"Post credit bubble wealth transfer will beggar belief"

John Plender of the Financial Times warns us that the movement of assets from shaky players to the solvent has only just begun. Those who complain of crown jewels begin sold to foreigners had better get used to more of the same.

Plender points out that investors are taking real risks, not merely that their investment may go down in price (the Japanese investment in Rockefeller Center in the 1980s, for instance, did not work out very well) but that the dollar may well deteriorate.

It’s cold comfort to point out that emerging markets were in the same position in 1997-1998. The US is, well was, the world’s leading economic power; we aren’t prepared for an Argentina-like fall in standing. But as economic historian Niall Ferguson pointed out yesterday in the FT:

Yet, on closer inspection, we are indeed living through a global shift in the balance of power very similar to that which occurred in the 1870s. This is the story of how an over-extended empire sought to cope with an external debt crisis by selling off revenue streams to foreign investors. The empire that suffered these setbacks in the 1870s was the Ottoman empire. Today it is the US….

The US debt crisis has taken a different form, to be sure. External liabilities have been run up by a combination of government and household dissaving…..

As in the 1870s, though, the upshot of this debt crisis is the sale of assets and revenue streams to foreign creditors. This time, however, creditors are buying bank shares not canal shares. And the resulting shift of power is from west to east…. This is happening at a time when the gap between eastern and western incomes is narrowing at an unprecedented pace.

In other words, as in the 1870s the balance of financial power is shifting. Then, the move was from the ancient oriental empires (not only the Ottoman but also the Persian and Chinese) to western Europe. Today the shift is from the US – and other western financial centres – to the autocracies of the Middle East and east Asia.

In Disraeli’s day, the debt crisis turned out to have political as well as financial implications, presaging a reduction not just in income but also in sovereignty…..

It remains to be seen how quickly today’s financial shift will be followed by a comparable geopolitical shift in favour of the new export and energy empires of the east. Suffice to say that the historical analogy does not bode well for America’s quasi-imperial network of bases and allies across the Middle East and Asia. Debtor empires sooner or later have to do more than just sell shares to satisfy their creditors.

Plender continues with this theme but steers clear of the geopolitical implications:

When financial market bubbles burst, a transfer of assets from the weak and undercapitalised to the strong and liquid invariably follows. The unprecedented scale of the credit bubble that burst last August suggests that the extent of the resulting wealth transfer will beggar belief.

The process is already well under way. So far, sovereign wealth funds have mopped up some $25bn worth of equity and debt in Citigroup, UBS, Merrill Lynch and Morgan Stanley. One of the safest predictions for 2008 is that this will lead to political friction of the beggar-thy-neighbour kind, with Western politicians complaining that their financial crown jewels are being sold for a song. Yet it is far from clear that the jewels are outright bargains….

Meantime, a deterioration in credit quality is spreading from subprime mortgages across the financial system. The combined capital and liquidity constraint on the banks is in turn having a malign impact on the real economy where the banks will themselves induce a second round of asset transfers from weak to strong as they tighten lending conditions or put in insolvency experts, especially lower down the business scale.

A final problem is that until all the complex mortgage related structured products can be valued in a way that carries conviction, valuing banks will be a hazardous process. Much hitherto lucrative securitisation business may have gone for ever. The one certainty is that much more capital will have to be raised.

Then there is a currency question. To the extent that their investments in the west are unhedged, sovereign wealth funds take a big risk. There must be a fair chance that the dollar could weaken even further as financial unbalances in the US continue to unwind. There are few safe bets in currency markets, but in Europe the nearest thing to one is that sterling, attached to a debt-sodden UK economy afflicted with larger financial imbalances than the US, will sink. Those high growth economies of eastern Europe that have large current account deficits look similarly vulnerable on the currency front. So while there will be opportunities to buy these countries’ assets cheaply, the timing will be tricky.

For western politicians to complain about the loss of crown jewels is special pleading of a particularly invidious kind. For there is a marked similarity in what is happening today to what happened in the 1997-98 crisis in Asia. Then hot money from western banks exacerbated financial bubbles and inflation across the region. When the hot money pulled out, more stable western funds snapped up Asian assets on the cheap. Now official money from Asia and from the petro-economies has contributed to the western credit bubble. And the sovereign wealth funds are mopping up after the burst.

The significant difference is that the debacle in Asia was followed by truly appalling losses in output and employment whereas the US is merely at risk of recession rather than slump. Not only is hypocrisy an issue here. There is folly when people in current-account glasshouses throw protectionist stones.

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  1. Steve

    I dunno. The implication is that domestic capital can’t be found. So far, the US and Euro banks that have done SWF deals have claimed that speed was the main factor. But I think there’s a bit of management self-interest at work: thus far, only the shareholders of UBS have complained about dilution, while US shareholders seem barely conscious of dilution and of common dividends being absorbed potentially by the new preferred issues. So it could be argued that at least for the present US management has snuck in dilutive capital without seeing a significant price adjustment in common shares. But if management brings new issues into domestic markets, that’s likely to be priced into the common shares immediately, with nasty consequences for current management. The cost and availability of capital here looks to me more like an agency problem than a wealth problem.

  2. mike

    The sale of income producing assets should be of concern to individuals and nations alike. But regarding Citigroup, it is really unclear whether it will be an income producing asset or not. It was probably a fair deal. Better buys will be available.

    The following was quoted as having come from the NY Times in 1989,
    “But some participants in the financial markets are not so sanguine. Some fear that the United States is losing its economic and political leadership, and that the consequences will be grave. At a recent seminar of the Friedrich Naumann Foundation in New York, George Soros, president of the Soros Management Fund Inc., said the October 1987 stock market crash marked ”the transfer of economic and financial power from the United States to Japan.”

    IMO, Soros should have been right. What he didn’t foresee was Japan squandering its wealth through Keynesian low interest rates to save the world economy.

    Here we are again. Will China & oil producers squander their wealth? Or will they buy income producing assets?

  3. foesskewered

    Suffice to say, the world is very different from that in 1989, the most worrying factor is the interconnectivity, a US recession is going to feed into the system and further raise volatility. A Chinese implosion is not going to leave everyone else unscathed either, the question is can anyone fgind a way out of the spiral should it start and how to stay globalised whilst disconnecting from the spiral.

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