7/1/2013 11:00 PM ET|
We have a global growth crisis
Understanding why global economies slowed simultaneously is the first task in devising an investment strategy for the decade ahead.
No matter the region, no matter the economic policy response, no matter the economic system, growth is very hard to come by.
Economic systems based on state-controlled/state-directed demand -- such as China and Russia -- have seen growth rates fall. Economic systems based on the creation of consumer credit -- such as Brazil -- have stumbled and can't seem to get up. Systems hoping to use cheap central bank money to stimulate growth -- such as the United States -- haven't seen growth commensurate with the trillions in debt added to central bank balance sheets. Economies such as the eurozone that have combined cheap debt with budget austerity can't -- now that Ireland has moved back into recession -- point to a significant success story.
The big question for investors: Why?
If you want to figure out where to put your money for the decade ahead, how much risk you can afford to take and what kinds of returns you might expect, understanding the reason behind the growth slowdown -- I'd go so far as to call it a "global growth crisis" -- is critical.
I have an explanation. I'll lay it out below; you can judge if it makes any sense to you and if you think it can help guide investment decisions.
I think the global crisis in growth has been brought on by decades of really, really bad decisions on how to allocate capital. Too much has gone into unproductive uses -- ironically, frequently in an effort to support economic growth.
The flood of cheap money from the world's central banks has multiplied the effects of this misallocation of capital by 1) making everyone believe that capital was really cheap and abundant just as the world is approaching an era of scarce and expensive capital; 2) allowing governments to believe that they could paper over the problems in their economies with cheap money; and 3) letting countries put off necessary decisions and investments until dangerously late in the game.
Even now many countries are still behaving as if cheap money can fix their problem.
Many, but not all. If you're investor with a long-term view, this is a time to overweight economies that show the best chance of escaping this crisis (either through intelligence or luck), to underweight economies that
show every sign of stumbling deeper into a growth crisis and to adopt stock-picking strategies that will let you avoid the worst of these potholes.
I'd put Mexico and Brazil in the overweight group. I'd put Russia and the European Union in the underweight group. And I'd put the United States and China into a toss-up group.
Of course, there might really be no global growth crisis. It could simply be coincidence. The Brazilian model of growth, founded on expanding cheap credit for a rising "middle class," could be failing at the same time the Russian model of state-controlled kleptocracy has run out of gas. That's possible, but given the differences of the economies involved, it seems unlikely.
It could all be global blowback from a slowdown in China's economy. That might (and does, to my mind) explain a good part of the slowdown in Australia and Brazil. But given how little, relatively, the U.S. economy depends on exports, it seems unlikely.
It could all be a result of the money-printing, blow-up-their-balance-sheet policies of the world's central banks. Central bank policies certainly play a role in the current stage of the crisis, but I see those policies more as a reaction to the growth crisis than a cause of it. Central banks launched their campaign of printing money and expanding their balance sheets in response to a global growth crisis already in progress.
The root causes
To take a look at root causes, let's turn to Russia and Brazil, two countries with very different economies but both facing a growth crisis.
Russia first: There's no real argument between experts inside and outside Russia that the Russian economy is in trouble. In May, the European Development Bank cut its forecast for 2013 gross domestic product growth to 1.8% from 3.5%. A month earlier, the Russian Ministry for Economic Development had cut its forecast for 2013 to 2.4% from 3.6%. In addition, the ministry warned that the country risks falling into recession by the fall of 2013.
And experts both inside and outside the economy say the country needs to act immediately to revive growth.
But the experts outside and inside the government offer very different growth prescriptions. The outside experts emphasize reforms to the country's financial system that would make Russia more attractive to foreign and domestic capital. We're not talking minor reforms, we're talking about changing the financial and legal systems so investors and entrepreneurs don't wind up in jail because someone with powerful political connections wants to take over their business or to eliminate a competitor. About 110,000 people are in jail in Russia for economic crimes. Some of those imprisoned have lost ownership of their companies to the police or other officials who brought them to court on fraud charges. You know there's a big problem because the government has proposed amnesty for 13,000 of those in jail for economic crimes.
But recent stimulus proposals from the Putin government focus on business as usual. President Vladimir Putin has proposed taking up to $43.5 billion from state pension funds and investing it in three big infrastructure projects: a modernization of the Trans-Siberian Railway, a new 500-mile high-speed rail line between Moscow and Kazan, and a new superhighway ring road around Moscow.
In other words, while the country desperately needs to attract foreign capital to modernize and expand the energy industry, which provides the bulk of government revenue, the Putin government has proposed the same kind of centrally controlled, big-ticket projects that haven't worked very well for the Russian economy as a whole.
The contrast between Russia's big infrastructure-focused, state-controlled, export-driven economic strategy and the strategy that has driven Brazil's growth in recent years couldn't be more extreme. Brazil's economic strategy, under the governments of former President Luiz Inácio Lula da Silva and current President Dilma Rousseff, was to grow a new consumer class by increasing incomes using conditional cash transfers from the government to lift families out of poverty and to try breaking the generational patterns of poverty.
A problem with global dimensions
For example, the Bolsa Familia -- which by 2011 covered 26% of the country's population -- provided monthly cash payments to poor families. The government then leveraged that higher household income through policies that provided cheap and easily accessible credit for the purchase of household appliances and other consumer goods.
That economic strategy has major success to its credit. In 2010, Brazil's economy grew by 7.5%. And Brazil had seen its Gini coefficient of economic inequality fall from 0.596 in 2001 to 0.518 in 2009. (The closer a Gini score is to zero, the more economically equal a country is. For comparison, the United States had a Gini score of 0.468 in 2009. China's Gini was 0.474 in 2012, according to the CIA World Factbook. Denmark, among the world's most economically equal countries had an estimated Gini coefficient of 0.248 in 2011.)
But recently that strategy has fallen apart. Brazil's growth slowed to 0.9% in 2012, and the economy expanded by only 1.9% in the first quarter of 2013. At the same time, inflation has climbed, hitting an annualized 6.46% in May. That's within spittin' distance of the central bank's 4.5% inflation target. Which leaves the Banco Central do Brasil with a no-win choice of slowing the economy to fight inflation or risking that inflation will run out of control.
You don't have to be an economist to figure out what's wrong with Brazil's economy; the protesters who have taken to the streets across the country in recent weeks point, accurately, to neglected infrastructure -- a nine-cent fair increase for bus rides in São Paulo for terrible service triggered these protests. The country has spent billions on soccer stadiums and let education languish. Health care is in scant supply and expensive.
Economists can put more specific numbers to those charges, but they don't disagree. A record grain harvest in 2013 has overwhelmed Brazil's roads and ports, with 12% of grain spoiling before it reaches consumers. Only 5% of Brazil's roads are paved, versus 50% in China. The country's ports and airports are rated among the worst in the world, and the country's road infrastructure is worse than India's.
In 2012, Brazil became the sixth-largest economy in the world, overtaking the United Kingdom. But only 17% of Brazilians aged 18 to 24 are enrolled in university degree programs or have a degree. Less than 50% of Brazil's workers have finished high school. Is it any wonder that productivity growth in Brazil has turned abysmal? From 4.1% in 2010, productivity has tumbled to 0.7% in 2011 and to 0.3% in 2012.
As with Russia, when the economy hits a crisis, the impulse in Brazil has been to try more of the same -- an impulse made easier, as in Russia and other economies, by having more of the same require only more debt rather than tougher structural changes.
In Brazil, though, that impulse has run dead into consumers who are drowning in debt. Credit outstanding to households grew to 44% of disposable income from 18% in a decade. It's impossible to fix Brazil's growth problem by engineering an increase in consumer borrowing.
I don't mean to suggest the Brazil and Russia are unusual. Indeed, my point in picking two countries with such disparate economic strategies is to argue that we're looking at a global growth problem that transcends national differences in economic policy.
The United States tried to use cheap mortgages and a housing boom to bridge its way back to growth after the slowdown in 2001 (1.1% growth) and 2002 (1.8%) following the heady growth of the late 1990s (4.2% growth in 2000 and 4.9% growth in 1999). And we know how that turned out.
China used massive stimulus to avoid the worst consequences of the global financial crisis, but the result has been an economy that's getting less bang for every stimulus buck.
State-owned enterprises get the bulk of available capital because they provide huge numbers of jobs for local governments. But profits have been dropping, in good part because all that capital has created massive overcapacity in industries such as steel and solar. In the first quarter of 2013, profit growth for state-owned enterprises dropped to 5.3% from 7.7% in the first quarter of 2012. Total productivity growth in China dropped to 2% in 2011.
As in the United States where it's easier to have the Federal Reserve do it than to actually introduce structural changes in the economy, China's economic policy has been to hope that the People's Bank can generate the growth the country needs while keeping inflation and asset prices under control.
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Why throw money to the wind ?
Since 1994, I saved up 1/2 million+ from earnings as electrical engineer.
I am saving $ 2500 each month.
I say no to stocks.
V_L....there is no "challenge". Challenge what? It is here and done, No leaders. None coming up and there will not be. Two lost generations with IQ's above ..... a cell phone. The cell phone wins, certainly. Our nation is "dumb" .... period. We need more on wefare! I must get into " reality TV" ..... legalize everyone as it makes no difference, now. If all these "guys" in office are not kicked out very soon.... game over. McCain ... go away. Schumer...go away. Pelosi....go away. Bahner...go away. Who is that idiot in Florida?... that is how important he is to me. Things do change "stripes" do they not. This guy in office will go down in history,,,,,,as the....
He is protectng his butt right now. He is scared and never should have gotten this far. God bless him and God bless,,,,,,,,,,,,what is left of America.
Growth (and "global growth") has only occurred throughout history with innovation and discovery - from the industrial revolution through the discovery and development of computers. Don't expect that to occur in countries that have built their economies upon US education and stealing US inventions. AND, you can no longer expect it to occur in the U.S.S,A. With leftist educational institutions wasting valuable teaching hours on teaching "diversity" and how to put a condom on a cucumber. vs math and science, we are I serious trouble,
First of all, repealing the laws of the free market is really about as practical as repealing the law of gravity or any other scientific principle.
After that has been said - with governments all over the world taking over larger and larger portions of the economy - what we really have is a reallocation to the least efficient. Governments are the weeds in the garden of the economy.
Thirdly, years of massive deficit spending - with no end in sight - cannot be done with consequences any more than can one drink, smoke and overeat for decades.
BINGO! someone needs to try the trickle UP economics model! put a few trillion into MY pocket and i'll spend it for you! i'll spend it like mad! my home town will see growth like never before. as will my local county, bigger cities, and the southern portion of the state. i'll outreach to friends and family to insure trickle UP gets further displaced thru the country as well.
"""I think the global crisis in growth has been brought on by decades of really, really bad decisions on how to allocate capital. Too much has gone into unproductive uses -- ironically, frequently in an effort to support economic growth."""
Understanding why global economies slowed??? Uh.......let's see: end of cheap oil, end of growth and the resulting forces of compressive contraction? Just a guess. I'm no economist but just a guess.
See...it is a closed, finite system so unless you have a spare planet someplace that we can pillage like we did this one for cheap resources, growth cannot and will not continue, no matter how many new financial swindles and frauds you invent.
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