The drop in gas prices over the last month has been a relief to us all. The economic sanctions placed by the European Union, Canada and the U.S. on Iran has simply shifted the flow of Iranian oil from west to east. The net result has been more oil on the global market with China, India and Russia picking up cheaper oil from Iran due to the lack of competition from western buyers. One would think that cheaper oil to the BRIC countries would be just the catalyst needed to help them develop their own internal demand for goods and services through the creation and evolution of their own middle class. Unfortunately, we are in an economic phase of global deleveraging and even the stimulus of low fuel prices will not keep their engines turning fast enough to save us from a second half slowdown here in the U.S.
The thesis of those who run our economy has been: If we can just provide enough economic grease to keep our own wheels turning the development of BRIC economies will, eventually, create demand for our goods and services. This is still probably true in the long run. What a different world it has become when our economic horse has become hitched to someone else’s wagon.
China has been trying to engineer a soft landing for their economy through government expenditures on infrastructure and the attraction of foreign direct investment. The struggle can be seen in their manufacturing output, which has declined for seven straight months. They’ve also lowered their lending reserve requirement to stimulate financing which has dropped by 19% year-over-year and is at its slowest pace since Q1 of 2007. This may simply add further capacity to an already slack market in the wake of China’s 15-year building boom. This is also a futile attempt to increase home ownership, as home ownership is one of the few ways Chinese people have been allowed to invest their newfound prosperity and therefore, already represents an outsized portion of their personal portfolios. The Chinese result will sacrifice its citizens as the high water mark buyers and lead to further class separation between the builders who profited and the people who got stuck with the bill. This will leave them with little disposable income to buy our Apple (AAPL) computers and Fords (F).
The Chinese situation looks hopeful compared to India. The trouble in India is as much political as it is structural. Indian politics are confusing even to the Indian newspapers. It’s easy to go from the Times of India to India Press or any one of their nearly 2,000 daily publications and find contradictory information. Foreign businesses find it nearly impossible to find the right agencies for the right permits. Even if one does, it is quite possible that the rules will not only change but, be made retroactive thus, invalidating the entire business plan of the entity that just put the whole package together. This is exactly what happened to Wal-Mart (WMT) between December of 2011 and February of this year. Permits were voided and taxes created by the new policy were made retroactive. Foreign direct investment is drying up rather than fighting its way through the bureaucratic red tape.
This still leaves Brazil and Russia to save us. Brazil just passed England to become the sixth largest global economy. However, Brazil’s balance of trade slipped into negative territory early this year for the first time since the economic crisis and once again ten years prior to that. Furthermore, their latest GDP readings were just positive enough, 0.34% to escape the technicality of recession. They are battling the decline by cutting interest rates for the seventh time in a row. This easing cycle has seen their rates decline by more than 400 basis points, including May’s cut.
Finally, Russia’s economy is shepherded by the fluctuations of natural resource prices on one hand and Vladimir Putin’s political inclinations on the other. The Russian shadow economy remains one of the largest physical cash exchanges in the world. The government recently limited official cash transactions to approximately $20,000 U.S. Dollars. The political confusion has led to a flight of foreign capital out of the country. Putin’s sincerest desire seems to be the development of a quasi socialist Russia in which the natural resources are shipped abroad by governmentally monitored, semi state controlled companies. Putin then wants access to these revenues to fund his own programs and basically, become the Arab peninsula of natural resources while triangulating politically with Iran and China.
It doesn’t matter whose horse we hitch our wagons to if we’re all headed down the same path. The global balance sheet expansion experiment that hasn’t worked worth a darn in Japan is now being replicated in Europe just as it has been put to work here in the U.S. The world will pull through it and those countries that have been willing to make the tough choices, either through an enlightened electorate body or, the tight fisted hand of an autocratic leader will be the first ones to rebound. Our future, I’m afraid, looks more like the path of Japan’s lost generation than ever.
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