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03 October 2023

The fallout from US meltdown

By Peter Cooper



New York University’s Professor Nouriel Roubini thinks the US is heading for the worst recession for 30 years, and a $1 trillion (Dh3.67 trillion) financial meltdown as the current financial crisis hits the US consumer. He told the Hedge Funds World 2008 conference in Dubai last week what to expect in a gloomy presentation.


For the record he believes the US entered a recession last December and will now endure four to six quarters of declining growth, making this the worst recession since the early 1980s and possibly as bad as 1973-4.


The NYU economist is definitely amongst the most pessimistic forecasters on the US economic outlook, but he is by no means on the lunatic fringe. Much of what he extrapolates is based on data where it is easier to see continued weakness than a sudden renaissance in activity. The nub of his argument is that US house prices have fallen by around 10 per cent and are set to decline by 25-30 per cent before bottoming out.


This will be a $6trn loss of wealth to the US consumer, and will result in total write downs of more than $1trn for the US banks. Now household spending accounts for 71 per cent of the US economy, compared for example to just five per cent for technology in 2000, so this is far more important than the dot-com crash to the economy. And it will be compounded by the ongoing credit crunch in financial markets.


Professor Roubini pointed out that securitization activity is down by 95 per cent on a year ago. Then you have to consider an impending commercial real estate collapse, the decimation of leveraged buy-out loans, the monoline insurance rating problem and over borrowing by some corporates.


According to Professor Roubini monetary and fiscal stimulation will prevent a repeat of the Great Depression of the 1930s but this will be the worst recession in a generation.


The glut of houses and cars is too high, many households will be effectively bankrupt and the unregulated shadow financial system of hedge funds and special investment vehicles will slow the recovery.
For the wider global economy his message is that the US recession will spread with similar property-driven recessions in the UK, Spain, Italy, Ireland and Portugal. Chinese exports will also dive with the US consumer buying less in the shops, and all the emerging markets will take a tumble.


The knock-on effect in energy markets will be a sharp reversion from recent record prices for oil and gas. But at the same time Professor Roubini says the Fed will cut interest rates below two per cent and possibly to zero, leading to further falls in the value of the US dollar and therefore higher gold prices.


In the Gulf States a lower oil price would be bad news for revenues, although accumulated cash piles from the past six years of high oil prices will allow government spending to continue largely unchecked. Only new projects would suffer, and with $3.4trn of work-in-progress there is already a concern that this is beyond the capacity of manpower and materials available.


However, very low interest rates would be wholly inappropriate for the Gulf and yet inevitable because of the dollar peg. As in Hong Kong this would almost certainly mean higher real estate prices.


Local stocks would also likely benefit as interest on bank accounts would plunge and discourage the holding of cash.


Indeed, the pressures on the Gulf currencies would be so intense that this might well be the death knell for the dollar peg. On the other hand, several other speakers at the Hedge Funds World 2008 event in Dubai thought that the US dollar was approaching the bottom of its recent decline.
And even if Professor Roubini is right then a series of recessions in European countries would surely start to correct an over-valued euro.


But if he has got his forecast right then sovereign wealth funds have been far too early in buying shares in global banks hit by sub prime as the worst stock declines have yet to come.


Professor Roubini notes that the S&P 500 is down 14 per cent from its peak, and expects it to at least repeat the 28 per cent average decline of past bear markets.


It looks as though the only people who will make money will be short sellers and the hedge funds, although the latter are going to have to live without the huge leverage that has helped them deliver stellar returns in recent years.


Yet even in a global recession some asset classes will do well. Gold and precious metals should benefit hugely from the tsunami of liquidity injected by the Fed to keep the global economy afloat. And that could well go for commodities in general.


For the Gulf States the outlook still looks positive. Low interest rates would keep real estate and local stock markets buoyant, while commodity price inflation would keep the cash rolling in.


There would also be some serious bargains overseas for petrodollar investors but patience is needed to wait for the best distressed bargain sales.