The New Normal

this type of debt. In those cases, not even all the interest is paid each month and what remains is added to the loan principal.

We now know that many conventional banks and insurance companies, including Bank of America and AIG, UBS and RBS, appear to have crossed the “P-line” along with the hedge funds. General Motors fits the definition as well, even though the company did not speculate in derivatives. The jury is still out on whether General Electric will have to divest assets to cover toxic levels of debt in its financial unit.

Pop!

McCulley believes that the Ponzi phase of the asset appreciation bubble burst in August of 2007 and we are now in a “reverse Minsky process,” working backward through the three phases. We suspect, however, that Minsky may have overlooked a 4th structure, one that we would call ‘conservative.’ This is the mindset that characterized many in the generation that lived through the Great Depression.

These individuals are savers, not spenders. They pay cash for goods and services. They are “mattress people,” i.e. mistrustful of fancy financial instruments and keep money in FDIC insured CDs and bonds. It is possible that the Minsky snap-back may send a core portion of the U.S. economy back into that most conservative of strategic mindsets.

McCulley points out that the Minsky process is pro-cyclical on the way up and on the way down. In other words, lacking full sovereign backing, the Shadow Banking System is particularly vulnerable to runs during the reverse Minsky phase.

We wrote a piece on this thesis a while back entitled ‘The Age of Austerity.’ David Rosenberg, the former Chief Economist at Bank of America recently echoed this concept, stating “This isn’t some flashy two or three quarter deal. This is a secular change in household attitudes. This is going to be a new era of frugality.”

New Normal

Mohamed El-Erian, PIMCO’s CEO agrees that the violent developments over the last 12-18 months affecting markets, households, institutions and governments are unlikely to be reversed in the next few years. According to El-Erian, it is as though the global economy suffered a heart attack, with industrial production falling off a cliff edge that had been in place since post- WWII. El-Erian believes that the seriousness of the circumstances should not be minimized. He writes, “Put another way, markets are recovering from a shock that goes way, way beyond a cyclical flesh wound.” He adds that trust can be lost quickly and takes a long time to restore.

In an interview on Bloomberg Radio this week, El-Erian opined that by this time next year, “the market will realize that potential growth for the U.S. is no longer 3%, but is 2% or under.” He added, “We are transitioning to what we call at Pimco a new normal.” This is not particularly good news as the last time the U.S economy grew at an annual rate of less than 2% for an extended period was in the 1930s.
In summarizing the conclusions drawn by the Pimco Secular Forum, El-Erian did not sound at all optimistic about a spontaneous and sustainable recovery in the global economy. Quite the contrary. He states that for those who are trapped in the dominant business-as-usual mentality, the new normal will feel like a huge shock.

El-Erian foresees a long, drawn out sunset with respect to the role of the financial sector in post-industrial economies, as financial risk is transferred to the sovereign governments themselves. Ironically, he sees the mainstream banking system becoming a “shadow of its former self.” El-Erian also expects a 3-5 year transitional period in which the global economic focus gradually shifts away from the dominant Western countries toward emerging markets led by China.

The International Monetary Fund projects a contraction in the world’s advanced economies in 2009, but emerging economies are expected to grow 2.5% on average, and some countries will grow significantly faster. With the bigger Western players sidelined, El-Erian foresees economic differentiation on a country by country basis, depending on local conditions and trade relationships.

We consider Brazil, Canada, Chile, China and India as five leading candidates for enduring prosperity and for growth at a faster pace than will be achieved by the U.S. or Europe over the next 3-5 years. We recently featured several Chinese companies in our profiles. Over the next few weeks we will profile additional investment ideas in these countries.

http://spearfinance.com/tsr/new-normal.htm

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