6 Themes Affecting the Global Economy

Though I write mainly about US economic and investment issues, I try to be think globally as I consider macroeconomics. I think that many economists are hobbled because they think about the US economy in a closed framework, neglecting the effects that the rest of the world has on the US. Prior to the end of the cold war, that was a useful shortcut, but now many aspects of the US economy depend on global, and less on local factors. (Some articles cited here will be dated, but are still relevant in my mind.)

This article is meant to take you through six themes affecting the global economy. Here goes:

China

I’ve been writing about neomercantilism and China now for almost five years. The negative effects are now obvious. Inflation has been rising in China, because too much credit is chasing too few goods. That inflation is funneling into US goods prices as well. China exports too much, and imports too little, which forces them to import US credit. This is getting tired, and the Chinese and Middle Eastern savings gluts need a new place to invest, or better, new goods to buy. Absent these adjustments, in order to cool the economy, the PBOC keeps raising reserve requirements again and again. Better they should revalue the yuan up 20%, or they will continue to import inflation from the US.

China has its growing pains amid this. Pollution is rampant, and standards for product safety are low. Beyond that, China now competes with the US and Europe for economic alliances in Africa. Given past bad blood there, the Chinese may at many points be better received, that is, until they abuse their welcome.

Currencies

The main question here is the demise of “Bretton Woods II” where the rest of the world uses the US Dollar as the main reserve currency, while the US continues to debase the dollar through the issuance of more dollar claims. You can read about it in any of the following articles:

• The end of the United States exorbitant privilege?
• Imbalancing act
• Has the moment come to replace the US dollar?
• Jim Rogers: More Pain for the Greenback, and the Failure of the Federal Reserve (Now, I would argue with Jimmy Rogers over a number of his facts, but he has the main thrust correct.)

Now, Ken Fisher told us not to worry about the declining dollar, but the euro-yen exchange rate. It’s too early to say, but that exchange rate is flat, while the S&P 500 is off 7% or so. Perhaps the overall carry trade is weakening, but not with the euro as a currency to purchase, yet.

Finally, not only is the weak dollar good for exports, but for tourism as well. Now maybe they buy some of our slack houses as well…. please?

Inflation, Especially Food Prices

All the buzz is over rice, which has risen fivefold in six years. You can read about it here:

• Forget oil, the new global crisis is food
• Inflation AND Political Unrest!
• Food prices ring alarm for Asian nations
• Jump in rice price fuels fears of unrest
• Rice Jumps to Record, Corn Near High as Demand Outpaces Supply

Now, that inflation is feeding back to the US, but slowly. You would think that this would be a great time to eliminate US farm subsidies, but no, they are too effective at buying votes insuring economic stability in the Midwest.

Now, in the face of these inflationary pressures, the ECB is not mimicking the Fed. They see the inflationary pressures, and aren’t loosening, at least not much. Australia is even tightening.

Recession Fears in the Developed World

Now there are similar stresses in housing in some places of Europe, as compared to the US. Consider Spain (and here), and the UK. Low-ish interest rates can lead to overbuilding anywhere, if the regulators look the other way. Japan may not have housing worries, but their growth is slowing, and they worry about the next recessionary leg of a what is proving to be a long recessionary era (since 1990).

Energy

It doesn’t matter how you slice it, Chavez has mismanaged the Venezuelan economy, and particularly the oil industry. Now he is trying to do the same thing to cement. Venezuelans are experiencing shortages and high inflation, as Chavez directs resources that he has stolen nationalized to his cronies and his foreign interests that he funds in order to make life difficult for US foreign policy in Latin America (not that I am a great fan of US policy there — I only recognize the conflict).

The Middle East has lots of new oil fields to tap at the right price, yes? Well, I’m not so sure. It is interesting to see the UAE develop a nuclear program. Perhaps they are looking to a day when oil will not be so plentiful? Then again, maybe we will have a big energy find in Greenland (an island that may once again be green, now that temperatures are rising to levels last seen in the middle ages).

Emerging Markets

Coming back to the beginning of the article, emerging markets (like China), are going through an adjustment period. Since these two articles were written, emerging market equities have fallen significantly. They may fall further; many of those nations are geared to global growth, and when it slows, it slows even more for them. Many of them are absorbing US inflation as well, and need to raise their exchange rates. That will hurt exports in the short run, but will aid in bringing economic stability.

Comments

[Doug Roberts]

Hi - Like the article. One of the links - " Inflation AND Political Unrest!" goes to a nonexistent post.
Thanks.
Doug

[john the bear]

Do you have a forcast for FXI? I bought 60 and 70 strikes for Jan 09. How does this look to you now?

[jmkeynes]

You may want to consider long bond interest rates, too. Up until the late 90's, whenever commodities went up long bond prices went down (since yields went up to account for inflation). But, since 2002 commodity prices have run away. Go to yahoo and try charting 10 or 20 year treasury interest rates (^TNX or ^TYX) against commodity prices (^DJC) starting in 1997. You'll see that in 2002 commodity prices have just soared.

Probably the Jim Rogers article talks about this. Anyway, eventually treasury yields will have to go up with inflation (and/or commodity prices have to go down with deflation).

My guess is that as china and other countries (e.g. Saudi Arabia) form sovereign wealth funds they'll start moving money out of treasuries and into other asset classes. So, all other things being equal, this would mean that long term treasury interest yields will be going up, and bond prices down.

[Will Rahal]

Employment in the financial sector will continue to decline.
In an inflationary environment, P/E contract as the financial markets fall out of favor and the sectors associated with the production of mines and Natural Resources(NR) do well.
I have posted a chart showing the ratio in employment in Financials relative to NR. It is closely associated with the financial markets.
see
wrahal.blogspot.com/2008/04/tangible-vs-...

[granger]

yeah, i have been holding the Rogers Commodity Fund. I have also been lightening up on some preferrerds (which act like a long term bond). i am focusing my income portion to short term instruments, like EFR & FCO. I want to be in vehices that will adjust as rates start their eventual rise. Inflation protected Money Markets are another idea. Inflation and higher rates are coming and here to stay, sadly. As for equities, growth equities and dividend payers (ones that are growing their dividend) are my focus.

[paultaut]

Global warming......yes it is....nothing new...How do you think GREENland got its name in the first place? Go to an art museum, take a look at the Tropics in Italy...Paintings that are 600-700 years old show that the present global warming is normal...But thats too easy, Figures don't lie...liars figure...Gore would have made to a high level post at Enron.

Apparently you don't have access to even the easiest Chinese business news....sales quotes in US dollars are good for 7 days only...used to be 1-2 months, every other currency taken has the 1-2 month quote. A quote for 3 months pegs the Remimbi at 6.60 vs. the presently list 7.0 spot, 700,000 chinese companies are doing this...they are exporting inflation.

OPEC won't meet til September, Opec's output has decreased by 100,000 barrels a day, they are experiencing unprecedented internal demand...anyone look at the Dubai constuction background during the Dubai Golf classic...the construction and massive energy use to do it should be easily visible to anyone. It is not limited to Dubai.

Remember, years ago, Clean your plate because people are starving in China? They are going to be starving in Africa,North Korea,parts of China(10 yr. draught), Mexico,etc. and its only partly a corn to ethanol problem. Rice Feeds 3 Billion people...they don't eat corn.

Whether the Dollar is strong or weak, will only impact us internally. The cost of everything will continue to rise until the BRIC countries are as industrialized as we were back in the 1960's. Supplies of everything will remain constrained unless the World goes into a prolonged Recession to allow inventories to rebuild.

That ain't gonna happen...A lot mo politicians now boys and girls.

[chinesepetti]

First please stop whinning about product quality from China; the debt trapped American consumers always have options; make them yourselves or buy from other countries. Second I go to China every 6 weeks I could not see any difference in terms of air quality in big Chinese cities compared with American cities. Third; China last year export to the rest of the world was only less than 10% of it's whole GDP, this is a 1.2 billion people market and it is already the biggest phones market and 2rd biggest car market. China can prosper just making and selling things to it's own people without selling a thing to the rest of the world. Fourth it's the Chinese who export the inflation as the new labor laws was in force the bigenning of 2008 and the workers demanding more pays. Last Chinese has every right to secure resources for its development but she will never send it's armies to rape and muder another nation for oil. Shame on you david !

[greywater]

China doesn't need to send armies to rape and murder for oil - yet. In the meantime they will just continue to rape and murder their own people and the people in the countries around them - like Tibet.

[No Moss]

Iwishing, I'm an American who lives in China, and you cannot be serious about air quality! The filthy air of any Chinese city, including Shenzhen, where I live, cannot be compared to any US city outside of Los Angeles, and Los Angeles would be a clean air city in China. The air in Beijing and 10 huge cities I could name is filthy. FILTHY!! There is nothing to compare with them in the developed West.

The internal market you speak of is an infrastructure buildout, not a consumer market, since the consumer market is about $1 billion, or perhaps 15% of the US consumer market.

Product safety is an issue in China, and so is product quality. It's an issue within China as much as it is outside of China. Food products, toys, baby forumla, toothpaste, medicines, pet food, pretty much every consumer product category that could pose a hazard has been been implicated at one point or another. The former head of the Chinese equivalent of the FDA was implicated recently for taking massive bribes. I believe he was executed.

Despite government efforts (and Beijing is trying, although the realities of government of such a large country require that they frequently wink at the activities of the local communist party), corruption, shortcuts, and indifference to product safety and efficacy are endemic.

You are right, though, when you say that China is exporting inflation. Besides the strong RMB, China has high inflation. Food, especially pork and chicken, which are staples in the Chinese diet; ; rents; imported goods because of their high tariffs and price gouging at the retail level; coal, oil, natural gas, iron ore, metals and minerals in general, coking coal; and even rice and other grains are up substantially. This represents a real problem for a country where 2/3 of the population are truly poor and susceptible to even small price rises in basic goods. The government has acted to increase incomes, and more of this is on the way.

China is amoral in its approach to geopolitics, meaning that it looks after its own interests without considering the needs or suffering of others, and I don't see that they're too much worse than others in that regard. It certainly has no basis for criticizing others, though, since it will deal with the devil to advance its own interests.

[No Moss]

Er, make that a consumer market of $1 trillion. Sorry about that.

[Steven Hurwitz]

It has to happen eventually. What some of you call "exporting inflation" is just the increasing power of Chinese labor, they have certainly earned their due by now, a growing Chinese national recognition that continued deferral of the back end costs of manufacturing(pollution) is ultimately deadly and counter productive, and world market manipulation of prices of essential commodities, specially oil.

Overall, this nation need an overdue reappraisal of it's energy and transportation strategy (sorry auto industry), a shift in values away from consumption for it's own sake (sorry retail), and a more cooperative attitude in world affairs (sorry defense).

Higher prices have a focusing effect in all of the above.

[chinesepetti]

shame on you guys american or the the american in China; get out of Iraq Now otherwise you simply have no Moral ground to even make any comments about other nations. It's especially laughing for that american in china (No Moss) talking about filthy air in china; if it is that filthy why you still live in China, I suppose you make some $ there by enjoyng the filthy air; get out of China now! China never forces you to live there for breathing filthy air. go back to Los Angeles where all homeless live!

At last why not produce everything in america instead of buying from china; otherwise get a life ,shut up and stop whining.

[chinesepetti]

No Moss, I agree with you china is not perfect or even corrupt someway as you claimed; but if a listed bank CEO in China lost millioms dollars he might go to prison or be shot; meanwhile when Citi Bank lost more than 10 billion dollars CEO Chuck Prince was given 60 million dollars to leave. All readers can make your own mind which system is more corrupt. If you decide the american system is less corrupt the I wish you all American the best of Luck and I do not waste my time on this board anymore because I am talking to all retarded here!!!

[liouwenqing]

Hi, iwishing,

American do not have any moral superiority than Chinese.
There was a DuPont factory in Taiwan. After they leave, the land is totally poisoned. The rice grown from the near farms are also poisoned. Think of the evils done by US Pharmaceutical companies in Africa.
China need more improvements.
And, eventually, a grown China will have less angry Chinese.

[chinesepetti]

Stop the occupation in Iraq now! By Talking down other nations including China it is not going to help you guys to get over this miserable credit crisis in America and the rest of the western world.

[chinesepetti]

I like to advise every readers here; Mr Michael Petti worked in Bear Stern before, the information is on this website seekingalpha.com/author/michael-pettis
Thank you Mr Petti for your disclosure! You are a great American

[chinesepetti]

All Mr Petti's pupils and seeking alpha readers here; the story about Mr Petti just does not add up! According to Mr Petti's views (you can read all his articles about China on this site ; strangely he only wrote about China), everything in China is in crisis even the air is filthy so why he is making a living there; getting paid from the red Communist school; why not go back to Wall street to work for Bear Stern ? Bear Stern is not dead yet.

It is time for Mr Petti and his loyal pupils to disclose his relationship with the red Chinese government now!!! And all readers on this site should also make such a demand; otherwise it's an insult to the intelligence of all seekingalpha readers!