During the fall of 2009, I wrote a letter to the clients of my former employer called A Roadmap For Asia.1 The point of the piece was to outline a set of ideas that I thought were important for long-term investors to consider at that juncture. The world had just gone through a crippling financial crisis; yet somehow Asian economies had not only weathered the storm, but were performing much better than expected. I felt as though a new chapter was beginning in emerging markets, one where historic relationships and long-held assumptions might be overturned. My aim was to summarize a set of critical points for investors who hoped to be successful in those markets over the next decade.
One point I made then was that central banks in Asia were no longer taking their cues from the U.S. Federal Reserve. Throughout my career, I had seen bankers in the region tie their local currencies to the U.S. dollar—and in doing so, most found it necessary to follow the Fed’s moves, hiking or cutting rates in tandem. However, by mid 2009, U.S. financial and monetary policy stood discredited. Asian central bankers, emboldened and goaded on by local politicians, began to act independently of the Fed. Their domestic interest rates were increasingly self-determined, even as they still clung to policies designed to tie their currencies to the dollar. What I wrote then—and still believe now—was that this change would give rise to pronounced inflationary pressures within the region. I was concerned that most of those central banks lacked the experience and the independence to set credible policy. I feared that political masters would force the banks to adopt an overly “accommodative stance” (i.e., they would keep rates too low for too long), and that this would feed a sustained bout of inflation.
Eighteen months later, my record on this prediction is mixed. I am vindicated in that inflation is a serious concern for Asia’s emerging economies—indeed for emerging economies everywhere. This is because central bankers have favored lax policies that have stoked inflationary pressures. For example: despite inflation in excess of targeted levels, China’s central bank has made only gradual changes to domestic rates, perhaps for fear of tripping up the local housing market. Meanwhile, Brazil’s central bank surprised observers this week when it undertook only a small hike, even as inflation also accelerated past threshold levels. All this is broadly consistent with what I wrote in 2009.
However, my conjecture had one major shortcoming: I failed to anticipate the Fed would be the worst offender of all. Implicit in my commentary was the idea that most of Asia’s central banks, when untethered, would act in less than responsible fashion. Yet in late 2010, the Fed embarked upon one of the most expansionary monetary policies in U.S. history—superseded only by the easing that took place during the financial crisis of 2008. Some argue the Fed provided essential stimulus to an otherwise tepid economy. Personally, I disagree with such assessments, but that point is irrelevant. What is essential is that the Fed’s policy has had spillover effects on the rest of the world. Most emerging markets, lacking solid currencies and local-currency capital markets, choose to peg their currencies to the dollar, to denominate commodities in dollars, and to engage in dollar-denominated trade. As the Fed has literally flooded the world with dollars, it has spurred tremendous pricing pressure in emerging markets everywhere, especially on their currencies and on their commodities. I was right about resurgent inflation, but wrong about its ultimate source.
So where do we stand now? I hesitate to make a prediction, as I will be lucky if I am even half-right again. I’ll give it a shot though. I believe the inflationary pressures that have built up over the past year are by no means transient—they are here to stay. My suggestion: get used to it. Central banks in both emerging and developed markets have run loose policies for such an extended period that structural damage has been done. I am not yet concerned that any major economy is headed for hyperinflation. However, we are likely to see sustained, elevated levels inflation—the kind that will pose challenges to political stability, as in the Middle East—for some time to come. Frankly, I was shocked that just six months ago you could still point to a number of prominent strategists and economists who believed that deflation would win out. Their arguments were flimsy, and to the best of my knowledge, they are silent now. I admit that in the event of a catastrophic shock—say a severe financial panic in a large economy such as Spain or China—deflation could emerge as a legitimate threat. Yet apart from such an event, the world’s inflationary pressures will not dissipate anytime soon.
Next week, my commentary will address the same topic, but I’ll shift perspective from the macro to the micro—the view from the “bottom up.” If I am correct in my assertion that elevated inflation will persist, there will be serious consequences for companies operating in emerging markets. I’ll discuss how I have seen companies in emerging markets cope in practice with high and rising prices—and what I look for management teams to do in such circumstances.Andrew Foster
- The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect the writer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.
- Matthews Asia, "A Roadmap for Asia," Asia Insight, November 2009, http://matthewsasia.com/resources/docs/pdf/Asia-Insight/2009/MATAI_AsiaInsight_1109_web%20final.pdf