Riding the Shockwave

 | Mar 27, 2012 | 4:30 PM EDT  | Comments
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As big as problems are in the U.S., and they are enormous, they are even larger almost everywhere else in the world.

The shockwave of capital market and economic distortions that began with the collapse of Lehman Brothers still ripples through world markets and economies. It will take at least 10 years for what began in the U.S. in fall 2008 to reverberate fully throughout world economies. Unlike a rock dropped into a pool of water, the economic ripples caused by a collapse in U.S. consumption will get larger as they spread globally, not get smaller.

I've written in the past about the ABC's of Global Macroeconomics, explaining that housing sets the tone in the U.S., which, in turn, sets the tone for the world. In other words, if the U.S. sneezes, the world catches a cold.

Investors in the U.S., being first to experience the crisis of 2008 in their portfolios, attempted to mitigate risk by diversifying into foreign markets. One of the memes that grew out of the crisis was that the world's economies had decoupled from their reliance on exports of consumer products to the U.S. and could grow even if the U.S. entered a period of prolonged recession or stagnation.

This bizarre concept, which was promoted aggressively by U.S. bankers, appears to have been driven by concerns that if an alternative investment venue were not supplied, their investing clients would withdraw from the markets completely.

In reality, global markets and economies are more closely aligned than ever before. Put succinctly, the world may be broken into three discrete areas: consumers, producers and suppliers. The consumer countries are primarily the U.S. and western European Union member states. The producer countries are primarily the Asian countries of China, Japan and South Korea. The supplier states are the commodities- and raw materials-based economies of Australia, Canada and Brazil.

Since the collapse of consumption first occurred in the U.S. in 2008, its knock-on effect is evident in the collapse of consumption in Europe and production in China. To a great extent, the effect on the economies and financial markets of all three areas has been mitigated by the massive and historically unprecedented monetary and fiscal stimulus.

In all three areas, private sector consumption and has been replaced by public sector consumption. Additionally, in China, the slowdown in production of consumer goods has been offset by public sector investment in infrastructure. So far this has precluded the initial ripple effect from the 2008 crisis in the U.S. from reaching the supplier states of Australia, Canada and Brazil. The economies of these countries have actually benefited from the crisis because of how large the offsetting stimulus measures have been in the consumer and producing countries in the past three years. This, combined with the marketing of the decoupling concept, has caused investors to diversify into these markets, seemingly unaware of the risks.

Now that monetary and fiscal stimulus has been expended to their economic limits in the consumer and producer states, there is little policy room left to offset another recession. If that happens, policymakers will have to decide whether or not to let their respective private economies go through the process of correction and price discovery immediately, or provide fiscal monetary stimulus that ensures eventual insolvency. I have no idea which choice they'll make, but the real potential given the real estate-related losses being incurred by global banks is the driving force behind the collective monetary policies of the U.S., U.K., Europe, China and Japan.

In either case, the immediate economic effect on sovereigns and global trade would be measured in degrees, with the brunt of the losses overwhelmingly focused on the supplier states. Investors should be aware that this risk is not reflected in the capital markets of these countries.

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