Walker believes that China has been one of the biggest beneficiaries of the US easy money policy û and that China will be the biggest victim when the credit crunch bites.
In contrast, India will be a safer bet, on the back of its ôreal and return-oriented domestic demand story".
On the credit side, Walker says that the US is facing the biggest financial crisis since the 1929 Great Depression. ôThe flow of money into the real economy will inevitably be affected,ö he says, forecasting GDP growth for the US of 1.4% for 2007 and just 0.2% in 2008.
After booming on the back of AmericaÆs easy domestic credit and incessant demand for cheap goods, China will be one of the biggest victims of a sudden deterioration in US demand.
Walker blames globalisation for a phenomenon whereby capital intensive industries were the beneficiaries of US monetary policies. Prior to globalisation, the US would have built its own factories, but following the hollowing out of its own economy, they went to China. Once in China, the same poor investment decisions based on loose credit were made. Walker says this is quite ironic, given that China is one of the most labour-intensive economies in the world.
Walker adds that the credit created in the past five years has been unprecedented, and that the unwinding of this debt will play itself out over the next six to 12 months. He estimates the US will bottom out in 2010.
He does not believe the rest of the world will offset US demand, and says that Japan and Europe had already slowed in the second quarter of this year.
Walker sees portents in the current crisis surrounding British lender Northern Rock. ôWhat is happening at Northern Rock in the UK is very, very important. They were borrowing commercial paper and lending at 30 years.ö
Northern Rock is a building society, traditionally one of the safest financial institutions in Britain. However, Northern Rock has been an aggressive mortgage lender, with its loan book expanding by 43% year-on-year.
By the end of the year, however, its loan book will have only grown by 9%. The balance will have been passed on to other banks. This will bloat their balance sheets and diminish their ability to lend.
Special investment vehicles and conduits, used for off-balance sheet activities, will also be inexorably drawn back on to banksÆ balance sheets. That will crimp growth and hammer bank earnings.
Commercial paper, a crucial funding tool for all kinds of companies, is already drying up.
According to Walker, in the three years following the dot com collapse in the US, commercial paper issuance decreased by 22%. In the past four weeks, itÆs already down 14%. ôThis is the biggest credit crunch ever,ö he says.
Interest rate cuts by the Fed, estimated by CLSA to be 25 basis points on September 18, will æonly be chasing the marketÆ. Walker says the Fed essentially doesnÆt matter anymore, since although three-month treasury bills are moving down, commercial paper rates are soaring.
Banks are only too aware of the weak points in their own balance sheets to want to risk lending to their peers û whom they will assume to be in as bad or worse shape. The Fed is also constrained by fears the dollar will collapse if interest cuts are too deep. This could lead to inflation without stimulating growth.
Walker estimates that ChinaÆs industrial build-out over the past 10 years has been paid for by loose US monetary policy, as well as the undervalued currency. Underpriced inputs, from bank loans to commodity prices, have also been a factor.
In particular, real interest rates have been so low, that investment hurdle rates have been rock bottom û encouraging æmalinvestmentÆ and risk-taking. ôItÆs difficult to see how much the economy has been distorted by inadequate pricing signals."
China has real interest rates of just 1%, also fuelling asset bubbles in real estate and the stock market.
Walker is far more bullish on India, with a strong domestic demand story, and nominal interest rates of 13%. ôFactoring in inflation, you have interest rates at 7%. That provides a far superior hurdle rate to what is going on in China.ö
While Chinese GDP growth will come in at over 11% this year, Walker believes it could slow to 5% in the second half of next year, triggering a ôgrowth recessionö. ôChina has been relying on above-trend global growth. When that slows, there will be a serious supply-demand mismatch,ö he says.
In fact, given the speed at which fixed asset investment is producing supply in China, Walker estimates that China needs global demand to accelerate just to maintain its current growth rates.
A sharp revaluation of the renminbi could be in ChinaÆ s interest, as it would help slow the economy, reduce exports, empower the domestic consumer and tilt the economy towards a more sustainable framework.
However, Walker believes that a revaluation of the renminbi would be highly unlikely in an environment where global growth is slowing û if anything, the central bank will be looking to depreciate the currency, he estimates.