Sun setting on prosperity?

2008-12-17 08:01

Clem Sunter

Take a plane and one thing is certain: gravity. Run a business and another thing is certain: cycles. You need fuel to combat the one and a sound balance sheet the other.

Cycles are as universal as gravity for three reasons. First, two of our most basic instincts are greed and fear between which we can instantaneously switch. Second, we tend to behave like a flock of sheep. Very few of us live out Warren Buffett's words: "Be fearful when other people are greedy and greedy when the rest are fearful". That's why he is the richest man in the world and we are not.

Third, economies have feedback loops. Rising employment means rising income means rising employment and vice versa. These loops steepen the rise and aggravate the fall. So it is no surprise that we are where we are. Stuck deep in a scenario which Chantell Ilbury and I called "Hard Times".

The key uncertainty now is the length of the downturn. Is it a "V" of a classic recession or a "U" of something much deeper and longer? Opinions are divided, so let's play two scenarios which we'll call "Setting Sun" and "New Balls Please".

No rising sun

"Setting Sun" evokes memories of the property bubble bursting in Japan in early 1990. The Nikkei stock index in December 1989 was almost touching 40 000. Today it is around 8 000. Who said that investors are bound to make money out of holding equities for more than 10 years because you would have lost 80% of your money if you had invested in Japan 20 years ago? For those who did, it certainly wasn't the Land of the Rising Sun!

Yet Japan hasn't done that badly. It is still the second largest economy in the world. But it has been a slog. No more economic growth rates of 8% per annum. On the bright side, world class businesses like Toyota have managed to buck the trend by expanding their geographical footprint overseas.

In a "Setting Sun" scenario for the world as a whole (which implies a long night before the sun rises again), it's a similar deal. The property bust of 2008 means that markets will be exceedingly tough till at least 2020 and only the fittest will survive. No more easy returns on capital; the emphasis will be on grinding out better results based on improved efficiencies and innovation. Meanwhile, the corporate losers will disappear or, if they are large enough, be nationalised. Such is the extremity of the "Setting Sun" scenario that the experience will be passed on to future generations as a cautionary tale.

"New Balls Please" is a much nicer scenario to contemplate over the festive season. It implies a recovery in markets in the second half of 2009 with the global economy returning to a 3% per annum growth rate from 2010 onwards. The "V" will have been short and sharp and everybody will have learnt his or her lesson. Nevertheless the title of this scenario implies a new game requiring new balls. For a start, banks will be more regulated and won't lend so easily. The East will play as significant a role in the new game as the West. Moreover, global warming will shift the emphasis from communication technologies to energy-saving technologies and new energy sources.

Which one will it be?

So what are the flags indicating which scenario we are moving towards? Certainly any major military event, such as a strike against Iran to stop its nuclear programme, nuclear terrorism, Russian aggression, renewed conflict between India and Pakistan or civil war in China, will increase the probability of a "Setting Sun" scenario.

International trade will be too disrupted to recover. Any more national defaults like Iceland could also be interpreted as a red flag, particularly if they involve countries or banks which come as a complete surprise.

On the positive side, most slumps come to an end when prices get so mouth-wateringly low that people start buying again. A three-month rise in US property values is probably a green flag (just as the drop in late 2007 was a red one). Equally $20 for a barrel oil must be an indication of markets bottoming out.

In a funny way, the current stimulus packages being implemented by governments around the world are neither red nor green flags. They could be said to be prolonging the old game when it should be dead and buried.

One previous US Reserve Bank Governor once said that the role of a central bank should be to remove the punchbowl before the party gets too boisterous. Right now, central banks all over the world are adding extra shots of vodka to keep the party going.

Is that a good or a bad thing? Only time will tell.

Clem Sunter is a scenario planner and chairman of the Anglo American Chairman's Fund.

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