The Future of US Economy

A few months ago sudden cracks started appearing in the US economy hinting of an end to years of economic expansion. It only took a short while before the whole US, and subsequently the global financial systems started crumbling, sending shockwaves around the world.

The media is full of analyses and commentaries about possible reasons and for the collapse of the banking system and the economic downturn. There is not a day that goes by without debate on whether we are paying for our excesses or that we are unfortunate victims of the greed of a select few. Such debates are necessary. In fact, it’s incredible to analyze and find out why an institution like Bear Sterns went from having $18 billion on the books to a deficit of $30 billion in one week. Such a dramatic freefall warrants investigation.

What’s more interesting, however, is the simplicity of the problem. The fact that most people start pointing fingers during hard times is only normal but to get a real understanding of the events, one needs to sit back and determine the role that each and every one of us including our government has played in creating this mess. The fact is, that the heart of the capitalist society beats by spending and that every aspect of our government and our economy has been designed to encourage spending. For years all of us developed the habit of spending more than our means. Every time we desired something and could not afford it, we took on debt to pay for our consumption. The government, on the other hand, would reduce interest rates at the first sign of any distress, artificially boosting valuations for years. As such, we were able to afford to make bad financial decisions. The value of our homes would jump 20% per year, fueled by speculation and low borrowing costs. Eventually all this needed to stop and stop it did.

As Fareed Zakaria mentioned in the 10/20/2008 issue of the Newsweek magazine: “Under Alain Greenspan the Federal Reserve obstinately refused to inflict any pain. Russian default? Cut interest rates. Worried about Y2K? Cut interest rates. NASDAQ crash? Cut rates. The economy slows after 9/11? Cut rates.” The final blow to the hole system was the prolonged boost that was given to the housing market spinning the problem so far that it was almost impossible to tackle.

Like any responsible society, we now need to look at where we stand and where we want to be tomorrow. It’s not constructive anymore to find someone to blame for the problem. What’s constructive is to envision a future for us where we can live respectfully within the international community: Less arrogant and more productive. Mistakes of previous administrations have been made and the damage is already done but the US is still a large, efficient, modern, and vibrant economy. It is still the wealthiest economy in the world. As Zakaria mentioned: “It’s a different world out there. If Iraq cast a shadow on US political and military credibility, this financial crisis has eroded America’s economic and financial power. In the short run, there has been a flight to safety but in the long run, countries are likely to gain greater independence from an unstable superpower. The United States will now have to work to attract capital to its shores, and manage its fiscal house better. We will have to persuade countries to join in our foreign endeavors. We will have to make strategic choices. We cannot deploy missile interceptors along Russia’s borders, draw Georgia and Ukraine into NATO, and still expect Russian cooperation. We cannot noisily denounce Chinese and Arab foreign investments in America one day and then hope that they will keep buying $4 billion worth of T-bills another day. We cannot keep preaching to the world about democracy and capitalism while our own house is wildly out of order.”

Hunger for Power in the GCC

With the unprecedented economic growth and the construction boom of the Gulf countries comes an unprecedented appetite for energy. According to a recent estimate by Moody’s, the GCC will need an investment of $35 billion for the 10 years to keep up with the energy demand.

The states have been very smart about how to make such investments. Considerable attention is paid to ensuring that capital often flows into projects and companies that both contribute to local infrastructure and transfer intellectual property and know-how to the region.

Our projection is that solar power shall prove to be a dominant long term source of energy for the region. It is both abundant and with the right technology its economically feasible to produce.

Is the US Dollar Reversing Course?

There are pros and cons for a weak Dollar. Its effects on exports and consequently the US GDP during these hard economic times are clearly a plus. On the flip side, it can be cause for inflation both within and outside the United States. Internationally speaking, countries with currencies pegged to the US Dollar have the most to lose.

As the USD deteriorates in value such countries lose relative purchasing power of their currencies and their economies can feel inflationary pressures. In recent weeks, however, the Dollar has been showing some signs of recovery, which has brought some relief to Gulf countries. "The strengthening dollar is good for the Gulf region because it will reduce the imported inflation in the region and it also increases the purchasing power of the regional currencies." said Monica Malik, Director of Economic Research, EFG Hermes, a regional investment bank.

The slowdown in Euro economies has been more than anticipated by policy makers and if continued such trends can strengthen the US Dollar even further. Good news for those Americans who were postponing trips to Europe for fear of big dents in their checking accounts.
"Both the dollar weakness and the interest rate cuts have been painful for the GCC countries, but now the worst is over. However, it is in the interest of the regional economies to have greater flexibility in monetary and exchange rate policies to meet the needs of the regional economies," said Malik.

GCC Investment Opportunities must not Be Overlooked

While there is considerable enthusiasm surrounding every move made by rich Middle Eastern sovereign funds, capital movements in the opposite direction must not be overlooked. The Gulf Cooperation Council (GCC) Countries represent one of the fastest growing regions in the world.

While the US economy has stalled, the global economy has expanded at 4% to 5% annually for the past 5 years, according to the National Real Estate Investor. Worldwide, the number of high-net-worth individuals grew 6% in 2007 to more than 10 million. In the same period the number of people with more than $30 million in assets grew more than 8% to over 100,000. According to the World Wealth Report, published by Merrill Lynch and Capgemini, the assets of the wealthy are expected to grow by 7.7% annually to $59 trillion in 2012. Most of this growth is expected to be in rapidly expanding economies like those in the GCC.

As discussed in my previous posts, the regional governments have been very smart in how they spend the wealth generated from increased petroleum revenues. Considerable capital has been invested in critical infrastructure and industry, slowly but surely, transforming the region into a hub for trade, business, tourism, and finance.

The Goldman Sachs Group is one among many of the Western institutions that has been aware of such opportunities. In a recent move, the group launched a new proprietary fund to invest in select assets in the Middle East.

Recent Move by a Middle Eastern Sovereign Fund

In early August the Oman Investment Fund, the investment arm of the sultanate of Oman, acquired 50% partnership in Jurys Inns.

Jurrys Inns had been acquired by Quinlan Private, the international private real estate group back in 2007 and since the acquisition, Quinlan Private has expanded the group significantly opening new locations. The recent acquisition by Oman Investment Fund, gives it an equal representation on the Board of Jurrys Inns as Quinlan Private.

State investment funds such as the Oman Investment Fund, are actively seeking international investment opportunities and seek financially attractive deals where the investment can yield superior long-term returns.

Booming Economies and Increased Expenditure on Luxury Goods

When levels of expenditure on luxury goods rise, it is usually an indication of booming economies. Money has to be abundant before citizens can afford the luxury of private jets or residential palaces. Such is currently the case in most Gulf Cooperation Council (GCC) countries.

US financial institutions are well aware of this wealth effect. Citigroup, for example, was recently said to be discussing eight to ten private aircraft financing deals worth more than $400M. Private jet purchases in the GCC have doubled in the last 24 months from 43 in 2006 to 86 in 2008.

Purchases that might have seemed too extravagant a few years ago are now becoming common place in the Middle East. This all is good news to sound and strong US businesses. The cash rich GCC states have been a major source of capital for Western conglomerates in today’s hard economic times.