The International Monetary Fund issued a report in its World Economic Outlook saying a mere extra unplanned 0.5% growth in the U.S. will have bad consequences for the world because that will result in U.S. interest rates rising which will hurt the Emerging Markets. They are basically agreeing with my opinion that the EM countries benefited to much from U.S. Quantitative Easing and zero percent rates and when that stimulus is removed then EM countries will be hurting. The implication is that EM growth in recent years was partially bogus because it was aided by U.S. stimulus including the speculation in commodities exported by EM countries.

The report said investment levels in capital goods could be 14% lower than expected over five years because of a U.S. growth rate a mere 0.5% higher than expected. So that is a six-fold leverage in terms of a 3% annual degradation in investments in capital goods caused by a 0.5% domestic change. My opinion is that this confirms the opinion that U.S. stimulus leaked into the EM countries and created a false signal that incorrectly stimulated EM countries. This was partly due to U.S. investors seeking a high yield haven and partly due to commodity speculation which was in anticipation of U.S. inflation that never came.

I saw a graph about the job quit rate (Greenspan’s favorite indicator) which showed it is about halfway between recession and full employment and trending up sharply. This is a key indicator of the labor market. The implication is that the economy is healing rapidly which will lead to higher interest rates.

Rising interest rates act to suppress inflation which can make investors abandon gold and silver. Rising interest rates mean there will be a serious opportunity cost to buy non-yielding things like gold, commodities, growth stocks, etc. and thus investors will sell off their holdings of non-yielding assets. Rising rates and corporate profits.

Rising U.S. rates will make the dollar go higher and make EM currencies go lower. They usually borrow using bonds denominated in in dollars which will mean the coming EM devaluation will make repayment of principal much harder, leading to another international debt crisis. The typical crisis in EM is when their currency is devalued the foreign debts are unaffordable thus throwing their economy into a deep depression.

In previous decades the EM countries had a cost advantage over Developed Markets but now that has been eroded and what really matters is quality of output instead of the lowest price. If the output, which includes dealing with corruption, pollution, poor quality, dictatorship, inability to freely export or import goods, etc., then Developed country manufacturers may find these problems outweigh the cost savings of the EM. Profits don’t come from a huge army of low paid peons weaving jute mats, instead they come from sophisticated processes run by well paid knowledge workers. These knowledge workers are unable to be fully deployed at maximum profit in EM countries in some cases which undermines the sources profits that are needed to payback foreign loans, thus exacerbating the coming international EM debt defaults.

Investors need to seek independent financial advice about the risks of a surprise stronger than expected recovery which can damage Emerging Markets stocks, and hurt global real estate, commodities and long term bonds. I wrote an article “Global economy looking riskier”.

 

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