One global recession - multiple business cycle stories

A key international economic theme is that there is a global recession which has caused high correlation across countries, yet we believe there are multiple business cycle stories within the global story. These cycles are moving at different speeds and the key to trading currencies and international stocks is to understand the relative difference in economic growth stories across countries.

Within with the global business cycle, there are four sub-cycles that can categorize the world economies. These are inter-related but will cause economies to react different as we move through this crisis. Small differences in behavior may have a significant impact on which economy and currency will lead any recovery or be muted with continued poor behavior. Of course, some countries fall into more than one category which will lead to more complex valuations.

• The commodity cycle is still the focus of commodity currencies like the oil and metal producing countries. They have seen significant swings in price which have hurt exports in the short-run but much of the gains in price in 2007 and 2008 did not lead to significant capital expenditures in new production. These countries were able to see strong gains through an increase of the terms of trade which have now been reversed with the current decline in commodity prices. The currency impact in 2009 will be diminished as the commodity prices have started to stabilize at current levels. To some degree capital expenditures were not able to gear up during the 2008 spike, so large trade imbalances have not been created. The impact on the terms of trade was a temporary shock. Many of these countries may not see the same declines as last year. AUD, CLP, CAD, ZAR will fall into this group.

• The banking cycle focuses on countries that have had to move to bail-out banks. These shocks have lead to currency declines as central banks have monetized assets to stabilize the banking systems. The poster child for this subtext is Iceland which has seen a massive devaluation in response to the bank system failure. Other countries in this category will include the USD, GBP, and to a lesser extent EUR. Great Britain has moved to nationalization which has increased government expenditures and caused aggressive fiscal and monetary policies to offset the deleveraging of credit. The US has moved to increased the funds and credit guarantees to the banking system. The EU has seen more aggressive lending to banks. History tells us that banking crisis can last much longer than the average recessions seen in the post-WW II period. Of course, there are other countries which have not been effected by the global banking crisis. Canada has not seen any problems with banks.
  

• The industrial export cycle is focused on those countries which have seen a significant fall-off on exports as the global slowdown has hit trade. These countries are seeing plant closing and significant slowdowns industrial production. Japan has been hit hard by trade decline. The same has occurred in South Korea and Taiwan. Germany has also seen strong declines in trade. China has also seen double digit declines in exports with significant coastal plant closings. Japan has been aggressive at moving to monetary easing. While these economic hits are not trivial, the banking systems in these countries have not been faced with the same problems as the large multinational US banks. This may change but currently these economies can turn quickly if there is some trade pick-up. Here is where Canada is seeing industrial production declines becasue of a downturn in auto exports to the US.
  

• The debt cycle is associated with those countries which have excessive external debt which is placing significant pressure on exchange rates. Some Eastern European countries will be the focus of this cycle which may be hardest to solve. The debt cycle has been positive for the current account surplus countries like Japan and for those which have strong foreign currency reserves such as Brazil. Here we are seeing greater differential based on external debt, foreign reserves and roll-over of short-term debt. These countries will need international help which is less likely to be forthcoming.

The combination of mare than one cycle can have a tiered effect on some countries. Usinf Canada as a simple example, we seen it has been negatively affected by the commodity and industrial cycles but has be a benificiary of not having a bank crisis. Germany has a bank and industrial cycle to deal with in 2009. This simple classification scheme may provide some idea where we will see divergances from the high correlation of the global slowdown.