporate) that has significant debt exposure. But the public sector has been “delevering” since the Asian Crisis in 1997. So this observation, while true in many or most of the OECD economies, is far from being accurate yet from many of the Emerging Market’s standpoint. I say yet because present policies could drive the public to indulge in a debt spree.
Moreover, the notion of delevering puts into the prism that the world revolves around the US only. Similar to the defective idea that “decoupling is a myth”, recent events have disproved much of this misplaced conventional academic expectations as the world seems to be recovering earlier than the US, see charts in Investing "Ins" and "Outs": US led Global Economic Recovery and Decoupling a "Myth". Thereby, deglobalization and reregulation will likely accentuate the decoupling process as previously discussed in Will Deglobalization Lead To Decoupling?.
In the layman’s perspective, globalization can be interpreted as a process of world integration via the trade, investments, migration, and financial channels. A more globalized world should imply of more “recoupling”. On the other hand, deglobalization does the opposite.
Further, while many debt overstretched private sector in the OECD economies have indeed been “delevering”, governments have been substituting these losses with its own massive debt expansion binge see figure 1.
Figure 1: Economist: Pumping It Up
Savings rich and foreign currency surplus laden Asian nations have commodious room to undertake lavish fiscal stimulus.
If the policy options for Asian economies has been to choose between stashing US dollars at the cost of risking currency losses from a devaluing US dollar and spending these domestically then it would appear that Asia has opted for a “politically favorable” profligate public spending option-that’s because they can afford it!
US And China Pursues Diametric Policy Directions
Yet while many economists ascribed the recent the recent “outperformance” to these government activities, our take is much more of the “unseen”- aggregate colossal liquidity, the inherent low systemic leverage in the region, high savings, greater thrust towards regional integration in spite of the financial crisis, the aftershock of “Posttraumatic Shock Distress (PTSD)” effects and creative destruction have been the major driving force around Asia’s resurgence.
For instance, while the US seems to be antagonizing its closest and friendliest neighbor and ally Canada with “closed door” policies, China, on the other hand, has been aggressively adapting “open door” policies with erstwhile archrival, Taiwan.
Recently both key Asian countries announced more transportation linkages via new shipping routes, and the expansion of direct airway routes, aside from the easing of once prohibited investments where according to the Time magazine, ``For the first time, mainland investments would be allowed in a broad range of Taiwan manufacturing and services companies. China Mobile, the mainland's largest cellular-service provider, has already agreed to invest about $530 million in Taiwan's Far EasTone Telecommunications, although the landmark deal has not been approved by Taipei.”
Tax incentives have also been extended by China to the Taiwanese investors (Bloomberg).
Moreover, such collaboration hasn’t been confined to the economic plane but also extends to the world of politics, again from the Times Magazine, ``In perhaps the most hopeful sign of change, China recently relaxed its longstanding opposition to Taiwan's inclusion in international organizations. After being rejected since 1997, Taiwan was finally invited this year to be an observer at the World Health Assembly, the governing body of the World Health Organization — the first time it has participated in a U.N.-related forum since Taiwan lost its U.N. seat to China in 1971.”
In short, the underlying trend of policies undertaken by the US and China have been running on a diametric path. So if incentives drive human action, seen from the vastly divergent aggregate policies undertaken, then obviously the expected returns, considering the risks variables, should likewise be different. This view runs in contrast to mainstream ideology, who does not believe in incentives but on the inexplicable effervescent impulses of “animal spirits”.
So yes, the atmosphere where “heightened risk aversion”, a “distrust of conventional investment model portfolios” and “greater emphasis on surviving as opposed to thriving” most probably is applicable to the defunct US centric financial paradigm and the fast evolving politicization of the US economy which seemingly has become increasingly hostile to its business environment.
But we suspect that this path shouldn’t necessarily apply to Asia or to emerging markets unless a global trade war erupts.
Delevering In A World That Rewards Leveraging, Profiting Around Regulations
Yet delevering should be seen in the “right” context and not from a generalized point of view. We shouldn’t interpret some trees as representative of the forest. This is the Achilles’ heel of macroeconomists whose inclination is to oversimplify events.
Specifically, delevering is a market process being experienced by the private sector (mostly the housing and financial industry) in key OECD economies. This has not been valid relative to its counterparts for most of the Asian or Emerging Market economies-especially in the Philippines.
Aside from the thrust to replace private delevering with government leveraging, the collective policy thrusts by global governments has been to resurrect the status quo ante of systemic leveraging by imposing aggregate policies (Zero bound interest rates, Quantitative Easing, etc.) that encourage the “buy, speculate and spend” incentives, which effectively penalizes savers.
So systemic delevering isn’t likely to happen yet unless a global government bond bubble goes ka-boom which isn’t distant from our perspective.
Incidentally, Mr. Gross has been staunchly supportive of the same unsustainable serial bubble blowing interventionist policies. Mr. Gross expects the US Federal Reserve to buy more long term treasuries in order to keep mortgage rates down. However, we can’t say as to how long artificial rates can be maintained by the US Federal Reserve’s manipulation and distortion of the marketplace, considering the huge amount needed to “fix” the price of the treasury markets. But we understand that interest rates in the US are ultimately headed higher, and Mr. Gross thinks so too as revealed by actions-PIMCO has reportedly been selling US Treasuries.
It would appear that world’s bond king’s alpha (extra or premium returns) has been to arbitrage from regulations and maybe that’s why his strong support for interventionist policies.
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