Harry Long's  Instablog

 

"[L]ow interest rates often have the opposite of their intended effect.
Extremely low interest rates can vacuum liquidity out of nations.
Japan has been referred to as a nation where loose monetary policy
was like "pushing on a string." There was no push. It was a pull.
Liquidity was sucked out of the country as the Yen became the
world's carry trade currency of choice.  Borrowing in a currency
is the opposite of investment. It is liquidity-draining to the carry trade
currency nation. For all of the talk about about using monetary policy
to dampen the business cycle, no result could be more damaging
or procyclical."

 

I concluded the article by saying:

 

"Americans may finally realize that there is a free lunch after all--
we will be supplying it as speculators borrow in our low-yielding
currency to invest elsewhere."

 

We are living in truly interesting times. If Warren Buffett was correct in saying that the 19th century was the British Century, the 20th Century was the American Century, and the 21st Century will be the Chinese Century, there are multiple factors at work on seven different levels creating the boom in emerging markets.

 

I. The carry trade. Our interest rates are anemically low. Emerging market interest rates are higher. Capital goes where it is treated best.

II. Emerging market GDP growth rates. In March, everything was cheap. When you have compressed valuations, the smart money goes with the highest growth rate.

III. Emerging market competitive advantages: low cost labor, light regulation, and governments which want to help industry and job creation.

IV. Conversely, America seems hell-bent on destroying its economy: huge government deficits, the breaking of the social pact of property rights with the mal-treatment of GM debt holders, an inability to show backbone in demanding true free trade (foreign countries trade mostly freely with us, we are not allowed full access to foreign markets), the government demand for position limits on the commodity exchanges (forcing the very transactions off-exchange which the government would rationally want centrally cleared), horribly complex and ineffective regulation, the rise of zombie banks.

V. A turn towards the very socialist ideologies which successful emerging countries such as China have rejected (affirmative action for the formerly rich and stupid, bank investors, bank executives, etc).

VI. A rejection of our unique "Americaness": the values of self reliance, property rights, and rugged individualism which made us a great and prosperous nation.

VII. An increasingly crushing tax burden on those who produce and save in order to subsidize those who do not produce and spend(insolvent banks, California, etc).

The end effect of all of these factors has been to make emerging market equities even more attractive than emerging market debt. It's not just the carry trade at work. It is the combination of the carry trade with very attractive economic fundamentals. Indeed, countries such as China are seeing GDP growth rates that we have not seen in the U.S. for generations.

Disclosure:
Long EEM, FXI, PGJ, FCHI, HAO, EWZ.
Positions may change at any time.