Following the final release of February numbers, Brad Setser has an interesting piece to frame what's going on and why the "green shoots" are a fakeout from the equity bulls. It was interesting to see his conclusions align with a number of our previous posts including Japanese demand and export outlook, the true story and medium term outlook on international trade flows, and the macro factors for oil and indirectly the macro drivers on prices. However, it also got us thinking on what the future holds for trade flows.
It has been clear that the US consumer has been the driving force of the global economy and will be the constituency to lead us out of this depression. However, we can be sure that they will not be shouldering as much of the load this time due to the crushing and traumatic effects of the deleveraging process and its direct contact with the consumer. In a sign of the times, the US savings rate is FINALLY showing signs of revival and we are inclined to think that the "stable" savings plateau (once demand returns) will be materially higher than what we have been seeing recently.
The question then becomes who will fill in the gaping hole of US consumer demand? We think that by identifying the potential demand hole fillers and then actively looking for signs of recovery in that group gives the best option to call the bottom - not the lazy technicals approach to a large macro picture that seems the be the approach du jour with the Jim Cramer set. With a big sheaf of disclaimers and contingencies, we'd like to put forward two potential groups as preliminary "the next big thing(s)".
The coverage of the trauma that the Chinese have had to face while holding USDs is sufficient for a Lifetime movie. Going forward, they have a few options - as hypothetical policy makers, it seems reasonable to us that this would be a great time to finally allow the RMB to float and let the middle class enjoy some Johnny Walker Blue once or twice a year. However, this is a case where the classroom is miles away from reality. The political implications alone are sufficient to stillbirth this thing as it will become increasingly harder and harder to reconcile the effects on Chinese society and the Communist ideal. The optics alone would be traumatic; can you imagine a smiling middle class Chinese family at Disneyworld Shenzhen on the cover of the Economist? Complicating matters is the fact that most, if not all, economic data coming out of China is unreliable; attempting to generate an up to date picture will become a process of elimination i.e. (1 - rest of world).
However, the other options are not particularly appealing either. The various reserve currency ideas all fall prey to fundamentally the same problem; you can't export like mad and keep your currency weak indefinitely. It just doesn't work, much the same way that you cannot count on asset appreciation to be the main source of your wealth generation. It is unreasonable to expect an overnight change to have the current account surplus flowing to the Chinese people (and subsequently increase in Chinese demand) but the hope is that enough happens to make it matter.
This may be the opportunity for Japan to finally emerge from zombie status. The cause of the "lost decade" (and this decade too) is a big steaming bowl of zaibatsu, unsophisticated/slow/corrupt/ineffective government, a risk-averse investor mentality, and a culture being dragged, kicking and screaming, into the 21st century. We have been extremely bearish on Japan (and we still think there is more room to disappoint) but there are a number of extremely powerful factors that have the potential to finally reverse the course of the economy.
Firstly, the demographic picture is likely to generate some change solely on its own. The Japanese baby boomers are going to start dropping, and as they do so their massive savings are going to trickle down to the next generation.
Secondly, Japan has long fought the inexorable movement from a manufacturing economy to a service economy. Historically, the Meiji era was a turbocharged period that moved Japan from agriculture to manufacturing but the past 50 years have been the inverse of that for the journey from manufacturing to service. At a really macro perspective, it's astonishing that Japan has been stuck in "manufacturing" mindset and mode for as long as it has. However, our hope is that the massively traumatic drops in exports will highlight the weakness of the current system/model/mentality and will generate a combination of economic evolution and intelligent design to move Japan along.
Third, Japan's financial institutions have plodded along since the early 90s. We haven't closely been following the situation there but due to the inherent low leverage of the Japanese system, we can't help but figure that the financial system has to come out of this mess marginally better - if nothing else, at least in a comparative sense. This is a topic that needs to be closely watched and explored.
There are a few smaller factors, but those are the big ones. The decreasing Japanese savings rate has caught a lot of attention but a lot of other macro factors need to get in line before we believe that it will become sustainable. Another quick point to make is that if Japan does recover (if at least marginally) AND they allow the yen to float without central bank intervention, the resulting strength in the yen could become THE macro story for the next few years following. As the current generation of arubaito continue to mature, the potential for the Japanese to generate demand will really take off.
As we have mentioned, there are a whole host of things that could derail our thought process above. Additionally, the political and cultural aspects are critical at every level for this to happen. However, we believe these groups are worth closely keeping tabs on; at the least, no painting of a global rebound picture can occur without a firm story coming out of this subset.