One giant leap for globalization
This summer marked the 40th anniversary of astronaut Neil Armstrong’s first steps on the moon. On July 21st 1969 he uttered the phrase, “That's one small step for man, one giant leap for mankind."
There has been hours and hours of analysis about dropping the “a” as in one small step for a man, because it formed a grammatical contradiction. Armstrong said he hoped history would grant him some leeway and again further analysis suggests that the audio signal might have been interrupted during his historic walk.
I am recalling that famous two and a half hour journey on the moon’s surface because today there is a spirited intellectual debate on whether the financial crisis of the past year will fundamentally change our approach to business, or be just an interruption on the path to globalization.
During this month, nearly every strand of the crisis is being revisited to understand where we have been and what regulatory steps will emerge at the G20 summit in Pittsburgh. But, maybe we are missing the bigger picture.
I have listened to astronauts talking about the mind-stretching image of looking at earth from space. One’s perspective, I am told, changes dramatically after such an experience and maybe that is what we should be doing ourselves right now -- looking not at what transpired in the past year or the decade that led to the asset bubble, but instead on the global puzzle being assembled.
The smart minds are looking both forwards and back. Each year I spend a few days in the Alps with a group of German industrialists and businessmen to make sense of the world today. Last year, the talks took place just two days prior to the collapse of Lehman Brothers. I went back to look at what was said then and the analysis was incredibly prescient.
The business community pointed to historic bank bailouts on a scale we have not seen before, more regulation of financial products by central banks leading to global rules and finally an effort to weed out the Madoffs of the world. The final point seems to be more difficult to police after the other well-known and recent examples of Enron, WorldCom and Tyco.
The reality is one would never have dreamed of a $1.5 trillion deficit for the U.S., that Washington must drag around like a ball and chain for years to come. Europe and the U.S. are learning, much like Japan during the lost decade of the 1990s, the long-term implications of such a financial shock to the system.
J.P. Morgan Chase bank released a study talking about a sizable lowering of the classic return on equity for banks from 15 percent down to 11 percent with higher capital requirements and stricter regulations. No doubt, banks will remain under the magnifying glass.
But the Chief Financial Officer of Siemens, Joe Kaeser is suggesting something a bit different. His company has over 400,000 employees all over the world and only recently recovered from its own shock linked to compliance practices and kickbacks in 2006. Kaeser sees this crisis as the next big step for globalization.
While the West is living on borrowed time and money, the economies of the East have re-grouped quickly. Many tried to debunk the decoupling of the East from the West, but with the divergence of growth we are witnessing today it is difficult to not believe in a higher grade of de-coupling and the bigger march towards further globalization.
Eight, five and five -- those are the expected percentage annual growth rates for China, India and Indonesia for 2009 and Chinese Premier Wen Jiabao is confident that his $9 trillion stimulus plan will maintain that expansion through 2015.
Oil in the $60-70 range should provide above average growth for the Middle East. Both China and the Middle East remain dependent on Europe and the U.S. for growth, but certainly less so than before.
The next big step in globalization for the major industrial groups means to go where opportunity presents itself. GE for example recently landed a $2.5 billion deal to build power stations in Kuwait. Siemens secured a similar size contract for a water and power operation in Saudi Arabia a few years back.
It may have felt like we all stepped off the cliff in September 2008, with many forced to ask the simple question, "Is my bank safe?" Instead of winding the clock back a year, let’s take inspiration instead from Major General Armstrong and his historic words four decades ago.
Mind the Gap
As I went for my morning espresso macchiato this week I glanced at a newspaper stand and saw the British headline “Recession is officially over”.
A think tank here in London used the calculation of manufacturing output rising for two months in a row to support their premise. Everyone, including this writer, wants to call an end to the nasty times, after all this month marks one year since Lehman Brothers was allowed to go bust, which was the last nudge for the global banking system over the cliff.
The Dow Jones Industrials index is reaching out for the 10,000 mark and the FTSE 100 has recently passed the 5000 threshold, both technical and psychological barriers for investors. But no one really wants to address the ten thousand pound elephant sitting on the table: the recovery in the West will be tepid at best.
This past week on our programme we illustrated that point by suggesting we should all mind the gap — recalling the famous electronic audio call one hears in the London Underground marking the space between the train and the platform. But in this case, I am suggesting we should mind the gap of some of the global economic projections for next year.
For example, the International Monetary Fund has upped its projection to three percent, from an earlier, more cautious call of two and a half percent. The United Nations division on trade and development UNCTAD is suggesting something much less – just above one and a half percent.
Hold on a second; one is about the half level of the other which reflects the uncertainty that still hovers over next year. In the region, the outlook is brighter with the most populous country, Egypt, projected to grow about four percent and the UAE around three percent. This is where conservative banking rules and deeper pockets for the Gulf oil producers pay off.
G20 finance ministers met in London to try and work out the more delicate issues before their leaders meet in Pittsburgh September 24. Devising formulas to cap and stretch out bonuses are still on the cards as is a drive to create global regulations for derivative products that got us into this mess.
Sticking with our theme this week, there remains a gap that bankers are currently filling on their own. Current national rules governing those products don’t keep pace with those who are creating them. During the go-go days of the past decade that was okay when money was flowing in, but similar to life after 9/11 and the security that was introduced, rules to govern financial security need to evolve.
The G20, with Saudi Arabia and Turkey as members representing the region, want to finalize the rule-making by the end of next year and aim for implementation by 2012. In sum, lawmakers want to make sure the recovery is well in place and that there is no rush to legislate, with the approach being “let’s get it done right or not get it done at all”.
That is the positive way to view that approach. Dominique Strauss-Kahn the Managing Director of the IMF took a different view. Empowered to re-design the institution and play a leading role in the new global architecture, he said the consensus forming was impressive, but that the world is still awaiting stronger measures and definitive leadership.
The consensus seems to be moving towards boosting capital requirements to match the risks taken on by banks. This formula would provide - as U.S. Treasury Secretary Timothy Geithner suggested - shock absorbers to buffer future downturns. What seems to be missing in this equation is the ability to rein in banks during the boom times when they are taking on all the risks. Who will play the “bad cop” if you will? No one seems to have the answer to that just yet.
But that concern goes back to the failure of Lehman Brothers. In an era of globalization and consolidation, there are ever more powerful universal banks that combine commercial and investment banking activities under one umbrella. If they are indeed deemed to big to fail, will they curtail taking all that risk if big brother – the government – is willing to step in?
Probably not, but not putting safeguards in place to prevent that would mean we would be asked yet again to mind the gap in expectation of future financial shocks.
Not so Golden State
While we are in the midst of a global power realignment between the G8 and the G20, I found it useful to get a temperature reading in what would be a G8 country on its own, my original home state of California.
The landscape continues to attract scores of literary writers who are drawn by the size, diversity and the light. These are the same elements that provide the business vibrancy and creative energy. But there is a critical debate underway on whether the so called Golden State has passed its golden hour and what that may mean for the U.S. economic recovery.
Anecdotally, California remains a magnet for Middle East and European visitors. My British Airways flights to and from Los Angeles were filled with visitors from the region. It is fair to say that our Gulf visitors may have set a record for both the quality and number of bags checked in. So the allure remains, but the shine certainly has been dulled for natives who can put various pieces of the puzzle together.
For one, this downturn has created new terminology in the U.S: “staycation” - a very local vacation. My queries for a Santa Barbara beach house were met with a 20 percent inflation hike due to the local competition by Americans who could not afford or at least justify plane travel overseas.
But far more serious indicators are easily found beyond the shores and nearby wine estates of California. For example, the research belt that surrounds the University of California at Santa Barbara resembles a silver mining ghost town at the turn of the 19th century. Building after building has “for lease” signs posted on former offices of technology and defense companies. California is home to a quarter of the country’s agriculture products, but the latest crop of signs is an eerie indicator for the future.
Mohamed El-Erian, the respected Chief Executive of Pimco - the giant bond fund manager based in Newport Beach, California - recently signalled out “high and rising unemployment” as the main policy issue in the industrialized world. As the economic growth gap widens between emerging and developed countries, pressure will increase on G8 policymakers to protect jobs and wages. The International Monetary Fund placed that growth gap at four percent by mid-2010; it was a record six percent at the start of this year.
While the Middle East is struggling after the contagion of the Western led banking collapse, leading projections still peg economic growth in the region at around three percent for 2010. The excitement this week that the U.S., Germany and France may have bottomed out, greatly exaggerate the breadth of the recovery. It is abundantly clear that central bankers threw as much liquidity as possible at the problem, but there is little left in the arsenal to combat the general sluggishness and unemployment that persists.
A Los Angeles based friend has spent two decades as a banker for a handful of firms. He has been without a job for more than a year and candidly admits that he is not confident that a job exists in the same sector. All options are on the table he says, even moving away from a state that he loves. After being out of work for more than a year, he is no longer counted in the official national unemployment figures now at a 9.5 percent, a 26 year high. Others I spoke with told me not to overlook the “underemployed”, those who are working again but took pay cuts of 25-50 percent in which to do so. It is certainly difficult to fund education fees and buy homes if ones purchasing power has dropped so dramatically.
I was based on the West Coast as a correspondent during the last severe U.S. recession in 1991-92. California felt it especially hard because of the collapse in defense spending after the fall of communism. Real estate prices plummeted, the fall in spending on research and development hit Silicon Valley and Hollywood was trying to adapt to the digital revolution beginning to take hold.
The downturn forced changed and Californians adapted by retooling those sectors. The economy emerged stronger than before and continued to attract new businesses and foreign visitors to its shores. Both are hoping for the same response, but for some reason after this visit my gut says the script may be written differently during this tepid recovery.
Open up the Taps
John Keynes is not a household name. If there is any confusion, he is not being talked about for a record transfer in football, nor is he someone caught up in a Wall Street scandal. But just adding his middle name -- Maynard -- offers more clarity and, probably reminds us of his seminal work.
John Maynard Keynes is perhaps looking down upon us with a big grin upon his face. The 20th century economist was an advocate of big intervention, specifically the role of government to use the economic toolbox to mitigate the impact of downturns. These days we have different labels for what we are witnessing: prolonged recession, depression, or even repression. Keynes' theory utilized many times over the past seven decades, was later coined "Keynesian economics." It is being practiced with full force today.
A year ago, this writer and a long list of economic specialists were supporting the concept of decoupling. That is, the fast growing countries from Latin America to Asia -- with the Middle East, of course, included -- would continue their economic march while the United States and other industrialized economies cratered.
As Fred Bergsten, Director of the Peterson Institute for International Economics rightly pointed out we would witness the opposite. His argument was that the world will re-couple due to the interdependency of trade, capital and energy flows.
As a result, it is not only finance ministers in Washington, London, Brussels, Paris and Berlin dusting off their books and reading the works of Keynes, but those from Beijing, Delhi and Riyadh too. Big spending is in, budget deficits are a necessity and debt is not a worry.
Hold on a second -- not everyone is taking on water in their economic boats. The big savers of the world like China, Japan and Germany can breathe a little easier as can their counterparts in the Middle East.
“The region was saving for a rainy day,” says Middle East economist Marios Maratheftis of Standard Chartered Bank, “Gulf countries have the surpluses they can use, the ammunition to use now to cushion their economies.”
Since the rapid global growth days of 2004 when China revved up demand for oil and the U.S. was humming along, the region has been stockpiling reserves. During this window, an estimated $1 trillion was transferred to the region in terms of surplus oil and gas revenues. That sum is providing a nice cushion today, so regional governments are going into the red in terms of their annual budgets to insure their economies don’t do the same.
Maratheftis admits there are many unknowns in the region. He and many of his counterparts are predicting economic recovery in 2010. After talking to a number of leading bankers on background, I would -- excuse the pun -- not bank on this recovery.
Kuwait and the United Arab Emirates, according to Standard Chartered, seem the most vulnerable in terms of a potential recession with forecasts of zero growth and a half percent growth respectively.
At this juncture, governments are planning prudently with budgets based on oil prices of between $30-$60 a barrel. For example, the world’s largest producer, Saudi Arabia built its plan on a price of $37 for their local crude according to SABB, a division of HSBC. Seeing the growth tapering off, the Kingdom increased spending by nearly 25 percent in 2008.
Dubai recently unveiled their first official budget deficit of 1.3 percent of GDP -- a luxury in comparison to the West -- and increased spending by 42 percent.
Maratheftis believes the “budget deficits are fully justified; they are manageable and if anything they could be even larger.”
This may mean that they are probably written in pencil and not pen this fiscal year. If the economic smoke signals are worsening as many anticipate, regional leaders will go back to their monetary taps, make a few counter clockwise turns, and put more money into their budgets.
To date, the focus of that spending is similar to the stimulus package being finalized by the incoming occupant of the White House. Regional budgets have been big on infrastructure (perhaps too big), healthcare and education. These are the pillars of diversification, and they reduce over-dependency on energy.
It is difficult to get reliable numbers on actual surpluses in the region. Some are in foreign exchange reserves, others in general accounts and even more tucked away in a variety of sovereign wealth funds. While the world got used to seeing the initials SWF over the past year, they may begin to look for SDF instead, as in sovereign development funds.
The Chief Economist and Group Global Head of Research for Standard Chartered was an early mover tracking the shifts in these capital flows. Gerard Lyons says: “One actually saw a significant shift and therefore over the last year we’ve seen a greater demand within countries for the sovereign funds to spend more of their money at home.
“The next few months will reinforce that trend, namely sovereign funds, still wealthy, will be required to keep more of their money at home and spend more of their investment income at home.”
Governments are already re-deploying assets as is evidenced by these budgets. We don’t hear nearly as much about Middle East bargain hunting in London or New York for banks or trophy hotels and office buildings.
It is an evolving strategy with a domestic tilt and one that would have John Maynard Keynes smiling.
ABOUT THIS BLOGJohn Defterios’ blog accompanies the weekly business program, Marketplace Middle East (MME) that is dedicated to the latest financial news from the Middle East. As MME anchor, John Defterios talks to the people in the know, finding out their opinions on the big business moves in the region, he provides his views via this weekly blog. We hope you will join the discussion around the issues raised.
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