Since the start of 2014, investors have fretted over emerging markets. And they should. Early in this economic recovery, investors repelled by low returns in the developed world jumped for the stocks and bonds of emerging markets, whose markets promised faster growth.
In 2009 and 2010, emerging economies grew faster than the US; stock prices rose 46 percent annually, more than twice the gains of US equities. Hot money flowed in, but so did foreign direct investment, which is harder to extract. Last year, foreign direct investment in the developing world grew 6 percent, to a record $759 billion (R8 trillion), or 52 percent of the global total.
In their indiscriminate rush into emerging markets, though, investors forgot two important points: first, without exception, these economies depend primarily on exports for growth, which means the developed economies, especially the US, must be capable of buying their goods. Second, not all emerging markets are alike.
On the first point, the developing world’s export growth model, which worked well in the 1980s and 1990s, won’t be viable for four more years or so while the US continues to deleverage. Europe, meanwhile, has emerged from recession, but its economic growth will probably remain subdued at best.
The decline in the US household saving rate from 12 percent in the early 1980s to 2 percent in the mid-2000s drove growth in the US and the global economy. During the savings drought, consumer spending grew half a percentage point a year faster than disposable (after-tax) income and added about half a percentage point to growth in real gross domestic product.
Now all that is moving in reverse: Households are pushed to save by uncertainty over stock portfolios, exhausted home equity and the lack of retirement assets held by post-war babies.
Feeling the pain
The overseas effects of this reversal are powerful. For every one percentage point rise in US consumer spending, American imports – the rest of the world’s exports – have risen 2.9 percentage points a year, on average. So when Americans stop spending, the rest of the world suffers.
And the second, investors who rushed into emerging markets and failed to differentiate among them are feeling the pain. Emerging economies can be divided between sheep – developing countries such as South Korea, Malaysia, Taiwan and the Philippines with well-managed economies measured by current account surpluses, low inflation, and stable currencies, stock markets and interest rates – and goats, with current account deficits, weak currencies, high inflation, falling equity prices and rising interest rates.
The goats don’t have the funds to cover the outflows of hot money that began last spring. Goats such as Turkey, India, South Africa, Indonesia, Argentina and Brazil have been forced to raise interest rates to attract and retain foreign funds. They have other problems, including labour unrest in South Africa, which forced the government to raise wages during the economic slowdown. Turkey and India have problems with government corruption.
What’s more, overspending on subsidies in Argentina and Venezuela have caused inflation rates and current account deficits to balloon. The results are currency controls, domestic shortages and currencies that are overvalued when compared with black-market rates – even after the recent 15 percent devaluation in Argentina.
The agonising reappraisal of emerging economies by investors started with the US Federal Reserve’s taper talk in May and June last year. Emerging market officials never thanked the Fed for creating all those inflows of easy money, but now they blame the US central bank for outflows. To be sure, the human tendency is to blame outsiders for self-inflicted woes.
The Fed, however, shows no intention of bailing these countries out.
The sheep also have stable currencies against the dollar, with exchange rates relatively unchanged since 2009.
Moderate inflation of less than 4 percent has been the norm in the sheep countries for several years. The stock markets of the sheep economies have been fairly flat over the past decade, unlike the less well-run goats, whose equity markets have sunk. – Bloomberg
* Gary Shilling is a Bloomberg columnist and president of A Gary Shilling & Company. This is the first in a two-part series.