Gravitating Towards Trade War Scenario : Fallout of Depression

US President Barack Obama has fired the first shot to initiating Trade War. Last week he goes on record saying "Simply put, export growth leads to job growth and economic growth," This President Barack Obama opined while setting up an industry panel to achieve his ambitious target of doubling American exports in next five years. "This isn't just about where American jobs are today. This is where American jobs will be tomorrow", thundered the US President.

After having failed to create new jobs for US citizens through the usual route of driving domestic growth via fundamental economic activities, President Obama has now set his sights on achieving US economic revival by focusing on enhanced exports. To achieve the same he has already started advising competing exporting nations to go slow on their exports. Sample this reaction from a German official to President Barack Obama's advice "With his arguments that we should become a bit less reliant on exports and allow the others to catch up, he's just trying to weaken us. Well, we're not going to take his advice."

But if we know the style and functioning of  US President, he is not going to go back in his new agenda of doubling exports to rekindle US economic recovery, just because Germans do not like it. On the other hand European nations are not going to accept whatever US President has set as his national goal. It is no longer the period just after World War II that European Union will kowtow to US diktat. US will find it very tough to arm twist European Union on reducing its exports, whatever be the Union's present state of economic crisis. And that may set off some kind of trade war, which can be the next level of global concern.

The spectre of the European Central Bank raising interest rates to damp inflationary pressures in Germany is receding away. European Central Bank will find it very difficult at this time to raise rates when many European nations are still struggling with their respective debt-ridden economies. Credit crisis in Europe has at least ensured that the stimulus package will not be withdrawn for several months, which means that present low interest rates are here to stay for quite sometime. This is excellent news for Germany's export-orientated industry since continuation of low interest rates means high inflation, which in turn means that exports will fetch more money to German exporters.

In a scenario where exports are so lucrative, do you feel Germans are going to pay any heed to the wishes of President Obama? And therein lies the danger of a global trade war, in case US decides to pull out all the stops to attain its national agenda of doubling exports at the cost of its exporting competitors.

Sovereign Debt Default : Price To Pay For Sub Prime Crisis

Sub Prime crisis seems to be a thing of the past. People are now grappling with Sovereign Debt Default crisis in Europe. Investors are accusing European countries for bringing about gloom and doom in the financial world. But what has caused such deplorable financial condition of European nations, a sphere where everything was hunky dory just a couple of years back? As was the general perception then, conditions in European Union was one of growth and prosperity. As per IMF estimates of 2008 GDP and purchasing power parity among various currencies, the Eurozone was the second largest economy of the world. It was a place which was touted to be making a bipolar world with aspirations of giving a countervailing effect to the financial clout of USA. In fact the Euro was deemed to be the next dollar in the coming years, slowly and steadily replacing the dollar in international trade. Central Banks of many countries were increasing their exposure to Euro as their reserve currency. So much so that in 2007 former US Federal Reserve Chairman Alan Greenspan opined  " it is absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency". Strong opinion that! But then what happened suddenly within a span of two years that Euro has lost all its sheen? Today Eurozone bonds are hurtling towards acquiring junk bond ratings as many European nations are staring at the spectre of being declared insolvent.

How has this sudden capitulation taken place in such strong and vibrant economies? Why Europe, even US is reeling under the pressure of mounting debt. On 30 June 2010, the Congressional Budget Office(CBO) in US predicted that US debt will reach 62% of GDP by year end, which happens to be the highest percentage since just after World War II. Further, China happens to be the biggest creditor to US and also has huge exposure to Euro in its reserve. So you see, with every crisis of US and Europe in terms of debt servicing, China will be wincing in pain. Many South Asian economies will do the same since their economies in turn are China-centric. In other words Asia will be in pain whenever Europe and US feel the heat of sovereign debt default. As for African nations, most of them are already so badly managed economies that they figure in the Forbes list of top ten worst economies of the world. Since they depend on US and its financial organizations giving aid in some form or the other, Africa also will be under the weather with US economy in spot. That leaves us with South American nations. Well most of those economies are fully dependent on trade with US and hence will be effected too, if US is forced to go through austerity drive to curtail its fiscal challenge. In short, the entire world is under threat of an impending economic crisis.

But our central question still remains unanswered. How has this catastrophic situation come about? What has triggered this avalanche of economic woes upon affluent nations? In quest of an answer let us proceed step by step in the following direction :-

• The US sub prime crisis had morphed into global credit crisis of epic proportions. As we had seen in my last post on 12th June 2010 titled "Wall Street Shenanigans - Is Iconic Brand US Under Threat?", billions of dollars had been lost by global financial institutions in the wake of sub prime crisis. Every financial institution worth its name was on the verge of being bankrupt.
• These financial institutions were the backbone of every nation and this backbone was under threat of being broken. That is when Governments had to step in to save these financial institutions. It was a rare display of synchronized actions taken by all nations as they pumped in billions of dollars to save their terminally ill financial institutions. Such heavy injection of steroids(bailout money) is being popularly referred to as "Stimulus Package".
• This unified stand taken by all nations speak of the severity of  threat of annihilation, since politics of nations has never before allowed the world to be united on any single issue. But this time was an exception, a time to unite for survival. On 28Mar2009 in a post titled " Aftermath of Global Slowdown"   I had emphasized that for the leaders of G20 nations, meeting on 02Apr2009, it was their last chance to steer the world away from global catastrophe. And this time leaders of 20 most powerful nations united to deliver what is now popularly known as "Stimulus Package".
• Apart from many actions which increased liquidity, Governments across the globe injected money to bail out their financial institutions who had lost billions to the machinations of Wall Street investment banks.
• This bailout money eroded the coffers of nations making them credit unworthy. Injection of bailout money to save financial institutions at that point was unavoidable, but then measures should have been taken to ensure that this money was used for activities that kickstart economic revival. Instead billions of dollars again ended up in the kitty of people who planned and executed sub prime crisis in the first place. Take the example of AIG taking US tax payers' money as bailout to the tune of $182 billion and immediately paying off counterparties like Goldman Sachs and other Wall Street banks at 100% on the dollar. No negotiations?? Joseph Cassano, former head of AIG's derivatives unit, appearing before Financial Crisis Inquiry Commission, said he could have saved tax payers billions of dollars by negotiating harder with banks. Are the American tax payers paying attention?
• So instead of reviving the economy with activities which create jobs, these billions of dollars of stimulus money were siphoned off  to people who have again used it for more speculative purposes like dollar carry trade. To read more on dollar carry trade do look up my post on 27Nov2009 titled "Dollar Carry Trade - Easy Money in Difficult Times".
• With no revenue generation activities and empty coffers of nations, time had to come when debt servicing and debt repayment by nations was to become difficult. And that time has now come upon the world in the form of impending Sovereign Debt Default. To get a grasp on the implications of Sovereign debt default it is recommended that you visit my post of 18Dec2009 titled "Sovereign Debt Default Scare - Is Dubai Too Big To Fail?".

From April 2009 till date we have witnessed stimulus induced growth in all markets across the globe. That is artificial recovery and has no fundamental moorings. Nothing has changed on ground as far as growth parameters of nations are concerned. Take the latest US Jobs Report for instance. Last Friday the US unemployment data showed that the nonfarm payrolls fell by 125000 in June 2010. Economic activity is just not picking up in US and hence new jobs are not being created. If new jobs are not created then consumption will fall. Consumption falls then inventories increase and so production activities have to be curtailed. Decreased production requires even less jobs and inspires further fall in consumption. Hence we go into a vicious cycle in which you can imagine what happens to the economy.

Stimulus Induced Growth that we have seen for the last one and half year is at its end. Having taken not enough measures to induce structural economic growth, US is on the path of double dip recession. And history tells us that the Great Depression of 1929 got prolonged for similar reasons. You can get more details on stimulus packages in my post of 17Jan2010 titled "Stimulus Induced Growth - Is It Global Recovery On Steroids". At this stage it is judicious to remember that earlier World Wars were basically fought not for ideological or emotional reasons but for economic reasons, sparked by trade wars. I hope the world leaders are listening.

Stimulus Induced Growth - Is It Global Recovery On Steroids?

In the first half of 2009 stimulus packages were injected into economy of each country, which managed to perk up the respective ailing economies from the brink of recession. This shot in the arm has been eloquently described by many economists as equivalent to keeping the world economy on steroids. I won't mind going along with such succinct description of the present state of global economy. The economic recovery from Mar 2009 low is definitely because of the steroids pumped into each nation's economy. And as it always happens with pumping steroids, recovery has been really spectacular. So spectacular has been the global economic recovery that one cannot be faulted for being believing that global economy has made a V-shaped recovery. But this is where one should draw the line. Stop and think - rationalize! Someday sooner than later, effect of steroids is bound to wear off. What happens then???

Simple! We all know the answer. If you revive a critically ill patient with steroids, then the patient develops steroid dependence. This means that you have to perforce keep the patient on steroids forever, otherwise the patient will collapse. Which implies that Governments across the globe will have to keep their respective economies on stimulus package forever, if they don't want a collapse of their economy. That is again not feasible. How much money can the governments print? Ultimately what will the value of such money? Hyperinflation as we see in Zimbabwe - is that what we are aspiring for?

Obviously the answer is that at some point of time stimulus packages will have to be withdrawn. However, what is to be seen is whether the magical carpet of stimulus package, on which most economies are presently floating, is yanked off at one go or their governments judiciously take the patient off steroids in small baby steps. Former scenario will definitely cause immediate death to any economy, while the latter prescription will only cripple an economy. So even if we take the best case scenario of gradual and judicious withdrawal of stimulus package, we still cannot sit smug with a misplaced notion of V-shaped recovery continuing, as in a structural bull run. If anything, do tighten your belts because we are about to witness a roller coaster down-ride of global economy, which will remind one of bungee jumping or free falling from super-high-rise structure.

As far as the fundamentals are concerned, US economy will have to witness a double dip recession. Apart from creating more asset bubbles in global markets, US stimulus package has achieved precious little fundamentally for its economy. On the other hand, emboldened by stimulus money US financial institutions have already started distributing hefty bonuses and compensations amongst its employees. For them its business as usual again, even though President Obama reprimanded them sternly. On Wall Street financial institutions devise newer and more complex financial instruments to stun the world with, like the case of short selling of mortgages, while the man on the main street is still reeling under massive unemployment. With double digit unemployment, consumption obviously cannot pick up and hence the main driver of US economy is dragging it backwards.

If US consumerism does not look up soon, then China is going to have it real rough. Fashioned on export-driven model, Chinese economy will soon be sitting on massive inventories with no place to sell. For about two decades plus Chinese economy has been witnessing runaway success owing to massive exports to US. China has a huge trade surplus with US, so much so that outside of US, China holds maximum US dollars. China is the biggest creditor of US. If US cannot revive its jobs' market, then the consumption data will not pick up. That means that US will be importing incrementally less goods from China. Now you can imagine what China will do with the huge piled up inventories. It cannot even spur up its internal consumption since the wages are very low - as low as one tenth of Japan. And with easy credit there is inflationary pressure of bubble proportions already building up there in many asset classes, like real estate. Time is running out for China. Ailing US economy has become akin to a millstone around China's neck.

Now you only decide - if two most powerful economies of the world are in dire straits, can we expect a structural global bull market? Isn't it more prudent to assume that global markets will witness another bout of bear hug? Its time to be cautious if you are a trader. If you are an investor then wait for mouth-watering levels to enter trade. Year 2010 will be a difficult year to negotiate both for investors and traders. But if you are playing the Indian stock markets then be rest assured that Indian markets are firmly in structural bull run. Which means that even as an investor at current level, you are assured of decent profits in fundamentally sound companies in one year's time. Indian markets will correct but they will recover quickly to surpass their all time highs in a year's time. That cannot be said for most of the other global markets, barring those emerging markets not heavily dependent on US exports. Apart from BRIC nations, MAVIN countries are coming on global investors' radars. Happy investing!!