The Fall of the Dragon
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Issue Vol 23.1 Jan-Mar2008 | Date : 06 Dec , 2010

Why should developments in the American housing / subprime market in 2007 and currently continuing into 2008 be of any interest to the defense analyst ? Well … probably it’s because what’s happening in subprime today has military implications and have the potential to change the balance of power globally. It is also the reason why a defense journal in New Delhi is carrying this article.

Very briefly, the theory here is that trouble which started in the US Housing Market and which led to the subprime crisis, will now lead to a recession in America. This recession in turn, will lead to the demise of the Chinese Communist party due to massive unemployment in the coastal region of China, as Chinese exports that currently contribute to 40 per cent of the GDP will take a huge hit. The problem will get especially acute due to the absence of a strong domestic market in China. Since the only part of China that is doing well is the coastal belt (interior agrarian economy is a mess), a dramatic rise in unemployment in coastal regions will create huge law and order issues all over that country. In the massive internal strife that follows, Tibet will be set free, and democracy will return to Burma. All this is  expected  to happen over the next two to three years.

“¦Chinese Communist party due to massive unemployment in the coastal region of China, as Chinese exports that currently contribute to 40 per cent of the GDP will take a huge hit.

The paper below goes into the compelling economic and political rationale for this forecast. The following commentary is therefore an example, of how two people, if shown the same data, can come to vastly different conclusions. All data used is from the Economist, Newsweek, The Economic Times and the BBC.

Angela Merkel met the Dalai Lama in September 2007. The US invited him to Washington and the US Congress, on October 17, 2007 despite severe opposition from the Chinese government, presented him with the Congressional Gold Medal which is the highest civilian award in the United States. It was in October 2007 again that the US also imposed sanctions on Burma and two months later, in December, the US House of Representatives again voted unanimously, 400-0, to award Aung San Suu Kyi the same Congressional Gold Medal. These events look un-connected, but they are not.

Analysts do not issue a Megatrend Watch on a quarterly basis or even on a yearly basis. They issue such reports only at a possible inflection point, as they can then capture a whole big move. These events, including subprime could therefore be the first symptoms of a megatrend. Most people have failed to connect recent events with what is happening in the financial markets as they have been so conditioned to huge volatility in the markets that even a global financial crisis has got passed over as an event, that given some attention, can somehow be resolved.

US Heading for a Recession

The current financial crisis has moved beyond  the subprime market, and is now affecting not only lenders and borrowers in subprime transactions, but global liquidity itself, as the biggest banks around the world are wondering how exposed their counterparts are to junk paper. This lack of trust has occurred because subprime loans were mixed with good paper by greedy bankers and traded as Collateralized Debt Obligations that investors around the world  gobbled up. The problem is so big that even the central banks may not be able to step in and provide liquidity. Over the next few months, close to $ 1 trillion or $ 1000 billion of loans are going to be reset to higher interest rates, which in turn will create huge problems in the markets.

10 percent of the Chinese population (most of it in coastal cities) controls 45 percent of the nations wealth with the per capita income in Beijing and Shanghai at $ 4000/ year levels. But the hundreds of millions of Chinese living in villages have an average per capita income of just $ 400 / yr.

Senior economist and former Treasury Secretary of the United States, Dr Lawrence Summers has in a recent financial times article dated 25th Nov 2007 said that the crisis will move from the US housing market to credit card companies. This will hit consumption and there could be a dramatic decrease in consumption as the prices of individual homes in the United states as an asset class could fall by up to 25 percent.

On the other side of the Pacific, Professor Esuke Sakakibara has similar thoughts. In a recent oil industry conference in Hyderabad, he said that it is critically necessary to be vigilant in 2008, as US housing and subprime losses could now be substantially higher than the latest figures published by the OECD, which put the losses at US $ 300 billion. This according to Professor Sakakibara, is due to off balance sheet items like mortgage backed securities (MBSs) and collateralized debt obligations (CDOs) coming back to banks balance sheets through an option, embedded in the contract to sell back to the original financial institution which issued the paper. This, according to the professor, has serious implications for the markets.

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The views expressed are of the author and do not necessarily represent the opinions or policies of the Indian Defence Review.

About the Author

Ashish Puntambekar

is lead designer at the Design Lab in Mumbai. He is the chief planner of the Defence Economic Zone project with 23 years of experience in large Infrastructure project design.

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