The Global Recession: The Way Down, The Way Out

1. The Global Recession:The Way Down,The Way Out Peter Zeihan Stratfor April 21, 2009

2. US maritime transport network Mississippi/Missouri/Ohio/ Red/Tennessee Ragged coastline (Intercoastal and San Fran) Contiguous Midwest Lack of security competition Canada -- too cold, only useful maritime network is shared Mexico -- too dry/mountainous, no maritime network The Geography of Economy:The United States

3. American Implications: Free Market • Easy work – building a transport network – is already done • Lack of security needs frees up resources • United States extremely capital rich • Lack of any pressing national requirements allows capital to flow wherever the market decides

4. The Geography of Europe Result: Trade and War • Peninsulas • Islands • Mountains • Coastlines • Rivers • Northern Plain • Very small space

5. European Implications: Chaos and National Plans • No clear sovereign • Different geographies tweak governance demands and tools in different directions • Collectively Europe has a fairly good natural transport network making it moderately – but unevenly – capital rich • The German example: • Rivers and coasts not naturally integrated, all shared • Successful economic development means integrating with security competitors and compensating for a complex geography • Germany must have a national development plan for the allocation of capital

6. Chinese Geography • Yellow River difficulty • Yangtze Basin is subtropical • Coast is rugged or muddy – few natural ports • Inland region very different culturally

7. Chinese Implications: Subsidized Finance • Result is a country that isn’t deeply integrated and doesn’t hold together well • Unification becomes a political imperative, but is a geographically complicated task • Must use infrastructure (expensive!) to attempt to bridge the differences and exert central control – the costs make China capital poor • Need to give the regions incentives to defer to the center => economic development via (very) cheap money

8. Chinese Implications: Subsidized Finance • Maximize employment, firm size, market share, activity and throughput • Capital pooled into the state’s hands, funneling it to achieve national goals; interest and payments negotiable • Debt levels, profitability and return on capital irrelevant • Remember Japan?

9. Japan is the Best Case Scenario • China’s banks are far worse off than Japan’s (minimal international exposure) • China is the most financially penetrated state in Asia (save Taiwan) • China has (so far) burned over $600 billion in attempting bank bail outs • No Chinese NPLs have been disposed of

10. The Way Down: The United States • Subprime trigger • ABS scared banks • Result was a liquidity crunch that has since been corrected • Now ‘just’ a ‘normal’ recession • No systemic weakness in the American system (not even in housing)

11. Total European exposure to American ABS is probably about $100 billion The Way Down: Europe

12. Europe lacks positive demographics The Way Down: Europe

13. Carry trade lending Foreign denominated wholesale/retail loans The Way Down: Europe

14. Overexposure to Central Europe Austria $300 billion Sweden $135 billion Greece $63 billion Italy $212 billion The Way Down: Europe

15. Credit binge Freshly euroed states The benefits of EU affiliation No debt from Soviet era The Way Down: Europe

16. The Way Down: Europe • EBRD already estimates that over 20 percent of all loans in Central Europe are non-performing • Spanish NPLs already at 4 percent • No meaningful program to address banking failures has begun

17. The Way Down: China • Did not suffer a liquidity or financial crunch • Exports, exports, exports • Cannot recover until her customers do

18. The Way Down: China Europe down nearly 30% China down over 50% Ready for the good news slide?

19. The Way Out: United States MoM Inventories and Retail Sales

20. The Way Out: Europe • Germany is taking the long view • High-value export-oriented economy means local stimulus will not work, so why try? • Banks take long-term corporate view – as opposed to short-term retail – so are not bearing brunt of recession • September election and EMU limit options • Impose conservative German lending policies on the rest of Europe • Negligible effort to addressing the wider banking problem

21. The Way Out:Europe • General recession now shifting the burden to non-capital market banks • So even those who were healthy are now coming under extreme pressure • Banks far more important for capital generation in Europe than in the US, and so they get hit much harder in recessions

22. The Way Out: China • Efforts to stimulate domestic demand failing • People who farm by hand only need so many white goods / cars • Chinese banks may not be as capital rich as we think • The story of the AMCs – the $1 trillion question • Current overlending – the other $1 trillion question

23. The Way Out: China All this to hit zero percent growth?

24. Sichuan: The Place to Watch • Inland (poor, worst run banks) • Large source of migrant labor (which is returning home) • Absorbing migrant labor from Tibet/Xinjiang (which is being sent home) • Mixed ethnically (much Han resentment) • 2008 earthquake (recovery botched)

25. Q&A