Emerging Markets: The New Spenders of the 21st Century

Includes: BKF, EEB, FXI, PGJ
by: Justice Litle

It’s hard, but not impossible, to see a world in which Americans spend a good deal less... while emerging market consumers spend a good deal more.

Jim O’Neill is the Goldman Sachs economist who invented the BRIC acronym – shorthand for “Brazil, Russia, India, China.”

Now O’Neill thinks the BRIC countries – or rather, the shoppers in these countries – will save the global economy in its great hour of need.

“The BRIC consumer is going to rescue the world,” O’Neill says. There are 2.8 billion of them... and they are “poised to spend more.”

2.8 billion is a pretty big number. (As the old saying goes, anything times a billion is big number.) It’s also important to note that these consumers are quite different from those in the West. Unlike us, they come from very thrifty beginnings. Many of them are preparing to open their wallets for the first time – as opposed to draining the last bit of juice from a close to maxed-out credit card.

“The best hope to keep the global economy growing may be people like Wei Yufang,” Bloomberg reports. “A peasant who farms a small plot beside the mud-brown Huaihe River in central China, Wei has a modest dream: to buy an air conditioner to give her family relief from the dusty heat that each summer envelops Xiaogang (Little Hill) village in Anhui province.”

The Chinese government would like to see many more Wei Yufangs.

It’s slow going getting Chinese consumers to open up, though, because the tendency towards thrift is so strong.

The Urge to Save

Many Chinese routinely save as much as half or even two-thirds of their annual income. Fittingly, consumer spending only makes up about 35% of Chinese GDP – roughly half of the total pie share in the United States. This is down from a 50% share in the 1980s.

Part of the reason the Chinese save so much is because there is no social safety net. The prospect of getting sick is especially frightening in China.

Wang Tao, a Beijing-based USB Securities analyst, says that “America’s healthcare problems can’t even compare... Healthcare is so expensive and distorted [in China] that no matter how much you save, if you get sick you’re going to end up poor.”

The Chinese also save mightily to pay for their kids’ educations. As in the United States, college is a big-ticket item there.

A New Generation

Is O’Neill’s BRIC optimism misplaced, then, at least as far as China is concerned? Maybe not.

As it turns out, the one-child rule has created a generation of pampered kids. Doting mothers and fathers bend over backwards for their sons and daughters. Accustomed to being the center of attention – and confident in their odds for long-run success – Chinese kids are thus far more likely to splurge than their parents.

While the parents and grandparents save, in other words, the new generation spends.

China is also working hard to change attitudes towards healthcare and retirement. The gradual construction of a social safety net will have a lubricating effect on willingness to spend, much how FDIC insurance lubricated the long-term expansion of the banking system in the United States.

So as fear of personal disaster loosens its grip, the BRIC purse strings will loosen more too. While the paradigm shift entails U.S. consumers spending less and saving more, the trend for O’Neill’s 2.8 billion is the opposite.

A Painful Transition – But a Necessary One

So what will the world look like when the American consumer hangs up his spurs?

An inability to imagine such a transition is in part what has Wall Street so afraid. Joe and Jane Sixpack have financed the global economy with their buying of “stuff” for so long... with their wallets snapping shut now, how can the world as we know it not end?

Well. The world as we know it is coming to an end. But that doesn’t mean armageddon. It just means we’re on our way to a new place... a new paradigm.

To understand why things will be okay in the long run (and certainly far better than they look now), it’s useful to recall a few things.

  • When the system is functioning properly, saving is just spending in another form. (That is to say, higher savings rates are not automatic doom.)
  • It’s not impossible to imagine a world where America embraces thrift. It’s just hard to picture after 25 years in the other direction.
  • Investors, being utterly lousy at seeing around corners, have a tendency to panic on the cusp of major sea change.

Saving versus Spending

To address the first point: As Henry Hazlitt pointed out in his excellent text “Economics in One Lesson,” saving is really just spending in another form.

If you put your money in a bank, Hazlitt notes, that capital becomes available for a worthy enterprise to borrow and put to good use. If you put your money in the market – savings as long-term investment – the capital again goes to companies that can make worthy use of it. So there is no reason saved money has to be dead money.

This is how it’s supposed to work – and it generally does work this way in normal times.

As of late 2008 the system has been wrecked by reckless leverage... due to a jamming up of the works banks no longer want to lend, and companies no longer have the financing they need to expand.

But when the system is finally healed – when the leverage toxins are fully flushed – saving will again be as good as spending as far as the health of the economy is concerned. Mortgage payments and bank balances will be recirculated back into the economy, markets will resume their normal function of channeling capital to companies that deserve it, and so on.

In a world where the system functions properly – without the idiotic Greenspan-inspired leverage excesses of recent years – it won’t be so bad if U.S. consumer spending drops dramatically as a percentage of GDP... Especially if consumer spending in the BRIC countries rises up, as O’Neill and others expect it will.

After all, doesn’t it make natural sense? As we who have far more “stuff” than we need cut back on our buying, and those who have not yet bought their first air conditioner step up their buying, the global mix simply changes.

The West’s increased savings can then be put to productive use – perhaps by the multinationals selling consumer goods to the emerging market world, or the companies tasked with repairing and upgrading the West’s tattered infrastructure.

Doom for Some

So picture a world in which BRIC consumer spending (the 2.8 billion again) rises to 50% of GDP on average, while U.S. consumer spending falls below that.

This would not be a disaster. If anything, it would be a far more healthy (and logical) balance of things.

Such a shift would, though, prove a disaster for many consumer-centric industries focused on American appetites. As my colleague Adam Lass likes to point out, binge retail is on its way to becoming a wasteland.

So if a business model is invalidated by the new market landscape, then guess what – that business model is toast, no matter how fervently the participants in that industry wish it not so.

But that’s the whole point of creative destruction.

A free market economy is either dynamic or it is dead. The creative destruction process is vital because it allows resources and capital to shift from one area of the economy to another... not as determined by central planning or government fiat, but in flexible real-time response to how the world is changing.

Economic systems that resist this sort of flexible change – that rely too much on intervention and central planning and resistance to change – wind up stagnated and brittle. Blessed are the flexible, for they shall not be bent out of shape.

The Market Doesn’t See It – Yet

Here and now, in December 2008, the market has no sense of what the world will look like the day after tomorrow.

The market has no true sense of anything now, for that matter, because so many of the normal functions have been broken. The markets now are like a plumbing system in which half the pipes have exploded from the duress of water pressure 10 times normal levels.

When the system gets pushed far enough out of whack by global margin calls and liquidity panic, the valuations stop making sense. Logic takes a time out. The academics who forget this (or foolishly deny it) remain blind to the fact that all their precise theories are grounded in a messy world of buyers and sellers.

So for now we’re still watching the Talking Heads movie (Stop Making Sense). But when the market needle starts swinging back in the “rational” direction – when logic gets a toehold again – I think cooler heads will prevail and a sense of the transition’s aftermath will sink in.

It’s hard, but not impossible, to see a world in which Americans spend a good deal less while others spend a good deal more.

It is also hard, but again not impossible, to see a world in which U.S. consumer savings play a useful role in a properly functioning market system – getting recycled as capital for banks to lend and companies to make wise use of. For now, it’s just a matter of getting from here to there.