Emerging markets used to be known as markets you couldn’t emerge from in an emergency. History is littered with examples of financial disasters in young, fast-growing countries, from the Argentine default of 1890, which almost brought down the Bank of England, to the Asian crisis of the 1990s.
In fact, it is hard to think of an emerging economy that hasn’t experienced at least one devastating boom-bust cycle on its path to development. The U.S. is no exception. British investors who bought into the great growth story of the 19th century—the American railway industry—ended up with ruinous losses.
This time, though, it’s different. Really, really different. We know this because Western financial institutions keep saying so. Almost with one voice, they are advising us to pour our savings into the stocks and bonds now being issued on a massive scale by the emerging world—and being underwritten, distributed, and traded by those same Western institutions.
So far, investors are following the script. In the first nine months of this year, the inflow into mutual funds specializing in emerging-market bonds was four times its previous annual record. Funds that invest in stocks poured $50 billion into emerging markets, and pulled $80 billion out of developed countries such as the U.S., Japan, and Europe. These flows are enough to singe your eyebrows. CLSA, a stock brokerage, expects the flow of “hot money” into China alone to exceed $1 trillion this quarter. No surprise that China is now exporting its real-estate bubble to locations as distant as Australia and that gaming revenues at the Macau casinos are through the roof.
Such is the hunger for all things emerging and exotic that the Mexican government has just issued a 100-year bond at an interest rate of just 6 percent. If you have the 100 years of fortitude necessary for that, you might want to consider extending your time horizon further. Brazilian and Hong Kong real-estate developers are among the companies that have recently issued perpetual bonds—thereby giving you the opportunity to lend them your money forever.
The immediate trigger for the feeding frenzy is another round of quantitative easing (QE) in the U.S. Just the prospect of more money-printing has reduced the value of the dollar and sent a tsunami of liquidity racing across the global financial system. Critics of the Federal Reserve maintain that QE will not work at all, or that it will work too well, creating hyperinflation. Some of these concerns are fair, but even so, QE could well be a geopolitical masterstroke. It strikes at the heart of the growth strategies of China and other rising powers, forcing them to reconfigure their economic systems or risk disaster.
Countries following the Asian developmental model rely on undervalued currencies and abnormally low interest rates. By prioritizing exports and capital investment at the expense of households and consumption, they have industrialized at warp speed. Pleas from trading partners about the need for global rebalancing have gotten nowhere. The policy elites in these countries see no reason to give up a winning hand and risk instability and perhaps their own legitimacy. Hence the stalemate and rancor at the G20 and other global gatherings. The latest round of QE raises the stakes enormously: pouring liquidity of this scale into booming economies is like drenching a fire with gasoline. The result will be even bigger asset bubbles or inflation or both.
The normal response to such a threat would be a sharp tightening in monetary policy. But that would cause currencies to rise or, in China’s case, necessitate a substantial revaluation. Export competitiveness would be lost; real-estate prices would dive; new sources of domestic growth would have to be brought on stream. These are tough problems, which is why governments have preferred to avoid them. Now the alternatives may be worse. Big asset bubbles do serious damage. The Netherlands was a superpower until the “tulip mania” of the 17th century; Japan has yet to recover from its 1980s blowout. It took a world war to pull the U.S. out of the malaise of the 1930s. Inflation is equally destructive, as China’s own postwar experience proves.
QE exposes the internal contradictions of the Asian developmental model and makes life a lot harder for countries that base their success on it. Financial bubbles make life uncomfortable for investors, too. If you’re out of the market, you’ll suffer pangs of regret all the way up. If you’re in, far worse torments await you on the way down.
Tasker is a founding partner of Arcus Investments.