Monday, March 24, 2014

Emerging economies depend on Developed countries

Since the start of 2014, investors have fretted over emerging markets. And they should. Early in this economic recovery, investors repelled by low returns in the developed world leaped for the stocks and bonds of emerging markets, whose markets promised faster growth.

In 2009 and 2010, emerging economies grew much faster than the U.S. did; stock prices rose 46 percent annually, more than twice the gains of U.S. equities. Hot money flowed in, but so did foreign direct investment, which is harder to extract. Last year, foreign direct investment in the developing world grew 6 percent, to a record $759 billion, or 52 percent of the global total.

In their indiscriminate rush into emerging markets, though, investors forgot two important points: First, without exception, these economies depend primarily on exports for growth, which means the developed economies, especially the U.S., must be capable of buying their goods. And second, not all emerging markets are alike.

On the first point, the developing world's export growth model, which worked well in the 1980s and '90s, won't be viable for four more years or so while the U.S. continues to deleverage. Europe, meanwhile, has emerged from recession, but its economic growth will probably remain subdued at best.

The decline in the U.S. household saving rate from 12 percent in the early 1980s to 2 percent in the mid-2000s drove growth in the U.S. and the global economy. During the savings drought, consumer spending grew one-half percentage point a year faster than disposable (after-tax) income and added about half a percentage point to growth in real gross domestic product.

Now all that is moving in reverse: Households are pushed to save by uncertainty over stock portfolios, exhausted home equity and the lack of retirement assets held by postwar babies.

The overseas effects of this reversal are powerful. For every one percentage point rise in U.S. consumer spending, American imports -- the rest of the world’s exports -- have risen 2.9 percentage points a year, on average. So when Americans stop spending, the rest of the world suffers.

On the second point, investors who rushed into emerging markets and failed to differentiate among them are now feeling the pain of that mistake. Emerging economies can be divided between sheep -- developing countries such as South Korea, Malaysia, Taiwan and the Philippines with well-managed economies as measured by current account surpluses, low inflation, and stable currencies, stock markets and interest rates -- and goats, with current account deficits, weak currencies, high inflation, falling equity prices and rising interest rates.