Emerging Markets and the Global Monetary Merry-Go-Round

Good new report from HSBC out making a variant on the emerging markets decoupling case, while launching an emerging markets index (EMI). They argue that the global monetary merry-go-round continues to spin – for while.

I’m less sanguine than they are about decoupling – in the absence of a safety net it is hard to see how domestic consumer spending ramps up in China – but the monetary point is a fair one. Read on:

Our optimistic views on the emerging world are also based on what we call the monetary merry-go-round. Low US interest rates typically encourage capital to flow into the emerging world. Attempts by emerging nations to limit the resulting exchange rate appreciation lead to offsetting capital outflows in the form of rising foreign exchange reserves which are often invested in US Treasuries. Higher demand for Treasuries keeps yields low and, hence, leaves US interest rates low, thereby allowing the merry-go-round to repeat, seemingly ad infinitum.

The merry-go round leaves the global cost of capital too low. A hunt for yield develops. Before the credit crunch, this hunt led to huge investments in mortgage-backed securities which, in turn, fuelled the US housing boom. Post-credit crunch, however, the hunt for yield has gone elsewhere. Investors are now keen on the emerging nations with their strong secular economic prospects.

The implications are simple. Emerging currencies will be under upward pressure, their asset markets should appreciate and their sources of growth should switch from exports towards domestic demand, thereby helping to narrow their, in some cases, large current account surpluses. Indeed, the EMI shows that total order books are rising at a faster pace than exports, supporting the view that recoveries are domestically-led.

In the absence of an imminent upward move in US interest rates, the merry-go-round should be able to spin a few times more. There are, however, limits to this process.

Comments

[derryl:]

"I’m less sanguine than they are about decoupling – in the absence of a safety net it is hard to see how domestic consumer spending ramps up in China – but the monetary point is a fair one."

The lack of a safety net is certainly a constraint but I would suggest that nations like China have time on their side in the effort to switch from exports to domestic consumption. About a billion Chinese still live like they have for thousands of years, poor but fairly self-sufficient. China plans to introduce pensions for these people which provides them some money to participate in the consumer economy. If the Chinese fund these pensions by taxing those who are currently using their recent riches to bid up asset prices, then bubbles can be constrained at the same time as the consumer base is massively (albeit shallowly) broadened.

Decoupling was never going to be sharp and total, but I believe the trend will be supported by fairly intelligent Chinese fiscal policy. I don't know how long the monetary merry-go-round can spin either, but when it stops China had better be prepared to do some serious import buying with its newly valuable currency backed by large fx reserves.

Oct 06 09:25 PM

[theobannion:]

Too many northern investors see the third world (aka "emerging mkts," "develooping nations," etc.) as small USA's when we were just coming out of the depression. They have no idea how different these cultures can be from what North Americans are accustomed to. For example, after 150 years of capitalism, countries amazingly rich in resources like Peru & Argentina remain largely backwaters of poverty, despite the recent gains in their economies & their bolsas. In the former, Alberto Fujimori, a ten year "president," left the country with an estimated $919,000,000 from the national treasury. His predecessor left the country to avoid prosecution for having stolen millions from said treasury. Addicted to documenting everything, Fujimori video-taped his right-hand man, Vladimir Montessinos, shoveling huge stacks of bills out of a bag to the owners of the networks. In the US, in contrast, the networks are happy to go along w/ Washington for nothing more than the privilege and benefits of being one of the partners in the plutocracy. (I will leave you to consult your history books to see who the present president of Peru is. Hint: Discredited ex-presidents can run for office if they can sneak back into the country.)

You can go to jail for life in some of these countries for "political crimes," while men convicted of multiple homicides regularly get out after 2 or 3 years. Hard to believe I know, but it's just a matter of having your lawyer find the right judge. Often enough, the police will let you miraculously escape immediately, for a consideration of course.

I read recently how cheap Russia was at a mere 6x earnings! It had dropped to 3x at the bottom of its decline. LOL.

Russia is run by gangsters, misnamed in the press as "the Russian mafia." I doubt very much that any reputable auditor would find that the managements in these countries aren't cooking the books.

My father in law had a pile of his savings in a local bank, paying a stunning 12% interest! I told him to take it out immediately; he thought I was a very funny guy. When he finally went to make a withdrawal, he was told that he would have to wait for his money. That was almost a year ago. He's still waiting. Has the government closed the bank? Arrested someone for fraud? Is the bank offering much less on your savings?

No. Situation normal - AFU.

Best of lulck,
SOB.


Economists refuse to allow cultural elements into their prognostications, but unfortunately for unwary investors, it's necessary for their survival that they do so.

Oct 07 08:47 AM

[theobannion:]

I find it stunning that the US is bending over backwards to do business with China, one of the world's worst human rights abusers, while keeping in place a blockade on Cuba because "it's a communist country."

I guess there are communists, and there are COMMUNISTS, some offering bigger markets than others.

SOB.

On Oct 06 09:25 PM derryl wrote:

> "I’m less sanguine than they are about decoupling – in the absence
> of a safety net it is hard to see how domestic consumer spending
> ramps up in China – but the monetary point is a fair one."
>
> The lack of a safety net is certainly a constraint but I would suggest
> that nations like China have time on their side in the effort to
> switch from exports to domestic consumption. About a billion Chinese
> still live like they have for thousands of years, poor but fairly
> self-sufficient. China plans to introduce pensions for these people
> which provides them some money to participate in the consumer economy.
> If the Chinese fund these pensions by taxing those who are currently
> using their recent riches to bid up asset prices, then bubbles can
> be constrained at the same time as the consumer base is massively
> (albeit shallowly) broadened.
>
> Decoupling was never going to be sharp and total, but I believe the
> trend will be supported by fairly intelligent Chinese fiscal policy.
> I don't know how long the monetary merry-go-round can spin either,
> but when it stops China had better be prepared to do some serious
> import buying with its newly valuable currency backed by large fx
> reserves.

Oct 07 08:53 AM