LAST Thursday evening, the focus of the TV show IMPACT on TVJ was on the “Crisis in the Global Financial Markets and the Implications for Jamaica’s Economic Prospects”.

IMPACT is correct to focus on this issue. The structural headwinds from the end of a six-decade global developed country debt super cycle will eventually affect every Jamaican. In the developed world, on which we in the Caribbean still depend, all the economic numbers are far below every typical economic recovery since World War II. The over-leveraged US consumer is basically now being forced to save, in a process that will take many years, weakening final demand by households on a structural basis. It would not be an exaggeration to draw a biblical analogy that the seven fat years of the credit boom that ended in August 2007 will be followed by (at least) seven lean years.

This is because the developed world is now facing, simultaneously, a public sector government debt crisis, a central bank funding crisis (particularly in Europe), and an equity capitalisation crisis (meaning that leverage is still too high) in many first world banks with the significant exception of Canada.

In 2009 we had a global financial crisis due to the indebtedness of private households. Countries such as the US, the UK, Spain, and Ireland all suffered from a banking crisis as predominantly real estate loans went bad. Extremely stimulative fiscal and monetary policy helped to prevent a 1930s type of systemic breakdown, but at the price of severe damage to the balance sheets of countries such as the US and the UK. As occurred in Jamaica, the damage from the financial crisis has also now paved the way for multiple sovereign debt crises around the world.

The so-called economic recovery in developed markets has been driven by a massive fiscal expansion, amplified by an inventory swing from restocking after the huge panic inventory liquidation of late-2008. Even if we don’t see an actual double-dip, where the US economy goes back into recession over the next six to 12 months, it will still feel like one — a very choppy, sloppy economy, with high underemployment. There will be some further forced de-leveraging, but the de-leveraging process will be slower than in the past few years as most of the decline in the US housing market is behind us.

Regional debt markets still OK

In an exclusive interview, Oppenheimer’s Dr Carl Ross — a world expert in emerging markets — argued that despite the massive sell-off in the emerging market, (stock markets of between 10 and 20 per cent depending on the market) holding up fairly well.

The price of the debt of the more credit-worthy countries, such as Brazil, was only down a few points (in sharp contrast to their stock market), so that in absolute terms their interest yield had risen only slightly despite an absolutely brutal stock market sell off. Their interest rate spread over US treasuries had risen a bit more because of the sharp rise in the price of US treasury debt, ironically making it more valuable after the S&P downgrade.

Even for riskier markets, such as Venezuela and Argentina, whose debt had been hit harder, Dr Ross said he was now seeing people dipping in their toes, attracted by yields as high as 15 per cent in the case of Venezuela, which was far above US 10 year treasuries which yield less than 2.5 per cent.

He believes that with the Fed pre-committing to keeping interest rates low into mid-2013, this should make it attractive for investors to buy dividend paying stocks, as well as making the opportunity cost of holding gold as a hedge near zero.

Interestingly, Dr Ross notes that the Caribbean bonds that his Atlanta Oppenheimer office focuses on have also traded relatively well, falling only a few points on average. For example, the Jamaica 2019’s had traded down to a price of around 104 (well above their issue price) on extremely light volume.

Worried about the US economy

Dr Ross was however concerned that the United States had not yet started what he saw as an inevitable programme of fiscal austerity. In Dr Ross’s view, the election debate in the United States is going to be about “what am I going to take away from you”, which cannot be good for confidence.

Austerity will be the new world order

Throughout the developed world, fiscal policy has been extremely stimulative, but those positive factors have been spent, and we have now entered a situation where fiscal policy is turning negative.

Fiscal policy was already more restrictive in Europe than the US, with IMF style austerity programmes in those countries with a debt crisis — Greece, Ireland and Portugal — and fiscal cuts in Spain and now Italy. In the US, fiscal stimulus has become a net negative for the economy (a small decline), from the beginning of this year.

Some believe it is this fiscal drag that is responsible for the disappointing economic trends that we see in the US economy, not monetary policy, which in any case can do no more. The current political environment of the debt ceiling debate means fiscal policy cannot become more stimulative. One will therefore see continued economic disappointments in the US, Japan, and Europe. These will surprise the investment community, and will be the main factor driving equity markets.