The Global Recession:The Way Down,

The Way Out

Peter ZeihanStratforApril 21, 2009

The Geography of Economy:The United States

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

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

The Geography of Europe Peninsulas Islands Mountains Coastlines Rivers Northern Plain Very small

space

Result:

Trade

and

War

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

Chinese Geography

Yellow River difficulty Yangtze Basin is

subtropical Coast is rugged or

muddy – few natural ports

Inland region very different culturally

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

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?

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 0

10

20

30

40

50

bill

ion

s U

SD

/ ye

ar

Free ports Asia Europe US/Oz/Canada

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)

The Way Down: Europe Total European

exposure to American ABS is probably about $100 billion

The Way Down: Europe Europe lacks positive

demographics

The Way Down: Europe Carry trade lending Foreign denominated

wholesale/retail loans

The Way Down: Europe Overexposure to

Central Europe Austria $300 billion Sweden $135 billion Greece $63 billion Italy $212 billion

The Way Down: Europe Credit binge

Freshly euroed states The benefits of EU

affiliation No debt from Soviet

era

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

The Way Down: China

Did not suffer a liquidity or financial crunch Exports, exports, exports

Cannot recover until her customers do

The Way Down: ChinaEurope down nearly 30% China down over 50%

Total Exports

50.0

70.0

90.0

110.0

130.0

150.0

170.0

190.0

210.0

230.0

250.0

Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09

EU27 (billion EUR)

China (billion USD)

Ready for the good news slide?

The Way Out: United States

MoM Inventories and Retail Sales

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

Jan

ua

ry

Fe

bru

ary

Ma

rch

Ap

ril

Ma

y

Jun

e

July

Au

gu

st

Se

pte

mb

er

Oct

ob

er

No

vem

be

r

De

cem

be

r

Jan

ua

ry

Fe

bru

ary

Ma

rch

Ap

ril

Ma

y

Jun

e

July

Au

gu

st

Se

pte

mb

er

Oct

ob

er

No

vem

be

r

De

cem

be

r

Jan

ua

ry

Fe

bru

ary

Ma

rch

2007 2007 2007 2007 2007 2007 2007 2007 2007 2007 2007 2007 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 2009 2009 2009

Inventories

Retail Sales

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

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

IssuerCDS-Implied Rating Gap

Moody's Sr Unsec or Equiv Rating Domicile Outlook

Allied Irish Banks, p.l.c. -8 Aa3 Ireland Not On WatchBank of Ireland -8 Aa3 Ireland Not On WatchEFG Eurobank Ergasias S.A. -7 A1 Greece Not On WatchErste Group Bank AG -7 Aa3 Austria Not On Watch National Bank of Greece S.A. -7 Aa3 Greece Not On Watch Piraeus Bank S.A. -7 A2 Greece Not On Watch Banco Sabadell, S.A. -6 Aa3 Spain Not On Watch DNB NOR Bank ASA -6 Aa1 Norway Not On Watch HSH Nordbank AG -6 A1 Germany DNG Natixis -6 Aa3 France DNG Rabobank Nederland -6 Aaa Netherlands Not On Watch Raiffeisen Zentralbank Oesterreich AG -6 A1 Austria Not On Watch Banco Bilbao Vizcaya Argentaria, S.A. -5 Aa1 Spain Not On Watch Banco Santander S.A. (Spain) -5 Aa1 Spain Not On Watch KBC Bank N.V. -5 A1 Belgium Not On Watch Nordea Bank AB -5 Aa1 Sweden Not On Watch Swedbank AB -5 A1 Sweden Not On Watch UBS AG -5 Aa2 Switzerland Not On Watch Barclays Bank PLC -4 Aa3 United Kingdom Not On Watch Credit Suisse Group -4 Aa2 Switzerland Not On Watch Danske Bank A/S -4 Aa3 Denmark Not On Watch Deutsche Bank AG -4 Aa1 Germany Not On Watch DZ BANK AG Deutsche ZG -4 Aa3 Germany Not On Watch HSBC Holdings plc -4 Aa2 United Kingdom Not On Watch Lloyds TSB Bank Plc -4 Aa3 United Kingdom DNG Banco Comercial Portugues, S.A. -3 Aa3 Portugal DNG Banco Espirito Santo, S.A. -3 Aa3 Portugal DNG BAWAG P.S.K. -3 Baa1 Austria Not On Watch Bayerische Landesbank -3 Aa2 Germany DNG Credit Agricole S.A. -3 Aa1 France Not On Watch HBOS plc -3 A1 United Kingdom DNG Intesa Sanpaolo Spa -3 Aa2 Italy Not On WatchNorddeutsche Landesbank GZ -3 Aa2 Germany Not On Watch Royal Bank of Scotland Group plc -3 A1 United Kingdom DNG SEB -3 A1 Sweden Not On Watch UniCredit SpA -3 Aa3 Italy Not On Watch Commerzbank AG -2 Aa3 Germany Not On Watch Dresdner Bank AG -2 Aa3 Germany Not On Watch Fortis Bank Nederland (Holding) N.V. -2 A1 Netherlands Not On Watch Fortis Bank S.A./N.V. -2 A1 Belgium Mixed ING Groep N.V. -2 A1 Netherlands Not On Watch Landesbank Berlin AG -2 A1 Germany Not On Watch Standard Chartered PLC -2 A3 United Kingdom Not On Watch BNP Paribas -1 Aa1 France Not On Watch Societe Generale -1 Aa2 France Not On Watch WestLB AG -1 A2 Germany Not On Watch

The Way Out: China Efforts to stimulate domestic demand

failingPeople who farm by hand only need so many

white goods / cars Chinese banks may not be as capital rich

as we thinkThe story of the AMCs – the $1 trillion

questionCurrent overlending – the other $1 trillion

question

The Way Out: China

Outgoing Loans of Chiense Banks (monthly)

-100

-50

0

50

100

150

200

250

300

Feb

-07

Mar

-07

Apr

-07

May

-07

Jun-

07

Jul-0

7

Aug

-07

Sep

-07

Oct

-07

Nov

-07

Dec

-07

Jan-

08

Feb

-08

Mar

-08

Apr

-08

May

-08

Jun-

08

Jul-0

8

Aug

-08

Sep

-08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb

-09

Mar

-09

bil

lio

ns

US

D

All this to hit zero percent growth?

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)

Q&A