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Exhaustion & Imbalance


There is always pressure to sketch ones view of the New Year. It is as though we all get together and pretend that an arbitrary change in the calendar year must, by virtue of occurrence, signify real change. The pressure for a new outlook is particularly great after a rough patch -- like the one we have been in since the summer of 2007. I see the large shaping trends of 2008 in the last 6 months of 2007. Boring, I know. I do think there will be changes. I don't think the flipping of the calendar will usher in a dramatic new reality. The biggest changes are likely to be increased attention to the 2008 Presidential election cycle, consumer exhaustion and contagious international weakness. I do believe the much celebrated economic strength of the rest of the world will be tested. I expect the world -- that has already outperformed the US for several years -- to perform below the present expectation level. In other words, like the magic of real estate prices that only rise, I don't believe that developing world economies only grow. That said, I would not be surprised if several developing countries perform better than the US in the coming global slowdown. I am similarly sure that several will underperform us.

Housing and credit markets are so far from out of the woods that it barely seems fair to devote page space to reiteration. If we are lucky, 2008 will be similar to the last 6 months on 2007 in regard to housing price declines, default rates, payment delinquencies and fallout. Further large write-downs from financial institutions are guaranteed and already in the pipeline. So too are significant lay-offs in construction, real estate, finance and retail. This is all baked into the cake. Firms have been forced to stagger their loss provisions to avoid panicking investors and falling below minimal capital and balance sheet requirements. Thus, we know more write-downs are coming. So too are lay-offs on Wall Street and main Street. There will also be slower hiring growth -- if not reductions, in many nations, sectors and areas.

Like the boom we have been celebrating since 2003, the coming slowdown will be uniquely global. The last 4-5 years have seen the most rapid and wide global growth rates in 30 years. It might be interesting to note that the boom of the 1960s-early 1970s was even larger, longer and ended after the oil price shocks of the early 1970s. This boom is broader and has seen more growth in the developing world, led by India and China. Rapid growth in much of the developing world -- where most people live and population growth is centered -- has run far and fast. This can be traced to globalization, telecommunication and transport innovation. The recent boom has been uncharacteristically widespread. There is every reason to expect the slowdown to be similarly defined. That is just how it works with linked and integrated global markets and transnational firms. Nothing is all good and nothing is all bad.

The US was the consumption and financial center of the boom. America is tired. America is unbalanced. Our consumption and debt fatigue is tangible and showing up in more and more national statistics and economic reports. We are tired from too much borrowing and buying. The world is getting tired of lending and supplying. A massive structural imbalance has fueled a dirty, inefficient global growth engine for the last few years. International lending to America is the fuel. The nasty emissions from this combustible process are choking the international economic air. The byproducts of this growth are unsustainable debt and consumption levels in the US and overproduction with under-consumption in many developing nations. No set of statistics better illustrates this than the IMF's Global Financial Stability Report Statistical Appendix measures of leading capital exporters and importers. In 2006 China led the world with reported capital exports of 17.3% of the world total. In 2006 the US dominated all other importers of capital with 59.6% of imported capital sucked into our debt fueled miracle consumption economy. Our overspending and borrowing has a corollary in Chinese over saving, low consumption, low wages growth and export sensitivity. Since 2001, consumption and wages have fallen as percentages of China's rapidly growing GDP. Thus, both spending and the ability to spend from wage earnings, have failed to keep pace with economic growth. America had a consumption and debt binge boom across the same period. The spillover effects can be seen in oil prices, falling dollars, financial firm stress, raw materials demand from China's industrial boom and consumer and debt exhaustion in the US. The first shoe to drop was Sub-Prime.

If we are exceptionally lucky 2008 will be the first year of a long, slow, orderly rebalancing of the global economy. US consumption has to fall. We need to pay off more debt than we take on. China and much of the developing world need to shift toward greater reliance on domestic demand and rising consumption levels. This means rising wage levels in the developing world. Americans will have to earn more than they spend and net retire debt. American and world political and economic leaders have been aware of and nervous about this rebalancing process for several years. You will be comforted to know that they snapped into action and prolonged the imbalance to avoid recession or growth deceleration. They have been trying that again without great success. We have brushed up against the sustainability issue before. Painful correction has been successfully postponed by concerted action on international trade, currency and monetary policy fronts. Past stalling techniques may or may not work this time. It feels somehow different since August? America seems exhausted and the imbalances are so large. The pace and extent of rebalancing will define the US and international economic trend in 2008.