Emerging markets are on fireBloomberg News · Friday, Aug. 20, 2010
The global economy is like fried ice cream: If you don't act fast, it turns into a mess.
American pundits, Nobel laureates included, are predicting Japan-style deflation for the United States and Europe. They are urging the Federal Reserve to pursue another round of quantitative easing to stop the onset of an Ice Age for Western economies. The Fed didn't oblige at its last meeting, but it threw a bone to the deflation crowd by promising not to pull money out of its previous round of asset purchases to stimulate a recovery.
On the other side of the world, consumer prices are surging. Emerging markets as a whole now have an inflation rate of more than 5%. India is registering price increases of more than 13%. China's are more than 3%.
Much of the "heat" comes from the property market in emerging markets. Milliondollar flats in Mumbai have panoramic views of the city's slums. Hong Kong's real-estate prices have almost reclaimed their 1997 peak. Overpaid bankers who pay 15% income tax in Hong Kong are stretched to buy Beijing or Shanghai properties.
The emerging markets are on fire.
Deflation prophets in the West are in for a rude awakening. Eastern fire will turn Western ice into a mess, and 2012 looks like it will be the year of melting. The fuel for the fire is coming from deflation-fighting stimulus programs, such as that of U.S. President Barack Obama.
Stimulus is prescribed as a panacea for recession. In to-day's global economy, it isn't effective in the best of circumstances and is outright wrong for what ails the West now.
Trade and foreign direct investment total half of global gross domestic product. Multinational corporations drive both. They shop around the world for the lowest-cost production centres and ship goods to wherever the demand is. Demand and supply are dislocated. So when a government introduces stimulus, the initial increase in demand doesn't necessarily boost local supply. More importantly, if multinationals decide to invest somewhere else, there wouldn't be an increase in jobs to sustain the growth in demand beyond the stimulus.
Just as water flows down, stimulus affects low-cost economies more, wherever it is initiated. As the West pours money into the global economy through large fiscal deficits or central banks expanding balance sheets, the emerging economies are drowning in excess liquidity. Everything is turning red-hot.
How will this all end? The most likely scenario is that the West will have to stop stimulus programs when inflation spreads to it from the emerging economies.
The most immediate channel is through rising commodity prices. It's a tax on the West to benefit emerging economies that produce raw materials.
That's the irony: The stimulus in the West can immediately bring harm to itself. It's also the magic of globalization.
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