Richard Kapsch
September 27, 2009
Markets fell this week amid disappointing economic numbers and waiting for the G20 meeting. We expect little positive results from the meeting.
Introduction
Stock markets generally traded lower this week as traders moved to the sidelines awaiting the outcome of this week's G20 meeting. At midday Friday, the Dow Jones Industrial Average was down 166 points for the week (1.6 percent) at 9,654.01, while the S&P 500 Index was 25 points lower (2.3 percent) at 1,043.20.
Economic news released this week was generally disappointing, especially in the housing market. Sales of existing homes fell 2.6 percent in August (when analysts had been expecting a 2-percent increase) and sales of new homes dropped one percent the same month (vs. analysts' expectations of a 2.7-percent increase). Orders for durable goods fell 2.4 percent in August, against predictions of a one-percent increase.
All in all, it was not a good week for either the markets or the economy.
Group of 20
Heads of state from the Group of 20 began a two-day series of meetings in Pittsburgh Thursday. It was the third meeting of the Group in the past ten months. The G20 met in Washington in November in the depth of the economic crisis then met again in London in April as the world was taking its first strides out of recession.
This week's meeting should have been more upbeat than the previous two, with the global economy apparently in the midst of recovery. However, there still remained disagreements among the participants regarding futures courses of action.
The G20 were first established because its predecessor, the Group of 7 (US, Germany, UK, Japan, France, Italy and Canada) was considered to be unrepresentative of the true leaders as the global economy was currently constituted. Countries like Russia (which, in the mid-1990s, caused the G7 to be expanded to the G8), China, India, and Brazil were becoming more important than the old European stand-bys. Consequently, while the G7 continues to meet, a second group, the G20 was formed. As one might expect, however, even though the G20 includes more of the "movers and shakers," its size and unwieldiness preclude any concrete actions from occurring and limit the meetings to mere rhetoric.
April's meeting is a case in point. At the April meeting, the Group's concluding communiqué included five pledges of future action, only one of which has since come to fruition. The Group first pledged to restore confidence, growth and jobs. It is apparent that, although confidence and growth may be in the early stages of appearance, the global economy is still shedding jobs.
The Group also pledged to restore lending. The banks may be somewhat healthier but the lending hasn't materialized. Further, the shadow banking system – loan securitization – is nowhere near its old self. The Group also pledged to strengthen financial regulation and restore trust. So far, there have been few changes in regulation (although regulation reform is slated to be a major topic at this week's meeting).
In April, the Group also agreed to fund and reform banks to prevent future crises from occurring, but the banking structure has not really changed: no large banks (since Lehman) have gone under or been allowed to close and there has been little change in the capital structure of financial institutions. Core capital as a percentage of total assets, among the major banks, has only risen by 0.56 percent, to 7.9 percent of assets.
Finally, the G20 in April also pledged to promote trade. This is the only pledge in which there has been any progress at all. Protectionism, since the onset of the crisis, is up only slightly, and no more than would be the case in any other economic downturn.
So, we should expect little from this week's meeting.
The major issue at the Pittsburgh meeting looks to be the need for global rebalancing. The US is the key proponent of rebalancing and is backed by several European nations and the IMF. The US believes that the world cannot revert to its pre-crisis model of export-dominant nations (in Asia and including Germany) dependent on consumption from countries like the US. It is already clear that US consumption, which was heavily dependent on consumer debt, will not return to its former self. US consumers have been drastically cutting debt for the past year.
The IMF has said that the world needs a "rebalancing of growth and increasing consumption in emerging markets to have enough growth" to counter the loss of growth among the developed nations. The G20, the IMF states, also needs "to develop a long-term growth model."
The US plan includes the establishment of a peer-review process which will allow G20 members to hold each other accountable for implementing policies that move in this direction. (Good luck to the G20 in getting this through.) China's exchange rate policy will probably also be discussed. (By holding the renminbi down, the Chinese have fostered exports but also built up huge amounts of dollar reserves and thus contributed to the current crisis.) It is unlikely that this will get very far either.
The major opposition to the US plan will come from Germany and China. Germany who, along with China, is one of the world's major exporters, believes the conference should concentrate on regulating the global financial system.
China, which is paying lip service to the US proposal, really believes its own course of action – stimulating infrastructure and increasing bank lending – is the right course. China may have a point.
China has been criticized for going back to the same economic model that has enabled it to achieve 8-percent-per-year growth and better for the past two decades: expansion of exports at the expense of domestic consumption. On the surface, it appears the critics have a point. China's stimulus package, enacted in November, has allowed the Chinese to achieve annualized growth of 7.9 percent in the second quarter (after 6.1-percent annualized growth in the first quarter). China's economy is now expected to grow 8.3 percent for all of 2009 and 9.3 percent in 2010.
Household consumption has risen 9.3 percent since implementation of the stimulus package but fixed investment has gained 14.8 percent. According to Martin Wolf of the Financial Times, this rising ratio of investment to GDP could indicate declining returns on capital and the corresponding surge in credit and money could lead to an asset bubble (other analysts have come to the same conclusion).
In China's defense, although consumption was only 35 percent of GDP in 2007 (compared to 70 percent in the US), and approximately 41 percent today, for the past thirty years, consumption has accounted for 60 percent of China's growth. Between 2006 and now, the growth rate of consumption in China was more than 8 percent a year, Asia's highest consumption growth rate.
The G20 may criticize China and its exchange-rate and economic policies, but don't expect any agreement from the Chinese. In fact, don't expect very much from the entire G20 meeting.
Indian Markets
The Bombay Sensex Index was virtually unchanged this week, falling 48 points (0.2 percent) in lackluster trade. The index generally mirrored other world markets. The Indian Rupee was essentially unchanged in the week, closing at 48.15 Rupees per Dollar, up from 48.18 a week earlier.
Bombay Sensex Index – One-Year Chart 092409
Indian Rupee vs. US Dollar – One-Year Chart 092409
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