Pray that this lightning bolt doesn't hit the spot

PUBLISHED : Wednesday, 16 December, 2009, 12:00am
UPDATED : Wednesday, 16 December, 2009, 12:00am

There's an old saying that lightning never strikes twice in the same place.

It's not true, but doubtlessly, anyone who has survived being hit once earnestly wishes it were.

Richard Duncan has mixed feelings on the topic. In 2003, the Hong Kong-based fund manager achieved a notable lightning strike of his own when he published a book called The Dollar Crisis.

In that work, Duncan argued that the United States' credit-fuelled consumption boom was a bubble inflated by the financial sector.

He hit the nail right on the head when he warned that the proliferation of asset-backed securities was freighted with moral hazard because the new instruments allowed 'the originators of the loans to enjoy most of the benefits of lending money without bearing the risks'.

These were being transferred to the investors who bought the securities and who would one day suffer for it, 'particularly since subprime home-equity loans have become the fastest-growing sector of the ABS market in recent years'.

Duncan rightly predicted that the crisis would come 'when the US property bubble pops'. Falling house prices would force US consumers, long used to financing excessive spending by borrowing against the rising value of their homes, to tighten their belts. Aggregate demand would fall, and US appetite for imports would drop by several hundred billion dollars, throwing the rest of the world into a painful recession.

Six years on, Duncan, now living in Bangkok, has another book out. In The Corruption of Capitalism, he re-examines the causes of last year's financial crisis and searches for possible solutions. For Asia, his conclusions this time around are even more disturbing than they were in 2003.

Duncan blames last year's crisis squarely on an unsustainable appetite for debt in the US. 'America just doesn't work the way it is currently structured,' he says, pointing out that over recent years, the US economy has required an ever-increasing volume of credit growth to generate more or less the same volume of output growth (see the first chart below). When the bubble burst, a contraction on the scale of the 1930s Depression was averted only by a drastic increase in government debt to support the economy.

Now Duncan argues the US has a choice: The government continues borrowing to keep activity ticking over with stimulus spending, much as Japan did in the 1990s; alternatively, Washington can take advantage of its ability to fund deficits in its own currency and borrow even more to invest in growth industries of the future.

Instead of borrowing US$7 trillion over the next 10 years as the Congressional Budget Office envisages, Washington should borrow US$10 trillion and invest the extra in developing solar energy, biotechnology and nanotechnology. Duncan says his strategy would slash the trade deficit 40 per cent through eliminating US dependence on foreign oil imports and gain America 25 years over its competitors in new technologies.

'It would solve the crisis permanently,' he says.

Alas, Duncan holds out no such hope for China's future. In his new book, he argues that although China's trade surplus with the US amounted to only 6 per cent of gross domestic product last year, when you factor in investment in export industries plus consumption by export-sector employees, altogether about 40 per cent of China's economy depends on exporting to the US.

When that engine broke down last year, Beijing's response was to support growth with an unsustainable credit expansion of its own (see the second chart).

'China's stimulus is like drinking a quart of Red Bull. When it wears off, you have to drink two quarts to keep going. Either way, you get sick,' Duncan argues. 'The biggest misconception in economics today is that China can continue growing at 8 per cent a year. Every bubble has to burst, and China is no exception. The prospects for the economy are terrible.'

Duncan's views today are just as unfashionable as they were back in 2003. Unfortunately, he was right then, so let's just hope the old saying proves correct for once, and that in this case, lightning doesn't strike twice in the same place.