advertisement
The cash coming out of U.S. home equity turned into massive purchases of goods and services from China, India, Japan, the oil economies of the Middle East and Russia, and the European Union. And that purchasing produced double-digit growth or near-double-digit growth in those economies.
Those economies pumped a good percentage of their cash back into the U.S. through purchases of Treasury bills and mortgage-backed securities. Those purchases lowered U.S. interest rates and made it possible for another round of home-equity refinancing at lower interest rates and another round of home-equity cash-outs.
Global insurance policy
It was great while it lasted, but now it's time to pay the piper. The fountain of U.S. home-equity cash has dried up. U.S. consumer spending is slowing, and so is the nation's economy. A weak dollar is enabling U.S. companies to increase exports, which cuts into sales by overseas companies. At some point, all this adds up to recession or near recession in the U.S. and a slowdown in global economic growth.Not so fast, Wall Street says. In your emphasis on cause No. 2, financial innovation, you've forgotten about cause No. 3.
In a global market, consumers in the fast-growing economies of China, India and Russia have become rich enough that they increasingly demand goods and services. These emerging-economy consumers can take the baton from U.S. consumers and keep the race going. Not only will that be enough to keep the global economy as a whole from slumping, but growth in these countries will moderate the depth and duration of any decline in the U.S.
Think of this increase in demand as a kind of insurance policy for U.S. and global economic growth. If an economic storm strikes the U.S., this policy will work to minimize the damage.
But any insurance policy has its limitations. For example, a storm can be so intense that it inflicts damage beyond the coverage of the policy.
More from MSN Money
And that's the danger we face in 2008. As long as the downturn in the U.S. economy is modest, then, yes, demand from overseas consumers with newly increased incomes can pick up the slack. But if the downturn in the nation's economy is serious, there simply aren't enough consumers in China and India and elsewhere to pick up the slack.
According to the U.S. Bureau of Labor Standards, consumer spending accounts for about 60% of the country's $13.2 trillion economy. That's about $8 trillion. A 1% drop in U.S. consumer spending equals $80 billion.
The Chinese, Russian and Indian economies are significantly smaller than the U.S. economy, ending 2006 at $2.7 trillion, $1 trillion and $900 billion, respectively (at the exchange rates then). And consumer spending makes up a significantly smaller percentage of overall economic activity in these countries. Consumer spending in China, for example, makes up less than 30% of the total economy.
White-swan pricing
Using that 30% figure as an average to get a ballpark number, each 1% drop in U.S. consumer spending would require a 7% increase in consumer spending from China, Russia and India. That seems doable for these economies. At that level of decline in the U.S. economy, the global insurance policy could work, I'd say.But increase the severity of the U.S. decline to 2%, and China, Russia and India would have to grow consumer spending by 14%. That would be tough. China is going full-tilt, with inflation racing ahead, and its GDP is growing at just 11% a year.
So investors are facing another version of the problem that sank the mortgage-backed debt market. Within some definition of "normal," the insurance policy works. In the mortgage-backed debt markets, in the normal world, AAA-rated securities are indeed safe. And in the economic realm, in the normal world, the U.S. economic slowdown is short and shallow.
Video on MSN Money
Is more bad economic news ahead? The year is ending with weaker-than-expected reports on retail sales, employment, housing and durable goods. But the ability of big banks to raise capital should prevent a downturn from turning into a panic, MSN Money's Jim Jubak says.
But if we get an abnormal event -- what's called a black swan -- then "safe" mortgage-backed securities fail, and the U.S. economy experiences a downturn that lasts longer than Wall Street expects.
Right now, the stock market is priced only for white swans. Given Wall Street's recent record on valuing debt securities while underestimating the ramifications of a black-swan event, that makes me nervous.
A game of wait-and-see
So put me in the "show me" camp. I'll believe the downturn in 2008 will be "normal" when I see housing prices stabilize, when I hear Wall Street CEOs saying they know the size of their eventual write-offs and when I see banks willing to lend to each other again.Until then, I'm going to follow the strategy I outlined in my Dec. 21 column of building cash and taking small test positions in stocks that I'd love to own at the right price (and when I see less risk in stock prices in general).
In an earlier column, I gave you a list of five stocks that I'd like to buy when the time is right. Here are five more:
In my first column of the new year, I tackled how to invest if we get the worst of possible worlds in 2008 -- no growth and high inflation, also known as stagflation.
Continued: Developments on a past column
< previous | 1 | 2 | 3 | next >
Rate this Article
High