The world has just gone through a deflationary cycle of asset compression, debt defaults, bankruptcy followed by unemployment, and the unraveling of large swathes of the earlier (bubble) economy, most of which will not be seen in their earlier form again.
Declaimer: This article was originally in May 2010, and some data points may be outdated.
We saw a similar thing during the dot-com ‘boom’. Parts of the economy just blew up in our faces, with the embedded investments vaporizing in the hands of their investors, just as happened recently with the MBS/ CDO/ CLO alphabet soup. But look at subsequent events after the Dotcom boom, to understand just how the economy (and the markets that track it) came back.
Post a bubble collapse, the economy never comes back with the same sector reviving again in a linear, predictable fashion. Like a bomb explosion, the crater is left intact and life returns AROUND it, never IN it. The Dotcom boom blew over, and life returned (at least) to some dotcoms, who lived out (partially) their initial promise. Dotcoms became an intrinsic part of the broader economy, if not as independent entities, but certainly as integral to other large, broad-based business organizations.
Let us try and describe the last (bubble) collapse; I will call it the Lehman collapse since nobody has yet given it a name. My take on it was that it happened because of a lot of risk-managing instruments that became risk-taking instruments, rather like a virus vaccine that goes out of control.
The collateral damage was more than usually found in other bubble collapses, but apart, this one has many of the same elements found in other (normal) bubbles. First, it is accompanied by the same asset compression, debt defaults, etc that are found in most bubble collapses. With some talk about hitting bottom, we should perhaps now focus on how things will look when the world (economy) comes back.
One thing is for sure, it won’t be anymore because of bricks-and-mortar investments in Asia for a moribund OECD market, funded by Asian savings and fed by badly- appraised Western credit risk. This time, the revival model will be that Asian savings will stay in Asia, and nascent OECD savings will go to deleverage the Western debt pile. So it would have to be something that almost NOBODY across the world can imagine just now: Western production and Asian consumption, with Asian savings decelerating even as Western savings accelerate. And just what would that be?
There is one thing that Asians need a lot of (incrementally), the West does not need much of, Asia is willing to pay for and the West is competent to produce cheaply and sustainably. And that (hold your breath) is CLEAN energy…..!!!
The mood across the world is changing in favor of Climate Change Programs. From the refusal of the Bush Administration to even acknowledge the problem, to the upfront programs already signaled by Obama, there are enough signals from the Western world (the Geo-Thermal Act, the recent Clean Energy Act, Japan’s recent announcement that it will take a 30% cut in 2005 levels by 2030, etc) that they are dead serious about pushing through a revised post-Kyoto draft at Copenhagen.
At the heart of this tectonic change is a very important, never-before event: 3 billion people are coming into the world consumption mainstream. They will need lots of things, but their limited purchasing power will ensure that only they can produce for themselves or others; but that they will not allow anybody else to produce what they need to consume. However, there is one important exception to this, which, if it happens, will catapult the world to recovery, because it meets the fundamental prescription: ie, that those who are indebted, must now produce for those to whom the money is owed. The (reverse) surplus so created will pay down the debt, preventing the prospect of deflation among the savers (Asia), while creating a feel-good in the OECD, as they get to being savings and Current Account surplus.
The problem is the ‘thrift trap’ that Asia has fallen into; Japan is the most spectacular example of this. The rest of Asia is not much better, unable to consume and unable to understand the impact of this attitude on their economic welfare. Be that as it may, Asia has for the long run a deficit with the Middle East on energy costs, which were made up by exports to the West.
That Western export must, therefore, be a BOTP (Bottom of the Pyramid) product, and the obvious ones are energy and water, besides, of course, food. And that is how the US/ Europe are going to come back. The first, most obvious one is that “the cost of energy must go to zero”, which is why you must watch these Climate Change and Energy Efficiency & Conservation (EEC) developments like a hawk. This is an uncharted sector of the world economy that did not even exist at the time of the last (bubble) bust. It is the logical place for the first appearance of the fabled (but elusive) green shoots, and I will write in detail about this, once I find out myself.
The second is my current favorite theme, water. I don’t know if this monsoon has recovered, but I sincerely hope that the Govt does not forget the 50 lac people who just congregated in Lalbagh….food and water riots are a terrifying prospect, more than all the terrorism that Pakistan can put together. We need a Solar industry, that drives the Water Management industries (e.g. desalination, piping and transportation, water recycling/ treatment, sewage recycling, rain harvesting and storage systems, micro-irrigation and water conservation, dryland farming and biotech, etc.). An entire new culture has to be built around water, and we don’t even know where to start…but one of the best companies in the world, GE, has already got off the mark!!!
The third is the more obvious one, food. Assuming that we will mismanage both the above initiatives, i.e. not do enough on both energy and water, we will be faced with a food crisis. The tables will well and truly have turned then. The affluent West will produce food for us, while we do their manufacturing for them, diametrically opposite to how the Industrial Revolution started. The difference this time will be that manufacturing will be the low-margin, commoditized activity, while agriculture (the new, water-and-energy efficient, biotech-driven agriculture) will be the hi-tech, hi-margin activity. If that does not happen, Asia will get rich and the West will get poor; but the more likely prospect is that the West will innovate on all the above, while we are still fighting for our “right to pollute, and set right the inequities in the world”. We will probably win the battle, but lose the war…!!!
Remember that the existing imbalances will only be corrected when the poor start to consume (not save), while the rich start to produce (not consume). Can you imagine America as a producing economy and China as a major consumer? Both these are antithetical to the known behavior patterns seen so far, so much so that almost nobody sees it happening any time soon. But that is on existing paradigms. If we have to postulate an optimistic scenario, then the post-Kyoto industries are the place to watch.
