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« on: 05 October 2008, 0:32:16 am » |
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'One thing on which economists have been proved wrong again and again is in the flexibility and reactivity of the US economy. Despite all the terrible things it has been through this year, the US will still record higher growth than either Europe or Japan.' - Iconoclastic economic forecaster Thierry Apoteker
The Business Times
Published October 4, 2008
THE US will avoid a recession, but will enter a protracted period of low growth. Hundreds of banks will disappear. The world economy is at an inflexion point and has entered a new phase of rising inflation that could last as long as 20 years. Corporates and investors alike will face a completely different landscape and will have to rethink the assumptions that have guided them for the last 20 years. And the US dollar will do better than most expect.
That, in brief, is what the future looks like to the contrarian, and uncannily accurate, economic forecaster Thierry Apoteker. His company, T-A-C, boasts a client list that includes more than 30 major banks and corporations as well as official institutions like the European Commission, the Asian Development Bank and Unctad.
Mr Apoteker and most of his 14-strong research team operate out of a farmhouse in the small town of Saint-Hilaire des Landes in Brittany, about two hours from Paris. This is deliberate, and not only for lifestyle reasons. 'If you want to be independent, you should locate yourself physically far away from big money centres like Paris or London,' says this fast-talking Frenchman. 'If we were in Paris, we would be having lunches with bankers and financiers there and we would probably end up thinking the same as them.'
Astounding track record
Mr Apoteker's speciality is studying and predicting financial crises, especially in emerging markets - using complex quantitative models. A lot of forecasters do this, but Mr Apoteker's track record is astounding.
'One thing on which economists have been proved wrong again and again is in the flexibility and reactivity of the US economy. Despite all the terrible things it has been through this year, the US will still record higher growth than either Europe or Japan.'
In 1993, he put out a 'crisis signal' for Indonesia within three to five years. Indonesia's economy imploded in 1998. Korea made his 'crisis signal' list in 1995. One to three years was the time frame. Korea experienced a severe exchange rate crisis in 1997. He forecast Thailand's 1997 crisis too, long before it happened. Ditto for Brazil's currency crisis of 1999 and Argentina's economic implosion of 2002. Overall, during 1980-2002, Mr Apoteker predicted crises in 50 emerging markets with more than 90 per cent accuracy.
Of late, he has, like many other forecasters, turned his attention to the financial crisis in the United States. The general reading of the US economy is almost, to an economist, doom and gloom. A certain recession, we are told.
Mr Apoteker doesn't buy it. The US will succeed in avoiding a recession, he says and will, in fact, end 2008 with positive growth that will be higher than in either Europe or Japan.
What makes a recession depends on your definition. The technical definition in the US is two consecutive quarters of negative growth, quarter on quarter. However, as Mr Apoteker points out, most people, especially in Europe and Asia, consider a recession in less technical terms, to be a situation of zero growth for one year. By this definition at least, the US will certainly avoid recession, he says. 'After growth of 1.7 per cent in the first half of this year, we would need to see very serious negative growth for the last two quarters for there to be a recession in the US,' he points out.
'We do indeed believe there will be at least one quarter of negative growth, but overall, we estimate US growth will come in at around 1.5 per cent this year. It would be difficult to call this a recession, especially for a European; in Europe, 2 per cent growth is considered the potential growth rate.'
He would only change this view if US consumer confidence collapses or a credible and comprehensive stabilisation plan for the financial industry doesn't materialise (the US Senate approved a revised plan on Wednesday).
Mr Apoteker says the US economy's fundamental strengths should not be overlooked, or underestimated.
'One thing on which economists have been proved wrong again and again is in the flexibility and reactivity of the US economy,' he points out. 'Despite all the terrible things it has been through this year, the US will still record higher growth than either Europe or Japan. What does this mean? It means that the US economy is more dynamic, it is stronger structurally, and the return on capital in the US is still higher in the US than in Europe or Japan.'
Moreover, in others. And longer term, the US has better demographics than Europe or Japan, which is also a plus for the housing market. 'The segment of the population which is growing fastest today in the Uhe believes that the US housing market has stabilised in some areas of the country and is 'close to the bottom' S is the segment between the ages of 30 and 45. These are people who buy houses. Obviously, if they are laid off, they will postpone it, but the moment they see an attractive price, they will go in.'
In looking at the financial crisis, Mr Apoteker says, it's important to get to the core of the issue, which is endogenous transactions within the financial sector, rather than a wider problem. 'Up to June 2008, borrrowing by corporates was still growing,' he points out. 'The idea that there was a credit crunch for corporates is untrue; you don't have many corporates going bankrupt. The credit crunch was between financial institutions. No financial institution was willing to lend to another financial institution.'
He adds: 'One statistic is very revealing. The overall financial sector in the US, whatever standard economic measure you take, is about 10-15 per cent of the total US economy. But corporate profits in the financial sector in recent years have been 45 per cent of total corporate profits. So you've had excess profits in the financial sector for several years. How did that happen? It happened because of extraordinary leverage.'
He explains that this goes back to 1999, when the firewall separating banking from other financial activities was removed, which enabled banks to create subsidiaries that could operate outside regulatory control. (The international regulatory standards such as Basel I and II applied only to banks, not to these subsidiaries.) So while banks were prevented by regulatory constraints from taking on high leverage for their banking activities, their subsidiaries had no such constraints. Nor did hedge funds, which operated with asset to capital ratios of 50 to 1.
'So, the financial products may have been very complex but the business model was very simple,' says Mr Apoteker. 'You borrow a lot with very little capital at low interest rates, so you have very high leverage. And if you're a bank, you're no longer just a lending agency. You have entities that make loans not to keep on their books but to securitise and sell on.'
Now, with a lot of this leverage being unwound, there will be a shake-out in the US banking sector, he says, which could involve hundreds of bank failures - a process that has already started. 'Strangely enough, the US was the only country which has not had a consolidation of its banking industry; there are still thousands of banks in the US,' he notes. 'But now lots of small and medium sized banks, which bought assets they did not understand, will be absorbed.'
Nor does he buy the scenario of a banking system 'meltdown' as predicted by economists like Nouriel Roubini of New York University. 'A consolidation, no doubt, but certainly not a meltdown,' he says. But he acknowledges that in the near term, hedge funds could be next in line for a big shake-up, because of their extraordinary leverage and dependence on short- term refinancing - which will not be forthcoming.
The consolidation of the US banking system, which will proceed well into next year, will hurt the real economy, he adds. 'It will lead to a slower distribution of credit in the US, which will be aggravated by tighter regulation. So while the US will avoid a recession, it will have a longer period of sub-par growth, and so will Europe.
'So what is likely to happen is not a short and sharp recession and then a bounce-back, but lower growth for several years, something in the range of 1.5 to 2 per cent, maybe for four years,' says Mr Apoteker. 'That's how long it will take to absorb the leverage and excesses of the last decade. So it won't be a massive shock, it will be an extended period of slow growth.'
But alongside that, we will also see a new era of rising inflation, he says, on the back of high liquidity being pumped into the world economy, as well as rising costs and wages. 'If there is one key issue every corporate should start to think about now it is this: the two-decade-long deflationary period in the world economy is over. We are getting into a long period of relatively high inflation that could last for 15-20 years.
'If you look at history, you have long waves of deflation and inflation. The last wave started in 1981 when Paul Volcker was the chairman of the US Federal Reserve. The inflation rate in the US was 14.7 per cent. He decided this was a problem and he raised the Fed funds rate to 17 per cent.
'So, since 1981 there has been this disinflationary process. The bottom of that long phase was 2004. Since then, inflation has been creeping up.'
And it's going to continue, he says. 'All the elements are in place for a long-term trend of creeping, rising inflation. Producer price inflation in the US is already above 10 per cent. Who would have thought that five years ago?'
In the next few quarters, however, Mr Apoteker says that headline inflation could come down slightly, from around 5 per cent now to 3 to 3.5 per cent, because commodity prices have softened and economic growth is slowing. 'But remember, in the heyday of disinflation, the inflation objective was 2 per cent.' The trend, he says, is unmistakably up.
Mr Apoteker rejects the view that China and India will have the effect of keeping inflation down because they produce goods and services at low cost. 'They will not continue to exert downward pressure on prices as much as before,' he says. 'Export prices from China have already started to increase. They have stopped appreciating their currency and oil prices are still high. How long can China continue to have low inflation domestically?
'Remember, at the same time as China and India are producing, they are also consuming, and that is putting upward pressure on commodity prices. And the development process itself means that their wages will increase, and they have started to do so. Productivity in China cannot go up by 15 per cent a year for 20 years.'
Over the medium term, the ageing of societies - especially Japan, China and Europe - will add to inflationary pressures. Because an ageing society means fewer younger workers having to pay for the pensions of increasing numbers of older people, the former group will demand ever-higher wages.
The new era of rising inflation will have huge implications for companies and investors alike, according to Mr Apoteker. 'Corporate planning will have to be very different from what it was in the last 20 years,' he says. 'If you are a corporate or a bank and you have made your plans on the basis that this is a disinflationary period, you will have to change. The way you manage your workforce, the way you manage productivity, how much attention you pay to the prices of your inputs and to differentiating your products, all that will have to change.'
New investing paradigm
Investors will also face a new paradigm, says Mr Apoteker. 'If you are a long- term asset investor, if you have a five-year horizon, now is the time to get into real estate, especially in the US. Because inflation rates will push up values in the long run.' But while inflation will be a global phenomenon, not all real estate will be attractive; local factors will be important, he adds.
For portfolio investors, Mr Apoteker recommends index-linked products. As for stocks, those that will do well, will be of companies with pricing power. But stocks of companies that will suffer from higher costs without having pricing power to pass them on should be avoided. Also avoidable are fixed-rate products like long-dated bonds.
Finally, on currencies, Mr Apoteker makes a characteristically contrarian call. 'If you look at one year to 18 months, the fundamentals are pro-US dollar,' he says. 'The US will have a shrinking current account deficit because of lower growth. In the short term, the inflation differential which was in favour of the Euro-zone will narrow, as US inflation falls. Interest rates will also converge more. The next move by the European Central Bank will be either to keep rates on hold or cut slightly, and the Fed will have to tighten, for inflation credibility's sake. So all that would be positive for the dollar. We see the dollar appreciating to 1.30-1.35 against the Euro by the end of next year. And we will suddenly wake up and find that the US is still the fastest growing of the world's three major economies.'
Thierry Apoteker
# Born 1957 in Paris
# Graduate of HEC, French School of Management
# PhD in Monetary Economics, University of Paris Dauphine
# Formerly Chief Economist and Head of Research at Bank Indosuez (now Calyon)
# Founded T-A-C (Thierry Apoteker Consultants) in 1990, providing a suite of economic, financial and corporate advisory services, specialising in country risk
# Client list includes more than 30 major financial institutions and corporations, the French Ministry of Economy and Finance and multilateral bodies
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