Global Hard Landing

The US government is setting up an RTC-like organization to purchase bad assets from financial institutions for warehousing and disposing overtime. This is a step in the right direction. Market may feel good for a couple of weeks, which is how long this bounce would last, in my view. Details of the rescue may unsettle investors. The government may purchase the bad assets at very low prices. Many financial institutions still wouldn't be viable after the forced write-downs. The government may seek deals with them like with AIG, which would be hugely dilutive for existing investors. This is a bounce to sell into.

Apart from the short-lived bounce, there is little upside to stay in the market. While the financial crisis is far from over, the economic crisis is already around the corner. The US is heading for a hard landing. A significant part of the US consumption is kept afloat by the credit bubble. As the bubble collapses, the credit for consumption dries up, the US's economy will likely contract by 2-5%. 1997 for Asia is 2008 for America, 1998 for Asia 2009 for America.

Europe and Japan are already contracting. Their recession will likely last through 2009. They have little domestic demand strength and have always been export-driven. Their weakness will feed back into the US. It has benefited from strong exports in 1H08. The export support vanishes just as its credit crisis hits its consumers. The downward spiral is just beginning.

The risk for a hard landing in China is rising and fast. China's exports, 40% of GDP in nominal value and probably 25% of GDP in value added, may decline in 2009 for the first time in three decades. China was small enough and cheap enough to grow its exports regardless of global demand through market share gains. But, China is now the largest exporter in the world. Market share gain couldn't offset downward trend anymore.

China's property bubble is bursting. The fuel for the bubble was the export income and hot money inflow. Both sources are contracting. The property market is probably heading for a hard landing. The property burst will have a large effect on industry. Demand for auto and white goods won't grow much, may even decline.

Retail sales would do ok. Wages are rising at good speed due to better balance between demand and supply in labor market. But, China's consumption is only 40% of GDP. Even if it grows 10%, it contributes four percentage points to GDP growth. But, the income effect from slowdown or contraction in exports and property should have a meaningful effect on household income. 10% growth is clearly optimistic.

I believe that the government will initiate a fiscal stimulus package. The third plenum of the 17th Party Congress will convene next month. It could bring a consensus on the need for stimulus. The content is unpredictable. I want the package to address liquidity problem at local governments, redistribute income to farmers by raising prices for food products, and accelerate infrastructure projects. I would be surprised that the package can add more than 2 percentage points to growth. It could only be a cushion on the way down, not sustain high growth rate.

No matter how we look at production, demand, or income angles, China's growth rate next year would be significantly lower than in 2008. In 1998, electricity consumption contracted for two quarters. I wouldn't be surprised that the same happens next year.

With Europe and Japan contracting, the US is heading for a hard landing, and China possibly heading for a hard landing, market can hardly perform in the foreseeable future. If global recovery, probably a mild one, is possible in 2010, markets may perform only by mid-2009.

I remain bullish on energy and gold in the current environment. A cartel of rich men works. The OPEC is that now. It didn't work in the 1990s because they were poor and everyone cheated to gain income. They have no incentives to produce more in an environment of declining price. They can't even spend the money they have earned and don't need new money. Gold is a play on easy monetary policy. All major economies have negative real interest rates. The situation would only worse in 2009. Gold is a currency substitute. When currency supplies surge like now, it should appreciate too.

We live in interesting times. This is the end of the Greenspan bubble. Finance has led the global economy in the past two decades, because Greenspan's liquidity made Wall Street very big relative to real economy. It was a debt bubble in the derivative dress. The future will be very different. In 1989, socialism was discredited. In 2008, financial capitalism is discredited. The world would be different in future. In what form we don't yet know.