Global Decoupling Theory, Correlation Contagion

Slowly but surely people are coming to the conclusion that the global ‘Decoupling Theory’ isn’t holding up. (Duh)

Europe's Economy May Stay Sick Longer After Catching U.S. Cold: “Europe's economy has caught the U.S.'s cold, and may be sick longer.

Persistent inflation and budget deficits may prevent policy makers in the 15 nations that share the euro from moving as aggressively as their U.S. counterparts to cut interest rates and taxes. Meanwhile, Europe's labor laws will make it harder for companies to speed a recovery in profits by reducing payrolls.

“A European downturn will take noticeably longer to run its course than the U.S. one,” Nobel laureate Edmund Phelps, an economics professor at Columbia University in New York, said in an interview.”

Better late than never.

“Next year “might be a period of `reverse decoupling,' with the U.S. economy enjoying a sharp recovery and the euro-area economy stagnating,” says Dario Perkins, senior European economist for ABN Amro Holding NV in London. “A relatively inflexible economy and `sticky' inflation” will hold Europe back, he says.”

Understand this: The last few years have been nothing but a liquidity (read DEBT) driven party. Financial innovation, such as mass securitizations and the mass embrace of derivatives resulted in the development of what is now termed ‘the shadow banking system’. This resulted in flood of liquidity, which is characterized by easy access to cheap debt. This pushed up ALL risky assets over the ENTIRE globe. Now with liquidity circling the drain as financial institutions try desperately to digest their suddenly swollen and impaired balance sheets, the correlations of ALL risky assets are approaching ONE.

There is now no such thing as diversification within the risky asset class.

Correlation, Contagion, and Asian Evidence:
“Empirical evidence shows that contagion affects both developed and emerging markets and does not seem to vary with the relative fundamental economic health or trade and financial linkages of the Asian economies. Contagion occurs across both asset types and geographical borders and tends to have larger effects in equity markets than in currency and bond markets. There is evidence to support the hypothesis that contagion is regional and transmitted through developed markets.”

Related Posts:
The Global ‘Decoupling Theory’ is Garbage
Asia Tanks
The Dollar Smile Theory