Download Albert Edwards – Dollar Appreciation and a Global Recession

Albert Edwards – Dollar Appreciation and a
Global Recession
January 19, 2016
by Robert Huebscher
As the equity markets have suffered their worst performance ever to start a year,
we’ve heard the familiar refrain from the chorus of sell-side analysts: Don’t panic,
the economy is fine and the markets will recover. Among the few who are warning
that things could get worse – indeed, much worse – is Albert Edwards.
Edwards spoke at Societe Generale’s annual global strategy conference in London
on January 12. Edwards is the firm’s global strategist.
The underlying source of Edwards’ pessimism is the continued appreciation of the
dollar. This has “crushed” the competitiveness of U.S. corporations – mimicking the
1997 Asian conference but on a global scale.
In a recent note to Societe Generale’s clients, Edwards wrote that the U.S. just experienced a cyclical
bull market within a secular bear market, and the bear market has not ended.
“If I am right,” Edwards wrote, “the S&P would fall to 550, a 75% decline from the recent 2100 peak.”
No thawing in the ice age
Edwards has been right over the long term. In 1996, he predicted the beginning of an “ice age,” during
which equites would underperform bonds.
The chart below compares the returns of 10-year bonds to the S&P 500, including reinvestment of
dividends and coupons, beginning in 1996:
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Every time the returns look like they are about to converge -- as was the case, for example, in 2007 -equities underperform and the ice age endures.
Edwards said that quantitative easing (QE) is driving the instability in the financial markets. As the
U.S., Japan and Europe have used monetary policy to reduce interest rates, money is flowing to
emerging markets (EM), commodities and fracking in search of higher yields.
“Now,” he said, “it is all turning bust.”
Europe is facing its own set of QE-induced problems. France, Edwards said, is the “real problem.” “I
cannot conceive that only 10 years ago French unemployment was not only below Germany’s, but
substantially below it,” he said. This is because unit labor costs are converging across Europe, except
in Italy and France where, Edwards said, they are “far too high.” Nonetheless, Edwards said French
equities might do well, even though economically things are looking very poor.
“Draghi’s QE will not inflate the economy,” Edwards said. “The one thing that will work is devaluation.”
While the euro has dropped against the dollar, it has been fairly stable against a trade-weighted basket
of currencies. Essentially, most countries have been able to devalue against the dollar, but not against
each other.
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Spain is on the verge of slowing down very sharply, Edwards said, and Italy and Portugal cannot
tolerate another massive recession. “If that happens,” he said, “it will be curtains for the Eurozone.”
In the U.S., Edwards said that manufacturing is weakening and “inevitably the service sector will
follow.” The appreciation of the dollar is the cause, as it has made exports less competitive and
reduced revenues and profits from non-U.S. markets.
The dollar has risen as much as the yen did in the mid-1990s, which Edwards said was very
significant. The U.S., prior to the dollar’s rise, and Japan, in the mid-1990s, were relatively closed
economies; the exchange rate had minimal impact on inflation and growth. Yet when the yen rose, it
tipped Japan into deflation and caused problems for its banks. Even in sectors of the economy where
importers had a small market share, companies became the price setters for the entire economy, he
said.
“A rise in the exchange rate can tip you into deflation far faster than the economists say. Japan is a
real lesson for us,” Edwards said.
The biggest problem
The most important development in the financial markets is the shrinkage in EM reserves. Last year
was the first year ever that the EM, in aggregate, was in capital account deficit.
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The biggest driver was the Chinese corporate sector, Edwards said, which paid off much of its dollardenominated debt. China can’t devalue too fast without creating instability in its corporate sector.
Renminbi devaluation would make it harder to repay dollar-denominated debt. By following this path,
Chinese deflation will be exported elsewhere, Edwards said.
China looks like it has a nominal growth rate of zero, he said. “It feels like a hard landing.” China’s
growth has been driven by its financial sector. But as domestic borrowers have lost confidence in its
policymakers, demand for credit has dropped, and “that is the shape of things to come for the U.S. and
the Eurozone,” he said.
Edwards described these developments as a “mini-repeat of the 1997 Asian crisis.”
“Can it get worse? Of course it can,” Edwards said. World trade was flat in Q4, and he said that
ominous sanctions are being imposed. Just before Christmas, the U.S. imposed a 256% tariff on rolled
steel imported from China.
“Developments in the currencies will push the U.S. and global economies back into global recession,”
he said. “The financial crisis will reawaken. It will be every bit as bad as it was in 2008. It will turn very,
very ugly indeed.”
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