The rose-tinted glasses of the investing classes have finally fallen from their eyes when it comes to Western markets, at least. Suddenly, everyone recognises that we are entering, at best, a long period of low growth. They also see that it is unlikely that Europe's crisis will be resolved either in a hurry, or in such a way that doesn't cause horrible pain somewhere. So much so, that they are even pricing quite a lot of reality into the markets.
But that doesn't mean that the City's global strategists are feeling down. Far from it. Mention collapsing growth to the average economist, and he'll tell you not to bother yourself too much. While Europe and the US might be stuck in a stagnating rut, the emerging world is a different matter altogether. There, exciting, vibrant economies are operating independently of us. They've 'decoupled', they are growing at speed, and their energy will save the world.
The only problem with this and with most optimistic short-term platitudes you hear these days is that it owes as much to wishful thinking as toreality. Every time that investors look east, they pop their tinted glasses right back on.
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To me, the idea that emerging markets have genuinely decoupled from the major markets (the US and Europe) seems unlikely. The obvious way for this to happen would be for their economies to be rebalanced away from catering mostly for export markets to mostly domestic consumption. This might well happen one day. But it hasn't yet.
Take China. Back in the 1990s, 45% of China's GDP was accounted for by consumption. In 2007, it was 36%. Of course, the absolute number is up thanks to the fact that China's GDP is hugely bigger now than it was then. However, it is hard to argue that the Chinese as a whole have morphed into free-spending shoppers.
Any suggestion that they soon will, says Deutsche Bank's John-Paul Smith, seems "naive in view of the structural challenges which confront the emerging economies". These include the fact that the authorities in many emerging markets (China being the classic) remain "wedded to the mercantilist model".
This means keeping their exports competitive and their global market share up by keeping their exchange rates artificially low. That tends to suppress consumption (it makes imported goods expensive).
There is also the fact that, as global growth slows, authorities will try to shift resources towards the troubled parts of their economies. In China, for example, bank deposit rates are capped so depositors never get a real rate of return on their money after adjusting for inflation. Good for banks, bad for consumers trying to build wealth.
Next up is the lack of a welfare state. This makes it hard for the Chinese to prioritise present consumption over future security. In the UK, we know that while the state isn't going to lavish much on us, we aren't (unless things go significantly more wrong than they have already) going to die hungry in the streets. That makes it easier for us to spend than it is for those who know they are financing every calorie of their own futures.
Then there is the property bubble. Consumers unable to make a real return in inflationary China haven't been spending their cash. They've been parking it in new-build flats. It is, as Edward Chancellor of investment manager GMO points out, generally believed that "Chinese property has never gone down in value and never will" and that, even if something goes wrong, Beijing will somehow protect the market.
Given our experience in the West, you might think that's a pretty dangerous idea. But, even today, with residential construction making up around 10% of GDP (the same as in Spain at bubble peak), with 16m empty city apartments (according to CLSA), and with whopping credit growth (30% plus in 2010), you'd be hard pushed to find many Chinese investors to agree with you.
Finally, there is evidence of a credit crunch building in China.
CLSA's Christopher Wood refers to an "intensifying credit squeeze, in terms of very high interest rates" being charged in China's underground lending market. At the same time, property developers have started to complain of a lack of credit for non-state operated enterprises.
Real estate bubble cycles "peak at the point where credulity gives way to disbelief," point out Chancellor. They also give way when credit becomes scarce. China doesn't seem far from either of those points.
China has other problems: rising civil unrest, bad debt at local authority level, and a chance that the rest of the world will soon respond to its mercantilism with protectionism. Not only can it not fill our demand gap, but a sharp fall in its own growth is very likely. The US has had 17 recessions in the last 90 years. Why shouldn't China have a couple too?
There is a silver lining to all this for investors. Emerging market equities are getting cheaper (and possibly due a fourth-quarter bounce) and, if China does slow in particular if it suffers a hard rather than a soft landing we will finally see the pull back in commodity prices that we have been waiting for. Long-term investors will then be able to pick up pretty much everything they ever wanted.
This article was firs5t published in the Financial Times.
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