Hard lessons on confidence

--No decoupling --US consumers had been irrational, now are being forced be to rational --US dollar remain the reserve currency --big government is not over yet --Confidence is a fragile commodity, hard to earn and easy to lose Insight: Hard lessons on confidence By Joseph Quinlan Published: December 29 2008 16:03 Last updated: December 29 2008 16:03 This year has dished out a number of painful lessons for investors. Here is a sample of what we have learnt: Lesson 1: Like it or not, we’re all connected. Amid the global market meltdown in 2008, one thing has become clear: the debate about global decoupling is over – and the “decouplers” lost. There was a great deal of chatter this year about various parts of the world being immune to a US recession. The “decouplers” were emboldened by robust growth prospects in emerging markets, and by the expectation that Europe could hold its own in the face of a US downturn. Reality, however, has been different. Heading into 2009, the global economy is in recession. The lesson is that in a globalised economy characterised by rising cross-border flows of goods, services and capital, everyone – more or less – sinks or swims together. Lesson 2: The US consumer is rational after all. The US consumer has long been considered one of the most indestructible forces on earth. For many US households, living beyond one’s means has been standard, supported by rising home prices, bulging credit card debt and minuscule savings. The bursting of the dotcom bubble, 9/11, soaring petroleum prices – none of these forces could slow the pace of consumer spending and the myth was perpetuated that nothing could keep American consumers from the shopping malls at weekends. The US consumer, however, is more of a rational beast after all. The consumer is in retreat owing to falling home values, shrinking retirement accounts and the prospects of rising joblessness. The good news is it’s high time for overleveraged Americans to take a break. But the bad news is that until an alternative source of demand emerges, a frugal US consumer spells trouble for many export-driven countries. Lesson 3: The US dollar is hardly a banana republic currency. It was not that long ago that many were writing it off. The greenback was toast, with many in the Middle East and Russia hoping to be paid in euros. The debt-laden US was a spent force, so went the verdict, with the falling dollar the emblem of US decline. Yet, not for the first time, the demise of the dollar has been greatly exaggerated. As the global credit crisis has spread, the attendant flight to quality has triggered a surge in demand for dollar-denominated assets. Despite Wall Street’s being at the centre of the world financial crisis, the dollar has risen this year against the pound, many emerging market currencies – and even the euro. The buck’s strength underscores the safe haven status of the dollar in times of turmoil. The simple truth is this: by design and default, the US dollar remains the world’s currency of choice. Lesson 4: Big government is far from dead. All talk about the “death of capitalism” is just that: talk. But there is little doubt the role of government – in the US and abroad – is set to become larger. The “commanding heights” of the economy are shifting away from the tenets of privatisation, deregulation and free markets and towards more public sector regulation and ownership. Just how big a role the public sector will play in the future remains unclear. It is this uncertainty that has investors on edge. To be fair, government participation is part of the solution to what ails the global economy. The global credit crisis would be even more severe without massive aid from the public sector. That is the good news. The bad news: big government could increase the cost of doing business and undermine the entrepreneurial spirit of many economies. Lesson 5: Confidence is a fragile commodity. The most valuable lesson of 2008 lies with just how precious a commodity it really is. Confidence is hard to earn, easy to lose. Once it is shattered, putting the pieces back together takes a great deal of time and trust. It is the lack of confidence in the global financial system that has driven the global economy into recession and brought the global financial markets to their knees. At present, banks still aren’t fully confident about lending to one another or to qualified borrowers. There is still too much mistrust hanging over the global financial system. Not until confidence is restored will the global economy find its footing and the world financial markets find a bottom.