June 10, 2012 4:16 pm
Funny thing happened on deflation road
By John Plender
Earlier this year the notion that emerging markets could decouple from the economies of the developed world staged a come back, having been found wanting during the initial phases of the financial crisis. As risk assets returned to favour, emerging market equities outperformed all comers, partly on the basis of this argument. Yet to see why the decoupling theory makes no sense, you have only to look at the way US equities have recently decoupled from the rest of the world’s markets.
Last month, when risk assets received a definitive come-uppance after the first quarter’s cheery run up, US equities declined 6.5 per cent compared with a fall of 11.4 per cent for emerging markets. In the year to date the comparable figures were a gain of 4.3 per cent for the US against a marginal decline for the emergers, while in the year to May 31 the US declined by 3.8 per cent compared with an emerging markets plunge of 23.1 per cent. All these figures are from the S&P Global Broad Market Index.
The reason for this divergence can best be understood by looking at China. Over all these periods the Chinese market performed broadly in line with the emerging market group. Looking at the underlying economy, it paid a high price for its excessive trade dependency, as global trade shrank in the crisis. It then staged a powerful recovery on the back of huge fiscal and monetary stimulus.
Most of that stimulus found its way into increased investment, which currently runs at an astonishingly high level of around 50 per cent of gross domestic product. The result has been a rash of housing bubbles, misallocated capital and rising labour costs. Last year, as we know, the government was obliged to slam on the brakes. Yet the impact of higher wages lives on in the shape of much reduced competitiveness relative to the US. In effect, the real exchange rate has appreciated even though the nominal exchange rate has changed only marginally. So, too, with other emerging markets with currency pegs.
Part of the outperformance of US equities reflects this shift in relative real exchange rates. It is precisely what you would expect in a world gripped by deflationary forces. In both the developed and developing world countries with flexible exchange rates have tended to show the best equity market performances with the exception of those like Brazil whose exchange rates have been boosted by big speculative inflows. Worst hit have been the deficit countries in the eurozone with no exchange rate flexibility. As in the 1930s, when staying on the gold standard was a recipe for disaster, exchange rate pegs – or membership of European economic and monetary union – potentially works as a deflationary vice.
.
The same logic explains the variations in equity market performance between different emerging markets. Among the so-called Bric countries the worst performer over the past year has been Russia.
.
That reflects its dependence on natural resource exports. With the developed world deleveraging or deflating while Asia has been addressing inflation, commodity producers have been squeezed.
.
Whenever policy makers appear to retreat from deflation the mould is temporarily broken. Risk assets recover and emerging markets outperform. With mounting speculation about further quantitative easing in the developed world and the recent loosening of fiscal and monetary strings in China, we may now be in one such phase. Yet to escape from this deflationary, zero-sum world something more decisive is called for. Given endless policy half measures in Europe, the burden has to fall on the US and China.
Although the US has a huge overhang of public sector debt, its position as custodian of the world’s chief reserve currency means that it can borrow cheaply and extensively regardless. With signs that the economy is slowing, the case for a further attempt to jump start the economy is strongly urged by Keynesians such as Paul Krugman who believe the debt will be more manageable as a result.
.
Yet the politics of fiscal expansion are intractable. It could be that 2013 will see the US joining the deflationist camp by default.
.
China, meantime, has the fiscal capacity to boost growth and has made a gingerly start. It is committed to rebalancing its economy but appears once again to be overemphasising investment, which points to a further misallocation of capital and more trouble down the line. The message is that equity markets will continue to reflect the realities of debt deleveraging and mindless eurozone austerity, punctuated by occasional flourishes of optimism. It will be some time before the decoupling theory becomes a reality.
.
Copyright The Financial Times Limited 2012
Last month, when risk assets received a definitive come-uppance after the first quarter’s cheery run up, US equities declined 6.5 per cent compared with a fall of 11.4 per cent for emerging markets. In the year to date the comparable figures were a gain of 4.3 per cent for the US against a marginal decline for the emergers, while in the year to May 31 the US declined by 3.8 per cent compared with an emerging markets plunge of 23.1 per cent. All these figures are from the S&P Global Broad Market Index.
The reason for this divergence can best be understood by looking at China. Over all these periods the Chinese market performed broadly in line with the emerging market group. Looking at the underlying economy, it paid a high price for its excessive trade dependency, as global trade shrank in the crisis. It then staged a powerful recovery on the back of huge fiscal and monetary stimulus.
Most of that stimulus found its way into increased investment, which currently runs at an astonishingly high level of around 50 per cent of gross domestic product. The result has been a rash of housing bubbles, misallocated capital and rising labour costs. Last year, as we know, the government was obliged to slam on the brakes. Yet the impact of higher wages lives on in the shape of much reduced competitiveness relative to the US. In effect, the real exchange rate has appreciated even though the nominal exchange rate has changed only marginally. So, too, with other emerging markets with currency pegs.
Part of the outperformance of US equities reflects this shift in relative real exchange rates. It is precisely what you would expect in a world gripped by deflationary forces. In both the developed and developing world countries with flexible exchange rates have tended to show the best equity market performances with the exception of those like Brazil whose exchange rates have been boosted by big speculative inflows. Worst hit have been the deficit countries in the eurozone with no exchange rate flexibility. As in the 1930s, when staying on the gold standard was a recipe for disaster, exchange rate pegs – or membership of European economic and monetary union – potentially works as a deflationary vice.
.
The same logic explains the variations in equity market performance between different emerging markets. Among the so-called Bric countries the worst performer over the past year has been Russia.
.
That reflects its dependence on natural resource exports. With the developed world deleveraging or deflating while Asia has been addressing inflation, commodity producers have been squeezed.
.
Whenever policy makers appear to retreat from deflation the mould is temporarily broken. Risk assets recover and emerging markets outperform. With mounting speculation about further quantitative easing in the developed world and the recent loosening of fiscal and monetary strings in China, we may now be in one such phase. Yet to escape from this deflationary, zero-sum world something more decisive is called for. Given endless policy half measures in Europe, the burden has to fall on the US and China.
Although the US has a huge overhang of public sector debt, its position as custodian of the world’s chief reserve currency means that it can borrow cheaply and extensively regardless. With signs that the economy is slowing, the case for a further attempt to jump start the economy is strongly urged by Keynesians such as Paul Krugman who believe the debt will be more manageable as a result.
.
Yet the politics of fiscal expansion are intractable. It could be that 2013 will see the US joining the deflationist camp by default.
.
China, meantime, has the fiscal capacity to boost growth and has made a gingerly start. It is committed to rebalancing its economy but appears once again to be overemphasising investment, which points to a further misallocation of capital and more trouble down the line. The message is that equity markets will continue to reflect the realities of debt deleveraging and mindless eurozone austerity, punctuated by occasional flourishes of optimism. It will be some time before the decoupling theory becomes a reality.
.
Copyright The Financial Times Limited 2012
0 comments:
Publicar un comentario