Is The World Falling Apart? — Part II

When I asked the question Is The World Falling Apart? I was not aware that Hugh Hendry, a shrewd investor, a student of financial history, and one of the smartest people on the planet, had independently come to the same conclusions I did—great minds think alike .  That's certainly gratifying to me personally, but it also presages the deflationary Global Depression we both fear. Hendry is "shorting" both the Eurozone and China, and he rarely loses his big bets.

Before turning to Hendry's views, let's look at the apparent befuddlement of some American economists as to what the consequences of the European debt crisis will be for the United States. This is from Tim Duy's More On The European Impact—

Some clarification and expansion of my recent off-consensus analysis of the implications of the European debt crisis is in order. In short, I noted that lower energy costs and interest rates were generally positive for the US...

A collapsing trade surplus in Europe needs to be met with an expanding trade surplus somewhere else, and my view is that the US is the most likely candidate, especially as the trend is already in place - the external sector is a drag on growth, despite all expectations that a sustained rebalancing will occur in the wake of the US financial crisis.

I think that the decline in oil prices and interest rates is one mechanism by which markets essentially offset some the contractionary consequences of the European debt crisis. Like the declining Euro, they are price signals that correspond to propping up demand elsewhere, such as the US, thereby allowing the US to absorb the European contraction via an expansion in the US current account deficit. Thus, the surprising effect of the crisis is that US demand growth is higher than would otherwise be the case, even  as global growth in aggregate suffers...

I agree - it seems ludicrous to expect the US consumer to continue to power forward sufficiently to hold the US economy and the global economy together. Yet, I suspect that it is the course of least resistance, or at least appears to be at the moment.

Duy admits his view is "off-consensus," but ponder what he's saying here. He telling you that for the world economy to reach a new equilibrium after a large economic contraction in Europe, the United States must expand its current account (trade) deficit. In other words, America will import & consume more stuff. That's the hope! And he uses this graph from his first article Is the European Debt Crisis A Net Positive For the United States? to justify that view.

Duy extrapolates a happy retail sales future (green line) from "post" recession data

Tim, not only does it seem ludicrous to expect American consumers to hold the U.S. and world economy together, but it truly is ludicrous, OK? What about very high unemployment? So-called disinflation? Stagnant real wages? Increasing savings? Indebted households? Underwater homeowners? Etc. And America needs more imports like we need a hole in the head.

Let's get back to reality. Duy and other economists fail to mention a large contraction in China, but this possibility is much on Hugh Hendry's mind. Here Are Four Reasons China Will Start Sucking Wind—

People are way too psyched about China, says Hugh Hendry. In a piece he wrote for the Telegraph, the hedge fund manager admits that China has been growing like crazy...

But here's why China is not that great, according to Hendry:

• China, now the world's biggest creditor, is also running persistent surpluses. That's only happened twice before: with the US economy in the 1920s and with the Japanese economy in the 1980s.
• Unlike in most countries, China's share of consumption within its economy has fallen relentlessly, reaching 35% of GDP in 2008.
• Foreign demand for its exports dropped. Now China relies on a massive surge in domestic bank lending to fuel its growth rate.
• China's state planners have favored investment over consumption. China's investment spending has tripled since 2001. Domestic consumption never grows fast enough to absorb the supply, and Chinese profitability is already low.

This reasoning has led Hendry to short China.

May 18 (Bloomberg) -- British hedge fund manager Hugh Hendry is betting China’s “credit bubble” will burst, causing its economy to contract and triggering a global crisis.

Hendry’s Eclectica Asset Management has bought options on 20 companies in international markets that will profit from “a dramatic collapse” of China’s growth that’s been fueled by an unprecedented lending boom, Hendry said in a May 17 telephone interview from London.

Hendry joins hedge fund manager James Chanos and Harvard University professor Kenneth Rogoff in warning of a potential crash in China. The nation’s 13 trillion yuan ($1.9 trillion) of new lending in the past 16 months, bigger than the economies of South Korea, Taiwan and Hong Kong combined, is spurring industrial capacity expansion in the same way Japanese credit built inventory during and after World War I, Hendry said.

“There are striking parallels with Japan in the 1920s, when ultimately the whole system collapsed,” said Hendry, 41, whose firm manages $420 million in assets. “China could precipitate a much greater crisis elsewhere in the world.”

In short, Hendry is waiting for China's bubbles to collapse, just as I am. As for Europe, Hendry expresses his views in the video below. He and Gillian Tett of the Financial Times tear the eternally optimistic Jeffrey Sachs a new asshole. If you know anything about the political smoothy Sachs, who is almost always wrong about everything, you will likely agree with me that his punishment is richly deserved.

In my first article I concluded that there was at least a 50% chance of a Global Depression starting this year or early next year. However, I am not an investor, I'm not a gambler. But Hugh Hendry agrees with my analysis. He has backed up his views (and mine) with some large part of the $450 million he manages for his clients, all of whom have prospered greatly in recent years under Hendry's stewardship of their money.

Update on 6/2/2010 — When I posted this video, it played here. For unknown reasons, embedding has now been disallowed, so click on play and then click again to watch the video at YouTube.

Hugh Hendry on the European Debt Crisis: ‘I would recommend you panic’

Comments

[Jb]

Thanks for posting the Hugh Hendry video; he is new to me. I very much appreciated his 'let's cut the crap' position.