No Depression Here

As I browsed Lehman Brothers’ Web site a few days ago, I came across fertile material for fans of irony: “The history of Lehman Brothers parallels the growth of the United States and its energetic drive toward prosperity and international prominence.”

Well, let’s hope that what’s past isn’t prologue because Lehman is no more.

Much commentary of late has been focused on the potential demise of the US economy, with many observers talking about a repeat of the Great Depression. As is often the case, the newly converted perma-bears are the most adamant on the issue.

It’s understandable that investors are looking for historic parallels in an effort to grasp the magnitude of the situation. The current mess isn’t shaping up to be anything nearly as catastrophic as the Great Depression. And it’s becoming quite clear that we’ll likely avoid such an outcome.

For starters, the Federal Reserve has been extremely proactive this time around. It’s true that its moves haven’t been met with a lot of success, but the central bank has been proactive nevertheless. It was the Fed that opened the discount window more than a year ago, but financial institutions were afraid of the stigma and didn’t embrace the effort.

When things got worse, Treasury Secretary Henry Paulson grabbed the reigns. Difficult times require strong leadership, which is what Paulson is currently providing.

There will be bickering and ridicule from the chattering classes, but positions of power entail certain responsibilities, and this is what Paulson seems to understand well.

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People also forget that America has been through crises before, and it’s also endured restructuring phases for its financial system. One crisis concerned the deposit insurance scheme, which wasn’t in place in October 1929. As a result, people lost confidence in the banking system.

This isn’t happening this time around, allowing for easier navigation while authorities inject liquidity into the system. And with the Fed’s assets at around USD900 billion, the argument of a stretched balance sheet is rather naive. Current actions will certainly hurt the balance sheet, but it won’t be demolished.

Finally, the rest of the world is willing to provide any assistance possible in order to avoid the demise of the global financial system. Most important, the world has the financial muscle to perform this task, allowing even more flexibility.

The assumption here is that politicians will stop playing games and allow Paulson to proceed with his plan. It’s no longer time for rigorous oversight; now is the time for action.

Make no mistake; the consequences of the current turmoil--particularly the loss of confidence in the system’s purported invincibility and superiority--will be long lasting. And although the US economy will remain the biggest in the world for a long time, its credibility will suffer immensely. Along with its debtor status, that will pose a challenge going forward as the US addresses other nations on economic matters. History has shown that a debtor has no luck when lecturing its creditor.

Expect foreign creditors to eventually look for some level of management control or other concessions if they continue pouring fresh money into the system.

Looking at the future of the global economy, Asia provides the best possible place for long-term investing.

A lot of people would like to forget that the current crisis started in the US. It didn’t originate in some far off emerging economy. It’s the US financial system that needs serious repair. The Asia banking sector could suffer some collateral damage, but any repercussions should be easily contained.

Because of the cathartic phase Asia passed through after the financial crisis of 1998, its financial system is now in position to not only support the domestic economies but also to give a helping hand to failing financial institutions in the US and Europe. And, of course, the US Treasuries these countries snatched up over the years allow US authorities a more flexible approach to monetary policy.

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The region as a whole isn’t facing any deleveraging issues. Banks, consumers and companies enjoy low debt levels. And there are no serious economic threats from the poor liquidity conditions and financial insolvency issues plaguing the Anglo-Saxon economic system.

From a macro perspective, although growth in the developed economies is still extremely important, a strong economic performance from the big emerging economies going forward will compensate for that. Such a scenario will also provide more time for the US to address its problems and help the global economy avoid a deep, prolonged recession.

At the same time, Asian economies have entered a cycle of capital investment, infrastructure spending and domestic consumption that’s still in its early stages. Many opportunities for the long-term investor remain. Selling Asia outright will prove to be a big mistake.

Don’t ignore the dynamism these economies offer. An aging, indebted, slow-growing economy--such as that of the US--can’t offer the desired returns of developing Asia when it comes to equity investing.

Since 2006, global emerging markets--led by developing Asia--have been at the forefront of global economic growth, and I expect that trend to continue as they increasingly using their financial strength to support structural changes in their domestic economies. 

My recommendation to buy in these markets stems from the fact that, uncertainty notwithstanding, the macroeconomic outlook will remain reasonably sound, particularly for the largest Asian economies.

Asian valuations remain very low. As I noted last week in my premium service, The Silk Road Investor, most technical indicators are stretched to Asian Crisis levels, and the region is rapidly approaching absolute trough valuations.

Investors can pick up valuable assets at decent prices, but stock selection is important. As we sort out the global economic slowdown and companies cope with slower earnings growth, I expect domestic demand-related plays to perform better.