There is a 'connected disconnect' between the West and emerging markets and a vicious circle of excess liquidity, asset bubbles, inflation, rate hikes, and attracting further excess liquidity inflows.
See live interview on Captial Connection with CNBC on 16 February, 2011-
The following notes offer a more detailed exposition –
Controlling inflation as China grows
A 'connected disconnect'
US Purchase Price Index, industrial output, the latest Fed minutes and the Beige Book (Summary of Commentary on Current Economic Conditions published by the Federal Reserve Board eight times a year) all seem to support Bernanke’s contention that –
(a) Not only is there very little US inflation for now but inflation expectations are not reflected in the market;
(b) The US labour market is gaining some traction with mild improvements in industrial output and retail;
(c) The recovery is still slow with sluggishness in the real estate and banking sectors;
(d) Nothing to support a rate increase anytime soon, though inflation concerns are rising amongst certain members of the Federal Open Market Committee (FOMC);
(e) As the US economy shows signs of growth and Obama has pledged to reduce budget deficit by $1.1 trillion over 10 years, QE3 becomes less likely than before.
The US picture contrasts sharply with strong growth and rising inflation fears in emerging markets (EMs). China has already increased interest rates the 3rd time since beginning of 2010 and bank reserve requirements 7 times, coupled with loan quotas and apartment purchase restrictions to control liquidity and the rising real estate bubble.
There is therefore a globally-connected divergence and imbalance –
(a) Between the performance of advanced countries and emerging markets. EMs account for only one third of global economy but contribute two-thirds of global growth;
(b) Improved US corporate profits fail to translate into commensurate employment;
(c) A growing divergence between a robust Germany and the rest of the EU, especially those struggling with sovereign debt. This may threaten the long-term viability of the Euro;
(d) ASEAN countries more linked to China’s global production chain are affected less by the weak market in the West;
(e) A tsunami of liquidity in the West finds its way to EMs (usually with appreciating currencies) seeking higher yields but fuelling inflation, which is worsened by food scarcity caused by climatic extremes. So amongst other things, EMs raise interest rates to combat inflation. But these rate increases attract even more hot money from the West, causing asset bubbles. These in turn spur further EM rate hikes. A vicious circle.
China and the Emerging Markets – new promises
The economic shift from the West to the East (especially China) becomes even more evident. China has officially overtaken Japan as the world's second largest economy. China is reported to help build a trans-ocean rail link in Columbia to rival the Panama Canal.
Watch the space of China’s coming Five Year Plan (2011-15), promoting slower but more balanced growth – promoting domestic consumption (supported by breakneck urbanization), innovation, technology (e.g. IT, biotech, new materials, new energy, high-end manufacturing ), green industries, and social services. Expect the RMB to appreciate a little faster (say 5%), more RMB-denominated bonds, more IPOs, more outward investments to Western markets. Bubbles do happen but don’t confuse them with a ' bubble economy'.
The age of Mega-Regions is on the horizon. Hong Kong, Shenzhen and Guangzhou and surrounding cities in Pearl River Delta are expected to grow into the largest Mega-Region in the world (to be connected by high-speed rail and expressways) with a combined population 120 million. Similarly, Tokyo-Nayoya-Osaka-Kyoto-Kobe (combined population 60 million); Sao Paulo-Rio de Janeiro (combined population 43 million); and Mumbai-Dehli (combined population 62 million). See United Nations Habitat Program State of the World's Cities 2010/2011 and a report at http://www.guardian.co.uk/world/2010/mar/22/un-cities-mega-regions
Welcome to a brave new world!
Some investment concepts
Beware of property bubbles. Think food and urbanization commodities. Think emerging markets – retail on a giant scale.
Andrew
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