Priming the Liquidity Pump
The global economy is often like a line of dominos. One piece tumbles, causing others to fall too. This year, weak economic growth and heavy debt burdens in many developed markets had a domino effect on emerging economies, and many investors lost confidence in both. In response, central banks have taken actions to boost economic growth and prime the liquidity pump. In the short run, these actions in the developed markets can have a positive “trickle-down” effect on emerging economies, but they could result in a more negative long-term game-changer—inflation.
In September, the European Central Bank (ECB) announced an “unlimited” bond-buying program (known officially as Outright Monetary Transactions) to help sustain the Euro, in the throes of a debt crisis.
Europe is going through an historical change which our team believes could have a positive impact on the global economy going forward. There is a fundamental transformation taking place in the role of government in many European economies. People are now beginning to question the dominant role that many European governments have played, particularly when it comes to social welfare spending.
Many European leaders there realized that they cannot continue to spend at the same rate as in the past, running up deficits. And there is also a realization that government restrictions and barriers in the way of private enterprise are, in some cases, too cumbersome. So, as this debate continues, I believe there will likely be reforms on top of reforms.
Privatization of state-owned enterprises is one area that I think could potentially lead to higher economic growth and a much more prosperous Europe in the long term. However, it’s not going to happen overnight and there are many vested interests who want to protect their positions. But in my opinion, the trend is clear; there should be reform that leads to a more unified and stronger Europe, politically and economically.
While Europe is having these debates, the U.S. seems to be putting any debt reduction efforts on hold until after the general election in November. To help boost the economy and restore some confidence in the meantime, the U.S. Federal Reserve (“Fed”) announced it would buy $40 billion per month in mortgage-backed securities on the open market, the third round of its quantitative easing program (“QE3”).
Prolonged Fed Easing
Whether it’s called “QE3,” “QE4” or something else, it seems to me that the Fed will likely continue to pump money into the market until it sees a significant improvement in the U.S. unemployment rate, which stood at 8.1% in August. As I see it, we may as well call it “QE Whatever” until that happens. And, in my opinion, I don’t see it likely happening without some changes and reforms, including to the U.S. tax structure. In a domino effect fashion, this could, in turn, mean that the Fed, along with the European Central Bank, the Bank of Japan, and other central banks looking to stimulate their economies, keep priming the liquidity pump.
In my opinion, this can be positive for investors in emerging markets, at least in the short run. Along with many developed markets, many emerging economies have been subject to slowing growth this year, and investors have been reluctant to place their assets in what they perceive as “risky” markets, whether rightly or wrongly so. Events in the developed markets in the past few years have proven no market is without risk.
However, in my view, the billions of dollars flooding into the financial system will not all flow into what many investors believe to be “safe haven” assets, such as U.S. Treasuries and other government bonds. There is lots of cash in the system right now, and I would expect more institutional flows into stocks generally. Some of those flows could wash up on emerging and frontier market shores, particularly if confidence in Europe—and the global economy—grows.
Unequal Opportunity Inflation
Given this flood of cash, I believe the biggest threat we need to be cognizant of in the long term is inflation. This is true in developed and emerging markets alike, although emerging markets tend to experience a greater negative impact. Generally, a larger percentage of the population is in lower income brackets, so price increases in essentials like food and fuel can be harder to absorb. One way to help lessen the effects of inflation is by increasing productivity, and to achieve this, I believe many economies need to reduce the role of government. Why? Because when governments are running enterprises, productivity is often reduced.
So, as a result of this high level of monetary easing and the potential threat of inflation, my job as an investor is to look for individual companies in countries that show potential to be able to survive, and even thrive, in the face of these challenges. And one thing I’ve learned is that in any economic cycle, there are always potential opportunities somewhere.