Greg Fleming, Future president of investment management at Morgan Stanley
While financial markets are improving across the globe, economic power is shifting as the BRIC countries grow in both size and influence.
Approximately 12 months after the financial crisis reached its apex - or nadir depending on your perspective - the best news in the global economy is the fundamentally better condition of the markets. On the whole, it is clear that the crisis of confidence in the financial markets has been addressed.
The palpable fear that stalked the system following the Chapter 11 bankruptcy filing of Lehman Brothers created, for all intents and purposes, a liquidity-run across the funding markets. Stung by the losses incurred as a result of the Lehman bankruptcy and the uncertainty of where the risk might manifest itself next, creditors throughout the funding spectrum - the repo markets, term lending, prime brokerage - pulled back from financial projects of all kinds and the wholesale funding credit wheel ground to a halt.
Today, the crisis in the financial markets has mostly abated. Rates on borrowing between financial institutions, reflected in the London interbank offering rate (or Libor), which had spiked to as much as 500 basis points over Treasury bills during the autumn of 2008, are back to more normalised levels of 10 to 20 basis points. Financial institutions in the US are once again raising term debt without Federal Deposit Insurance Corporation guarantees. Commercial paper markets have returned to more normal functioning without Federal Reserve involvement. Higher-risk assets across the product spectrum have snapped back in value, boosting returns for investment managers and pushing many hedge funds back above their high watermarks. In short, government efforts to eliminate the fear and uncertainty gripping the financial markets and to create a more stable backdrop for the most part succeeded at the end of 2008 and the first part of 2009. Volatility remains, but it is likely to continue to decrease as time goes on and confidence builds.
The broader economy in the developed markets, and in the US and the UK in particular, is in a much more problematic state. The US consumer, still the single largest economic driver in the world - some economists estimate the US's economy is still three times the size of China's - continues to grapple with significant headwinds. Unemployment in the country is approaching 10% - higher in some states - and getting the rate back down looks more challenging in this cycle than at any point since the 1970s. To significantly reduce the unemployment rate, gross domestic product growth would need to rise consistently in excess of 3%, an expectation that looks difficult to achieve in this rebound.
Savings rates are higher, which is essential for the long-term health of the US economy, but again takes buying power out of the economy in the near term. The impact on the major exporting economies such as China of a lagging US consumer sector will be more significant than many expect, and the key challenge for China will be to find consumers for the productive capacity it has built. Perhaps over time it will be the Chinese themselves, although it is difficult to convince people to decrease savings rates where there is little or no social safety net.
So what lies in store for the global economy? Three major trends will play out over the coming years: consumers, businesses and ultimately governments will continue to reduce leverage in developed economies; business - and wealth creation - will continue to be increasingly global in nature; and financial services companies will strategically respond by investing in wealth management capabilities while building their presence in Brazil, Russia, India and China - namely, the fast-growing BRIC countries.
The march to zero
First, the trend to less leverage across developed societies will continue. One of the major positive changes wrought by the destructive nature of the financial crisis is a more conservative approach to leverage on the part of many across these countries. Beginning at about the time of Ronald Reagan's election to a second term as president around a theme of 'morning in America', savings rates for Americans began to fall from between 8% to 10% of personal disposable income to effectively zero by the year 2000. The decrease in savings rates was an inexorable steady march toward zero as Americans attempted to sustain their standard of living.
Ultimately, the last leg of the leveraging of the US consumer was the equity in their homes, tapped for enormous sums in the first decade of this century. Even in a developed society such as the US, savings rates of zero are not sustainable, and the cost of this will ultimately be borne somewhere in the society as people retire without sufficient income to support themselves or, in many cases, run into trouble well before retirement and look to the government for some kind of assistance.
About turn: Lenovo bought IBM's PC business in 2005 (pictured) but dropped the brand less than two years later in its efforts to create an international business
Prime movers
Second, globalisation of business and wealth creation will accelerate. Around the time the Berlin Wall fell in 1990, there were approximately 1 billion people worldwide participating in some form of a capitalist economic model. Nearly 20 years on, that number is closer to 5 billion, with a significant percentage of the increase contributed by the Pacific Rim countries.
This has and will continue to have an enormous impact on businesses and how they operate. By the year 2020, it is estimated that one-third of the 500 largest companies in the world will be from the BRIC countries, which constitute nearly half of the globe's population. Companies all over the world are adjusting the way they are structured and operate to take advantage of the disproportionate growth that will occur in the BRIC and other developing markets. One example is Lenovo, the Chinese computer manufacturer that bought IBM's PC business in 2005. In less than two years, Lenovo dropped the IBM brand as part of the company's efforts to create a truly international business. Research is headquartered in Bangalore, India, and operating teams consist of professionals from all over the world, irrespective of where the operation is based.
Good to grow
Lastly, financial services companies will strategically respond to the deleveraging cycle and the faster growth in major developing economies by investing in wealth management and in creating a global footprint. Top-tier wealth management platforms that take advantage of the more conservative investment posture of individuals across developed markets will command an increasing premium in the marketplace. The consistency of wealth management returns, even through the depths of the credit crisis, will be reinforced by higher savings rates in major markets. Large financial firms will look for an increasing contribution from wealth management, and new competitors will enter the market.
The trend, begun in the 1990s, of building up capabilities outside the US and other big developed markets will accelerate. Major global financial services companies generated an increasing percentage of their earnings from outside their domestic market in the five-year period before the onset of the credit crisis. While growth in the US, Japan and western Europe flattened out, in the BRIC countries growth in excess of 20% was achieved year in, year out. Given the likely tepid recovery in the advanced markets and the speed of the rebound in the BRIC regions, these patterns will be reinforced over the next decade.
Greg Fleming was previously president and chief operating officer at Merrill Lynch and will join Morgan Stanley as president of investment management in February
