A not so widely recognised consequence of the long-running boom in U.S. consumer spending is the high growth that most Asian economies have enjoyed in recent years. Strong export driven growth has in fact more than compensated for relatively weak consumer demand in many Asian countries and allowed the region to grow out of the problems it faced during the crisis in the late 1990s.
The argument in favour of investing in Asia goes approximately like this: "Under no circumstances do I want to invest in U.S. dollar assets. With the big fiscal deficit and the large and growing current account deficit, it is an accident waiting to happen. I think the opportunities are far more exciting in the fast growing region of Asia, as strong exports and rising standards of living will continue to fuel growth."
Now, here is the problem with this argument. If the U.S. economy cracks under the weight of its indebted consumers (which, in our opinion, is not a given but certainly a possibility), Asia could be seriously negatively impacted. So attempting to hide from the U.S. imbalances in Asia is a strategy which could backfire spectacularly.
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The other problem facing large parts of Asia is the current combination of high (and rising) inflation and central bank inactivity. But before we go there please take a minute or two to consider the fundamental change in the dynamics of the world economy which is unfolding in front of our eyes.
It is obvious even to the untrained eye that volatility in economic growth has receded in recent years at least in our part of the world. In other words, recessions occur less frequently than they used to do, and when they do happen, they are less violent than in prior decades.
For this, central banks are often credited. There seems to be a widely held opinion that modern day central bankers are simply better at managing the economy than their colleagues of days gone by.
Perhaps they deserve some of the credit (they probably do), but we urge you to consider the following fact. Over the past few decades our economy has been transformed from being predominantly production-driven to being largely service orientated. We still need the production to take place for our society to function. But we have (successfully, we might add) moved much of the production to places like Katowice and Kuala Lumpur, where production costs are lower and profits therefore higher.
With the outsourcing of large parts of the production legs of the modern Western economy, much of the economic volatility has been exported at the same time. If this thesis is proven correct - and only time can tell if it is indeed correct - Asia and other outsourcing markets will turn out to be significantly more volatile than economies of the old world'.
If you don't accept this line of thinking, please consider the following. Whereas it remains a mystery to many that, following the rapid rise in commodity prices, old world inflation is still relatively subdued, the situation in Asia is very different. Countries across the region (in particular India, Indonesia, the Philippines and Thailand) are experiencing worryingly high consumer price inflation. Even more alarmingly, the central banks of these countries have done virtually nothing to curtail inflation. Sooner or later, they will have to make some difficult decisions.
Consumer Prices in Selected Asian Countries
Country, Consumer Prices (YoY), Latest Report
India, +5.6%, Dec
Indonesia, +17.0%, Jan
Malaysia, +3.2%, Jan
Philippines, +6.7%, Jan
Thailand, +5.9%, Jan
Source: The Economist
So why are the central banks of these countries taking little or no action? The most likely explanation lies in the region's dependency on economic growth. The crisis of 1998 is still fresh in many people's minds. Rapid growth has proven an effective tool in terms of revitalising the region, and Asian central bankers are probably under immense pressure not to kill the good run.
Unfortunately, as we know only too well from prior experience, this is exactly the wrong thing to do. Inflation rarely disappears on its own accord. Ultimately, the central banks will be forced to act, but then it is probably too late.
With a bit of bad luck thrown in, exports will start to slow at the same time as the central banks start their tightening cycle. The probable result? A classic case of stagflation.
At the same time asset inflation is rampant in many countries, but nowhere is it more apparent than in India where the local stock market has tripled in value in less than 3 years. Overvalued assets. Export dependent growth. Rising inflation. Inactive central banks. In some cases, large fiscal deficits. In a few cases, also large trade deficits. It is a movie we have seen before. And, unlike most Hollywood movies, this one does not come with a happy ending.
By Niels C. Jensen, chief executive partner at Absolute Return Partners LLP. To contact Niels, email: njensen@arpllp.com
