INTEREST RATE INCREASES ARE BEGINNING IN STRONG GROWTH COUNTRIES
India raised interest rates in a surprise move on Friday, March 19, 2010. This followed recent interest rate increases by Australia and Malaysia, all three countries are experiencing strong economic growth and rising fears of inflation.
There are of course consequences of rate increases, especially as they spread to more countries, some time in the future rising interest rates will lead to the moderation of the strong economic growth that Asia is currently experiencing.
In our opinion, this will not happen until Asia has dragged the world out of much of its current malaise.
CHINA IS TODAY’S ENGINE OF WORLD ECONOMIC GROWTH
The Euro zone is in terrible shape ten years after it was launched with high expectations of solving Europe’s problems with over-regulated markets, over weaning welfare states in some countries, and with expectations for increased trade within the bloc. After ten years, trade has improved, but the other problems still exist.
The welfare states suck the lifeblood out of the community, and much like our state of California, where many public servants retire after 25 years of service and receive very high pensions, Greece, Portugal, and several other Euro zone countries are in deep financial trouble. The members of the Euro community must choose either the status quo, which will mean the type of economic stagnation we have predicted in these pages for some time, or the alternative; to cut benefits and require public employees to work to a more reasonable retirement age.
With Japan stagnating for over twenty years, the Euro zone facing a long stagnation, and the U.S. suffering from an irresponsible spending regime, China is the world’s economic engine presently.
China supports the growth of countries such as Brazil, Australia, Canada, Indonesia, Malaysia, the U.S., and others by purchasing their raw materials and foodstuffs. They support machinery manufacturing worldwide by purchasing machines, machine tools, and other implements to build out the Chinese infrastructure and manufacturing base.
Today, we should all be aware that the world economic crisis would have been much more serious without the benefit of Chinese demand. Other countries, including India, have also played a part in this shift of economic demand from the West to Asia.
Rising China is a real contender
By. Gideon Rachman
Published: March 16, 2010
Is China like the US in 1890? Or is it more like Japan in 1980? If the parallel with America is right, China is likely to be the dominant power of the next century. If the Japanese comparison is more accurate, then the Chinese challenge to American hegemony could prove ephemeral.
The current mood in the US certainly feels like an exaggerated version of the "declinism" that set in towards the end of the 1980s, when the US was transfixed by the rise of Japan. A recent Pew opinion survey showed that a majority of Americans now believe that the Chinese economy is larger than that of the US. This is plain wrong. At the time the poll was taken, the Chinese economy was around half the size of America’s.
It was this kind of scare that took hold in the late 1980s. Japanese investors provoked angst by buying the Rockefeller Centre in New York – and it was Japan that was the world’s largest creditor nation.
The book that captured the declinist spirit of the late 1980s was The Rise and Fall of the Great Powers , written by Paul Kennedy, a Yale historian, who introduced readers to the notion of "imperial over-stretch". His argument was that America was staggering under the burden of its global commitments and was now in relative decline – following the path of the British, Napoleonic and Spanish empires.
Prof Kennedy’s book caused a sensation when it was published in 1988. But just a year later, the Berlin Wall fell and the Japanese stock market bubble went pop. By the mid-1990s the "Kennedy thesis" was itself in relative decline, displaced by sexier new theories about the US as the "sole superpower" and the "clash of civilisations".
Now America’s financial and military troubles – coupled with the rise of China – raise the question of whether Prof Kennedy was right, after all. Perhaps America’s post cold-war dominance was just a blip before the resumption of relative decline.
Re-reading the book, more than 20 years after its publication, it seems strikingly prescient in some ways – and strikingly wrong in others. The argument that America’s share of the global economy will inevitably decline – and that this will have knock-on effects on global politics – still looks spot on. But Prof Kennedy was also bedazzled by the rise of Japan, arguing that it was "likely to expand faster than the other major powers in the future" and would be "much more powerful" economically by the early 21st century.
I am not dredging up these old comments to make fun of Prof Kennedy. The point is simply that facts and conventional wisdom can change very fast. At the moment, China’s rise looks just as unstoppable as Japan’s did in the late 1980s. But there are plenty of analysts who see Japanese-style bubbles inflating in the Chinese economy. Perhaps the Chinese bubble will also go pop, leaving those who have predicted a "Chinese century" scratching their heads in embarrassment and surprise.
In fact in some ways, China is a less plausible rival to the US than Japan was in the late 1980s. Japan is a wealthy, homogenous, developed nation with a stable political system. China is, in many respects, just what its leaders always insist it is – a developing nation.
Although some western intellectuals have lauded China’s ability to plan for the long term, the country’s political system is inherently unstable. The actions of China’s government often suggest that its leadership remains very nervous about its power and legitimacy. China’s angry insistence on the unity of the nation also betrays deep anxiety about separatist challenges in Tibet and Xinjiang.
But in other, more important ways, China is a much more serious challenger to American hegemony than Japan ever was. The most obvious point is demographic. America’s population is more than twice that of Japan; it is less than a quarter of China’s. Japan was (and is) also a democracy, an American ally and the base for some 50,000 US troops. China is, by contrast, a geopolitical rival. If China keeps growing fast then inevitably its economy will, at some point, become larger than that of the US – and that process will certainly change the global balance of power.
So the big question remains: how much longer can the Chinese economy keep booming? Here the differences between the China of today and the Japan of the 1980s are more striking than the similarities. Because China is much poorer than Japan was back then, and has a much larger population, it probably still has tremendous scope for internal development and rapid economic growth.
China is spending a lot on infrastructure, but it needs to – many of its villages, for example, still lack paved roads. Even if the country experiences disruptions, burst bubbles and occasional recessions along the way, its strengths are such that we should expect it to make ground on the other great powers. China, in fact, may be like Japan – but more like Japan in the 1960s than in 1988.
If China has another 20 years of rapid growth in it, then the likelihood is that it will indeed take the title of "the world’s largest economy" some time in the 2020s. America probably achieved this status in the late 19th century. It took half a century and two wars for raw American economic power to translate into geopolitical dominance. I’m not sure whether that is a comforting thought, or not.
It does not appear that the U.S. and Europe have the flexibility to increase interest rates. Their economies are too weak and their underlying financial condition too debilitated to take the action of heading inflation off before it arises, which is what several countries in Asia and the Pacific Rim are trying to accomplish.
The U.S. is employing an inflationary monetary policy, and there is no doubt in our minds that the U.S. will eventually suffer from another bout of inflation such as we saw in the 1970’s. On the other hand, Europe led by a frightened Germany is heading toward slow growth and a more deflationary future. Why do we say that? Germany does not want the German taxpayers to bail out Greece, and perhaps several other European nations with financial problems [such as Spain, Portugal, and Italy]. They would rather have the IMF do the dirty work of forcing the over-extended countries to reform. The entrance of the IMF will help German taxpayer who would otherwise have to pay the bill for the profligate spending of others. The IMF always prescribes deflationary cost cutting and tax increases in cases such as Greece’s. Tax increases and spending cuts will impede Greece’s and possibly several other European countries’ growth for some time.
The global equity markets’ response to Greece’s problems…has been to rally. The Greek fiscal crisis has accomplished two things to help support equity markets. 1) It has convinced equity buyers that monetary policy in the developed world will remain loose for an extended period of time, and 2) it has given investors another reason to shift asset allocations away from some countries’ government bonds into an asset class that offers the opportunity to grow; global equities.
LONG TERM READERS WILL REMEMBER OUR RAILIING ABOUT THE COSTS OF THE WARS IN IRAQ AND AFGHANISTAN
At the beginning of the Iraq war we stated in no uncertain terms that the economic consequences of the war would be to burden future generations of U.S. taxpayers with declines in their standard of living due to the debts incurred by the current generation’s leaders. When the Afghanistan war began, we repeated the warning.
Today, we believe that, the U.S. unfunded liabilities for Medicare, Social Security, and health and retirement for service members and other federal employees as well as other “entitlement” programs total about $38 trillion. Remember, this liability is unfunded.
THE CURRENT U.S. HEALTHCARE BILL MAY BE EVEN MORE EXPENSIVE THAN THE WARS
Now it is our unfortunate duty to point out that the current healthcare bill will further burden and encumber the coming generations of American taxpayers. There is no question that U.S. companies will re-evaluate the costs of hiring new employees, and that corporate profits, and thus stock market prices, will be heavily impacted by the cost burden that corporations will be faced with to support the uninsured.
Just as with the cost estimates associated with the wars, the actual costs will likely be trillions of dollars more than the politicians report to the taxpayers; costs are conveniently forgotten, or worse, just lied about through lowball cost estimates by the Congressional Budget Office.
The healthcare bill will be very expensive for future generations. The big question is, how long will it be before the world realizes that, like Greece and many other nations, we are living beyond our means in the U.S.?
CURRENTLY THE U.S. AND MANY ASIAN MARKETS ARE RALLYING
Longer term, the costs will hurt U.S. corporate profits and stock prices as well as cause a rise in capital gains taxes, but the market has decided to focus on the positives that have developed in the short term.
There is plenty of cash available for stocks because investors are afraid to buy bonds. They fear bonds because many investors see inflation on the horizon in 2011, and they do not want to own bonds when interest rates are rising. Hence, they are selling bonds to purchase stocks. Additionally, the uncertainty surrounding the healthcare bill is now behind us, and the market sees that that income taxes will not rise until 2011. This confluence of events has caused them to return to enjoying the rally that began in early March.
On the positive side, commercial real estate is being refinanced, and the feared massive foreclosures of commercial real estate will probably not develop. Many U.S. states have problems, but investors are focusing on the problems in Europe and temporarily ignoring the U.S. problems. In essence we believe that investors are saying, “Make hay while the sun shines”.
We suggest that our readers focus their investments on exporting companies, food related companies, raw materials producers, iron ore, oil, coal, technology, and on stocks of other countries, especially those countries who can export to the fast growing nations such as India, China, and other Southeast Asian nations. Even U.S. financial stocks are enjoying a rally as a result of the end of uncertainty. We own some U.S. bank stocks with a short term investment horizon.
We will continue to avoid most Japanese, European, and U.S. stocks that produce products for domestic consumption. Gold is in a trading range, as it approaches the bottom of the range, we will add to gold shares.
Thanks for listening.
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