2012 Second Half Outlook: The Butterfly Effect Returns

2012 Second Half Outlook: Introduction: Psychology & Sentiment

2012 Second Half Outlook: European Debt Crisis Catalyst

2012 Second Half Outlook: The Butterfly Effect Returns

2012 Second Half Outlook: US Consumer Credit Growth Potential

2012 Second Half Outlook: US Employment & Income

2012 Second Half Outlook: Asset Prices Today

2012 Second Half Outlook: Policy Response & How To Invest

The following picture provides a great visual of just how interconnected our global economy is today. It shows that over 50 percent of the global trade now runs through Europe.

This means that austerity cuts in the PIIGS (Portugal, Ireland, Italy, Greece, Spain) have an impact on factory workers in India and China. The impact on those factory workers has an impact on investment demand in the United States and Brazil, and so on it goes. The PIIGS economies make up over 5% of global GDP seen in the following chart.

As Europe moves into recession, the butterfly effect has washed onto the shores of two of the largest economies in the world: India and China. The following graph shows India’s GDP collapsing downward to only 5.3%, below the 2008 financial crisis lows and the lowest level in 9 years.

The problems in China are even greater. Beginning in 1990, China built their economic model around export led growth. They did this by providing goods at a low price (through extremely low wages of Chinese workers) and artificially manipulating their currency to stay competitive. This model worked beautifully until the main purchaser of these goods, US consumers, hit a brick wall in terms of their ability to take on additional debt and spend (we will cover this topic in detail in just a moment).

As exports began to collapse in late 2008, China faced a serious problem. International newspapers reported that 20 million Chinese factory workers lost their jobs and were forced to return to the countryside to look for work as agricultural laborers. China needed a way to keep the economy growing until exports picked back up and they responded with the growth of credit through the banking system.

China allowed the total number of bank loans to grow by 60% over a two year period beginning in 2009. This number is staggering. Money flowed or was channeled into massive real estate projects. Visitors in China’s largest cities over past few years always reported seeing hundreds of cranes filling the skylines. China began to build empty cities and enormous empty malls. The factory worker jobs were replaced with construction based jobs.

Over 25% of China’s GDP is now related to the construction industry. Over the past 8 months there have been problems emerging for this “economic miracle." Real estate prices, which had been surging in price due to the massive credit expansion, have now reversed and are falling. Developer loans for massive projects built for future growth now sit empty and the loans are delinquent. The cranes that once flooded the skyline are now slowly disappearing as the massive effect of overbuilding takes hold.

China is now in serious trouble. They have have an oncoming banking crisis and an economy that is searching for its next form of growth. They are looking for the next “economic miracle” just as Japan was after their real estate bubble burst in 1990. Recent manufacturing data (their PMI) show a continuous and worrisome decline.

China’s goal was to buy some time until their global export model moved back into high gear allowing real estate workers to shift back into factory workers. In order for that to happen, the consumers of the largest economies have to once again be both willing and able to borrow and spend. We have already discussed the outlook for that prospect in Europe. We will now look at the United States .

Up Next: US Consumer Credit Growth Potential

h/t Sober Look, Richard Duncan