U.S. and Emerging Markets Are Linked At the Hip
The economic center of gravity has shifted east.
Ecologists identify three forms of symbiosis between competing species: commensalism (one species benefits); mutualism (both species benefit); parasitism (one species benefits, the other species suffers). It is not clear which of these three forms the current East-West money symbiosis represents.
It is a 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 United States alone has absorbed around 85% of total global capital flows (about $500 billion each year) from Asia, Europe, Russia and the Middle East. Cross border debt flows funded the U.S. government debt (up $400 billion) and a rapid expansion in U.S. private debt (up $1.3 trillion). Risk averse investors preferred high quality debt – U.S. Treasury and AAA rated bonds. A key growth area was asset-backed securities ("ABS"), including mortgage-backed securities ("MBS"), reflecting the strong U.S. 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. Barclay's (BCS) secured equity capital of up to 13.4 billion euros from China Development Bank and Singapore's Temasek Holdings in support of its ultimately unsuccessful bid for ABN-Amro (ABN). More recently, banks and sovereign wealth funds from the Middle East, Singapore and China have invested $40 billion in Citigroup (C), UBS (UBS), Merrill Lynch (MER), Morgan Stanley (MS) and Bear Stearns (BSC) to help shore up balance sheets ravaged by losses from the credit crisis.
The economic center of gravity has also shifted east. In recent history, U.S. 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 U.S. consumption miracle. 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, U.S. banks openly contemplated moving their management center to London. But London may only be 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 centers that remained relatively insulated from head count reductions. Strategy is also changing - HSBC (HBC) has recently re-focused on emerging market opportunities.
The East is now an important center for currency trading reflecting the volume of dollar reserves held by investors. Asia is also the center 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 spiritual enlightenment.
The importance of the East may lead to a change in management ethnicity. Vikram Pandit, newly appointed the Chief Executive of Citigroup, is of Indian origin. Dow Kim (until he left Merrill Lynch) and Anshu Jain (Deutsche Bank (DB)) 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 $2 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 growing backlash in China following the $3 billion investment in Blackstone (BX) that has decreased sharply in value (by about 30%).
There are also increasing signs that Western governments and public opinion is increasingly restive about the prospect of significant foreign ownership of key companies in strategically important sectors. Remember the fuss that ensued when CNOOC (CEO), the Chinese state oil company sought to purchase Unocal leading ultimately to the transaction being abandoned.
Availability of necessary infrastructure and skills in the East is doubtful; for example, an expatriate Diaspora 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 U.S. and European economies and institutions that are clinging to.
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