The East-West balance is tipping
Western and eastern economies share a symbiotic relationship, though whether it is good for both sides is increasingly being questioned.
Economic historians may record that 2007 was the start of the credit crunch, but also that it was a crucial shift in the balance of power from the West to the East. The 'East' as used here is metaphorical – including the Middle East and Russia, both flush with cash from higher oil revenues, as well as the geographically eastern.
There is a kind of symbiosis at work between West and East. In nature, ecologists identify three form of symbiosis between competing species: commensalism (one species benefits), mutualism (both species benefit) and parasitism (one species benefits, the other species suffers). It is not clear which of these three forms the current East-West money symbiosis most closely resembles.
The shift in power from borrowers (the West) to savers (the East). Even before the current credit crisis the vast current account surpluses and savings of the East were being recycled into investments in North America and Europe.
In recent years, the US alone has absorbed around 85 per cent of total global capital flows (about $US500 billion each year) from Asia, Europe, Russia and the Middle East. Cross border debt flows funded the US government debt (up $US400 billion) and a rapid expansion in US private debt (up $US1.3 trillion). During this time risk averse investors preferred high quality debt – US Treasury and AAA rated bonds. A key growth area was asset-backed securities (ABS), including mortgage-backed securities (MBS), reflecting the strong US housing market and high levels of home-equity lending. James Fallow writing in The Atlantic noted that "every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People's Republic of China".
The credit crisis has accelerated and altered the reliance on eastern capital. Barclays secured equity capital of up to €13.4 billion from China Development Bank and Singapore's Temasek Holdings in support of its ultimately unsuccessful bid for ABN-Amro. More recently, banks and sovereign wealth funds from the Middle East, Singapore and China have invested $US40 billion in Citigroup, UBS, Merrill Lynch, Morgan Stanley and Bear Stearns to help shore up balance sheets ravaged by losses from the credit crisis.
The economic centre of gravity has also shifted east. In recent history, US consumer spending, buttressed by a strong dollar, has been the primary engine of global growth. The current credit crunch has exposed the weaknesses of the US consumption miracle. US wages have barely increased in real terms in 30 years. US consumption relied heavily on cheap abundant debt. Rising house prices were converted into cash through home equity loans. At the height of the boom, around $US1 trillion in home equity was generated via re-financing of existing mortgages and second mortgages, thus fuelling consumption. Falling US house prices, slowing employment and the credit crunch will ultimately restrict US consumption. Markets are now looking to the emerging markets of Asia, Eastern Europe and the Middle East as the driver of the global economy.
In recent years, US banks openly contemplated moving their management centre to London. But London now looks more like becoming a transit stop on the way to Moscow, Dubai, Mumbai, Singapore, Hong Kong and Shanghai. As banks retrench capacity in New York and London, staff are sometimes offered the opportunity to relocate to eastern centres that have remained relatively insulated from head-count reductions. Strategy is also changing – HSBC has recently re-focused on emerging market opportunities.
The East is now an important centre for currency trading, reflecting the volume of dollar reserves held by investors. Asia is also the centre for structured products especially in interest rates, currencies and equities, reflecting the amount of investment capital, wealth concentrations and also the search for higher returns. Products originated in Asia increasingly flow back into Europe – a change in the historical pattern of product innovation. In mergers and acquisitions, the focus is on servicing eastern investors and corporations expanding into developed markets. Hedge funds and private equity funds are spreading into the East. Bankers are headed East for reasons other than spiritual enlightenment.
The importance of the East may lead to a change in management ethnicity. Vikram Pandit, newly appointed as the Chief Executive of Citigroup, is of Indian origin. Dow Kim (until he left Merrill Lynch) and Anshu Jain (Deutsche Bank) are prominent examples of eastern talent that play leadership roles in Western institutions.
How important is this shift in balance? In the 1980s, Western firms feared a takeover by gargantuan Japanese banks. In the 1990s, there were predictions of a new Asian century.
The jury is out on the merits of the recent investments in distressed banks. The investment rationale for many transactions is questionable. The flow of capital may also not continue at its recent rate. Citigroup is rumoured to have sought to raise $US2 billion in capital from China Development Bank. There are suggestions that there is opposition to the investment within China's government. This appears to reflect a growing backlash in China following the $US3 billion investment in Blackstone that has decreased sharply in value (by about 30 per cent). There are also signs that Western governments and public opinion are increasingly restive about the prospect of significant foreign ownership of key companies in strategically important sectors.
Availability of necessary infrastructure and skills in the East is doubtful; for example, an expatriate community runs Dubai. The sustainability of the East's stellar growth rates is also unknown.
For the moment, the West and the East are like Siamese twins that share vital organs. Eastern capital and growth offers one of the few bright spots in a darkening global outlook. It is the lifeline that the US and European economies and institutions are clinging to.
Australia's economic future increasingly hinges on how this rearrangement of global economic power plays out. The Australian economy is simultaneously hostage to developments in Asia and the US. As a supporting player rather than principal in the drama, Australia will have to play its cards very carefully in the great game of the new century.
© 2008 Satyajit Das All Rights reserved.
Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall). At the time of publication the author or his firm did not own any direct investments in securities mentioned in this article although he may be an owner indirectly as an investor in a fund.
There is a kind of symbiosis at work between West and East. In nature, ecologists identify three form of symbiosis between competing species: commensalism (one species benefits), mutualism (both species benefit) and parasitism (one species benefits, the other species suffers). It is not clear which of these three forms the current East-West money symbiosis most closely resembles.
The shift in power from borrowers (the West) to savers (the East). Even before the current credit crisis the vast current account surpluses and savings of the East were being recycled into investments in North America and Europe.
In recent years, the US alone has absorbed around 85 per cent of total global capital flows (about $US500 billion each year) from Asia, Europe, Russia and the Middle East. Cross border debt flows funded the US government debt (up $US400 billion) and a rapid expansion in US private debt (up $US1.3 trillion). During this time risk averse investors preferred high quality debt – US Treasury and AAA rated bonds. A key growth area was asset-backed securities (ABS), including mortgage-backed securities (MBS), reflecting the strong US housing market and high levels of home-equity lending. James Fallow writing in The Atlantic noted that "every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People's Republic of China".
The credit crisis has accelerated and altered the reliance on eastern capital. Barclays secured equity capital of up to €13.4 billion from China Development Bank and Singapore's Temasek Holdings in support of its ultimately unsuccessful bid for ABN-Amro. More recently, banks and sovereign wealth funds from the Middle East, Singapore and China have invested $US40 billion in Citigroup, UBS, Merrill Lynch, Morgan Stanley and Bear Stearns to help shore up balance sheets ravaged by losses from the credit crisis.
The economic centre of gravity has also shifted east. In recent history, US consumer spending, buttressed by a strong dollar, has been the primary engine of global growth. The current credit crunch has exposed the weaknesses of the US consumption miracle. US wages have barely increased in real terms in 30 years. US consumption relied heavily on cheap abundant debt. Rising house prices were converted into cash through home equity loans. At the height of the boom, around $US1 trillion in home equity was generated via re-financing of existing mortgages and second mortgages, thus fuelling consumption. Falling US house prices, slowing employment and the credit crunch will ultimately restrict US consumption. Markets are now looking to the emerging markets of Asia, Eastern Europe and the Middle East as the driver of the global economy.
In recent years, US banks openly contemplated moving their management centre to London. But London now looks more like becoming a transit stop on the way to Moscow, Dubai, Mumbai, Singapore, Hong Kong and Shanghai. As banks retrench capacity in New York and London, staff are sometimes offered the opportunity to relocate to eastern centres that have remained relatively insulated from head-count reductions. Strategy is also changing – HSBC has recently re-focused on emerging market opportunities.
The East is now an important centre for currency trading, reflecting the volume of dollar reserves held by investors. Asia is also the centre for structured products especially in interest rates, currencies and equities, reflecting the amount of investment capital, wealth concentrations and also the search for higher returns. Products originated in Asia increasingly flow back into Europe – a change in the historical pattern of product innovation. In mergers and acquisitions, the focus is on servicing eastern investors and corporations expanding into developed markets. Hedge funds and private equity funds are spreading into the East. Bankers are headed East for reasons other than spiritual enlightenment.
The importance of the East may lead to a change in management ethnicity. Vikram Pandit, newly appointed as the Chief Executive of Citigroup, is of Indian origin. Dow Kim (until he left Merrill Lynch) and Anshu Jain (Deutsche Bank) are prominent examples of eastern talent that play leadership roles in Western institutions.
How important is this shift in balance? In the 1980s, Western firms feared a takeover by gargantuan Japanese banks. In the 1990s, there were predictions of a new Asian century.
The jury is out on the merits of the recent investments in distressed banks. The investment rationale for many transactions is questionable. The flow of capital may also not continue at its recent rate. Citigroup is rumoured to have sought to raise $US2 billion in capital from China Development Bank. There are suggestions that there is opposition to the investment within China's government. This appears to reflect a growing backlash in China following the $US3 billion investment in Blackstone that has decreased sharply in value (by about 30 per cent). There are also signs that Western governments and public opinion are increasingly restive about the prospect of significant foreign ownership of key companies in strategically important sectors.
Availability of necessary infrastructure and skills in the East is doubtful; for example, an expatriate community runs Dubai. The sustainability of the East's stellar growth rates is also unknown.
For the moment, the West and the East are like Siamese twins that share vital organs. Eastern capital and growth offers one of the few bright spots in a darkening global outlook. It is the lifeline that the US and European economies and institutions are clinging to.
Australia's economic future increasingly hinges on how this rearrangement of global economic power plays out. The Australian economy is simultaneously hostage to developments in Asia and the US. As a supporting player rather than principal in the drama, Australia will have to play its cards very carefully in the great game of the new century.
© 2008 Satyajit Das All Rights reserved.
Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall). At the time of publication the author or his firm did not own any direct investments in securities mentioned in this article although he may be an owner indirectly as an investor in a fund.
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