BRICs

The acroynym BRICs was the great theme for the bulls of emerging markets, comprising the four largest emerging economies in the world, each with their own growth dynamic. Unfortunately the bull case for these four economies is now looking distinctly stale. China. China has overinvested in manufacturing capacity with the result that returns on assets is probably negative. This is reminiscent of Asia (Thailand/Indonesia) prior to Asian crisis of 1997. It is likely that the level of bad debt within the banking sector is extremely high although there are no precise figures on this. The authorities are well aware of the problem but they are loathe to tackle the problem head on and they rely on other stimulatory measures to boost the economy. These are not working with the result that economic data out of China will disappoint over the next few months. India. India is running a large current account deficit and is running into reform fatigue. There are some initiatives to boost infrastructure spending which is sorely needed, but again economic growth will probably disappoint over the next few months. Russia. The problem with Russia is political as Putin's position continues to weaken. Putin's problem is that he retains his Soviet instincts of throwing his opponents in prison on trumped up charges, whenever they have the temerity to oppose him. He cannot grasp the notion that for every opponent in jail, there will be 5 more to replace them. In the meantime, the economy is plagued by insecure property rights and capital flight. Brazil. Brazil has been tolerably well run in the last decade and much better than in previous decades and also compared to Argentina and Venezuela. Unfortunately, it needs to be even better run. Its trend rate of growth has been lifted from the 3% to 4% level to 4% to 5%. This is not good enough with teh result that the economy is running into inflation problems even at relatively low levels of growth. That is the bad news. The good news is that there are other large emerging economies in this world to invest in and each one should be viewd on its own merits. There is no easy way of making money in this world and a blanket enthusiasm for emerging markets and the BRICs in particular was not one of them.

The Bank of Japan

When economic historians look back at the Great Recession of 2007/09, the greatest criticism they will make is that policy makers put too much reliance on monetary policy and not enough on fiscal policy. They will argue that the fears over the rise of public debt to GDP were overdone and too much emphasis was put on the numerator, public debt, and not enough on the denominator, nominal GDP. It is much easier to control the ratio if the denominator is rising than when it is falling. This point has been completely missed by the authorities in Europe, particularly in Germany. They have decided to completely ignore the lessons of the 1930s when too many countries tried to adhere to the gold standard and failed miserably. Today’s ‘gold standard’ is of course EMU and the fiscal austerity imposed by Germany on the periphery economies is having the same disastrous results. If there is any doubt about this, simply compare European unemployment and retail sales to those of the US. European unemployment is now 12% and rising whereas that in the US is 7.7% and falling. European retail sales have fallen by 1.5% over the last 12 months whereas those in America have risen by 4.5%. One country that has changed course in recent months has been Japan, where Prime Minister Abe has insisted that the Bank of Japan adopt an inflation target of 2% and do everything possible to ensure it is reached. In addition, there has been a sea change within the Bank of Japan with a new Governor and a Board prepared to support him. Gone is the traditional timidity where the attitude has been ‘we have done all we can’ to be replaced by ‘let’s go for it’. To this end, the Bank of Japan has announced that it will double Japan’s monetary base and formally adopt the 2% inflation target. QE will now be the centre of what the BoJ does. This is a significant shift, not just for Japan but also for Asia and even possibly globally. If only policy makers in Europe would take notice! If one wants to temper one’s enthusiasm for Japan, it would be the need for the change in monetary policy to be accompanied by structural reform. PM Abe has talked about this need but in the obscure world of Japanese politics, do not hold your breath.

Cyprus

Cyprus has its deal with the EU to resolve its banking crisis but the question is at what price? There is the usual bad bank/good bank resolution stuff and it is bad news for uninsured depositors. No-one will shed much of a tear for the Russian depositors but not much mention is made of Cypriot businesses with over €100,000 deposits. Insured depositors are safe (for the time being). Cyprus will now see a substantial shrinkage in its banking sector and in turn in the economy, which will make it difficult to meet the debt to GDP targets. The other thing that is not clear is whether the EU now has a template for dealing with banking crises in member countries or whether it is still moving on a case by case basis. One could be cynical and say that the EU is enjoying what it is doing to the Cypriot banking sector, which is effectively killing it off and making several Russian oligarchs pay. Malta and Luxembourg should beware; the big guns could be out for them as well. But when it comes to Germany’s own weak banks, it is the softly, softly approach. There are double standards in all of this. This ‘agreement’ and all the associated issues over deposits increases the chance of bank runs in other periphery countries. In the long run, this may be no bad thing as it will highlight the perennial problem of moral hazard and the risks within banking and so lead to a shrinkage in deposits to GDP. In the short run of course, it is the last thing we need. The final point, which applies to all of the periphery, is that a hard-nosed approach by Germany and the ECB is perhaps understandable but for such an approach to work, Germany itself need to make a concession which is that she must become the spender of last resort. This she has conspicuously failed to do.

The latest global All-industry PMI data for February point to an economy inching forward. It is am improvement but not a terribly exciting one. The US is doing somewhat better, Japan is doing less badly than before and within Europe, Germany is improving but the periphery remains in a bad way. Italy remains a real concern. The OECD lead indicators are telling us that the developed world is doing a bit better than the developing world.