Dan Alpert is a founding Managing Partner of Westwood Capital, LLC and its affiliates. He has more than 30 years of international merchant banking and investment banking experience, including a wide variety of work-out and bankruptcy related restructuring experience.
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I feel more emboldened than ever (probably a good sign I should be rethinking my premise) to reiterate my general contextual theory that the developed world is experiencing the dual deflationary forces of a “supply shock” from the emerging markets, combined with a debt overhang remaining from the bubble period.
During the credit bubble the developed world (with the U.S. leading the way) attempted to neuter the supply shock with borrowed funds from our “suppliers.” Thus we plugged the yawning gap between domestic production and consumption.
Europe did fundamentally the same thing, except that borrowing was state sponsored and enabled by the fiscal and monetary disconnect inherent in the Maastricht Treaty. Europeans used their borrowing to fund their social welfare system and to offset (as in Greece) corrupt tax regimes. No matter, the underlying issue was the same, they were producing far less than they consumed – with the exception of Germany, which in exchange for an undervalued currency elected to close its eyes to the subsidies its banks we providing to others in the zone.
Net, net – Euro Zone-wide – the effect is the same as it is stateside. But instead of order of relative debt burdens (high to low) being households/government/financial institutions/businesses (except small businesses, which are much like households) as it is in the U.S., the order in Europe is government/financial institutions/households/businesses.
Japan, of course did it differently still – looking back on their two decades of debt deflation, sacrificing corporate, financial institution and government balance sheets, while households were left to slowly dis-save over time.
Debt deflation is debt deflation, wherever the debt resides. Growth suffers either way. Adding the excess supply and productive capacity of the 3.5 billion people in the emerging markets overwhelmed aggregate global demand even before the developed world over-leveraged itself.
So, the next question to ask relative to the market events of July and August is: Why are things breaking down again now?
The answer is not as elusive as it may seem to some market participants.
Effectively we have “maxed-out” again – been “cut off” to use another metaphor. For a while, the developed world continued to pump itself up with additional liquidity, initially (and in Europe still) in the form of transferring private and sub-sovereign risk to government and central bank balance sheets. Shortly thereafter, the developed world engaged in large scale (but poorly spent) stimulus to attempt to stabilize plummeting demand. Finally, we have resorted to supply-side moves – zero interest rate policy, quantitative easing and tax breaks (either new or continued).
But here we are again. The aggregate debt burden in the U.S. and Europe has been shifted about in what can only be deemed a shell game – but it has not been significantly reduced and may have even risen last quarter.
Now the markets have wisely concluded that it is politically unlikely that we will see any fiscal stimulus – to the contrary we are confronted with 1937-like calls for, and actions towards, fiscal austerity.
Finally, the wiser policy makers in the central banking dodge have realized that additional monetary stimulus is futile at best, and counterproductive at worst. Increasing the supply of capital or liquidity to a globe that is awash in excess supply of capital and the means to use it, is like throwing lighter fuel on sputtering barbecue grill. You get a raging flare of commodity and financial asset inflation, and then the fire dies again – because the charcoal is not arranged properly in order to grow the heat: the temporary inflation kills demand rather than enhancing it.
Ben, Barack, Tim, Claude, Angela and Nick, have not been tending the grill well, I am afraid. And there is no question that the fire is dying during the cocktail hour.
Not that their intentions were bad, mind you. Trying to reflate the economy and employing the wealth effect of rising markets to spur demand is – from a text book perspective – the right thing to do to combat a shortage of demand and disinflation in general. But if the secular, structural environment is inhospitable to such moves, re-employment and middle class deleveraging do not follow – both of which are the necessary prerequisites for economic growth and the raising of sufficient revenues to deleverage governments.
The problem, of course, is that there are no options left that seem viable within the political environment we now inhabit. Members of congress from the heartland and representatives of the burghers of Germany and Holland have reached, perhaps foolishly, the breaking point on both fiscal spending and central bank bloat – simultaneously.
We have long been unable – despite valiant efforts to make our currency unattractive (ZIRP, QE, etc.) – to devalue the dollar in order to re-inflate the economy. Our trading partners simply won’t let us in an environment of excess supply – everyone can’t devalue at once – and the curse of being the world’s reserve currency is that the dollar is also the flight currency in times of weakness. Protectionist measures – once again being grasped at by otherwise well-intentioned but desperate minds – are more frightening to the market than almost any other solution.
The markets have merely awakened to this fact as the previous measures have expired or been removed, the economies of the U.S. and Western Europe having reacted accordingly.
I have written at length on what to do about the situation in the U.S. – in short, QE3…bad; modest deflation in nominal wages, prices an asset values…needed; an ambitious public infrastructure rebuilding and re-employment program at modest wages…good; household and financial institution debt restructuring and hits to creditors…simply unavoidable.
But we can talk about all that after Labor Day. The markets, probably not incorrectly, have concluded that all of the above are not yet on the agenda of anyone with the power to implement and shepherd economic restructuring.
And that just means that the second and final items on the foregoing list off needed solutions will merely happen in a less controlled way. Needless to say – the markets don’t like that anymore than the hit to equity capital that will inevitably result from pursuing the necessary systemic repairs.
We can, of course, merely try to wait for the expansion of demand in the emerging nations. The events of recent weeks are what that waiting looks like. And it would be a very, very long wait.
Daniel Alpert
Managing Partner
Westwood Capital, LLC and affiliates
Office: 212-953-6448
www.westwoodcapital.com
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