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China and India's Growth Just Currency Related Illusions?

by: Larry MacDonald July 08, 2008 | about stocks: CHINA    
Larry MacDonald

Larry MacDonald

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Let’s explore an interesting development: the different inflation experiences of emerging countries and developed countries. In case you haven’t noticed, inflation in emerging countries is higher, demand-pull in nature, and advanced to the stage of a wage-price spiral; in developed countries, it is lower, cost-push in nature, and not advanced to a wage-price spiral.

Does this have any significance? One ramification could possibly be the unwinding of the secular growth stories of the emerging countries and a return to economic supremacy of the developed countries. It could also mean the stock markets of the developed countries will be more rewarding places over the next decade or so compared to the stock markets of emerging countries.

The cost-push inflation of developed countries is easier to resolve, I believe. It should ebb as long as central bankers refrain from overly stimulative monetary policy -- thereby letting the deflationary forces of the stagflation slow the economy to a non-inflationary path. And this is the course of action that the central banks appear to be following (e.g. a rate hike by the European Central Bank, little increase in the narrowly defined U.S. money supply in 2008, etc).

Demand-pull inflation and wage-price spirals tend to be more stubborn. Taming them usually requires a substantial tightening of monetary policy.  A greater setback in growth could be the consequence for emerging economies.

But the required policy restriction will also likely require emerging countries to give up on pegging their exchange rates to the U.S. dollar. That’s because higher interest rates attract capital inflows and generate upward pressures on the currency -- so if policymakers wish to fight a growing inflation problem, they can’t keep their fixed currencies.

A catalyst could come if and when U.S. inflation recedes and the Fed begins easing monetary policy. Emerging countries may not want to follow U.S. interest rates down (as required to maintain their currency pegs) because it pours more fuel on their overheated economies.

All of which begs a few questions. Could emerging countries now be mismanaging their economies to the extent they kill off their vaunted secular growth stories? They wouldn’t be the first to botch things: in the 1980s, Japan was said to be on a path to overtake the U.S. but then it fell into a two-decade deflationary period.

Like Japan in its heyday, China and India have been enhancing export competitiveness by maintaining artificially low currency rates. Could their well-publicized growth trajectories similarly prove to be chimeras? And could the U.S. and other developed countries once again emerge on top while providing the better stock markets in which to invest over the next decade or so?

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This article has 6 comments:

  •  
    Jul 08 11:31 AM
    Interesting note, however there is a difference in the nature of Chinese and Indian economies. On one hand the Chinese economy is driven mostly by exports. More than a quarter of the GDP is pegged to exports and considering the fact that the US depends on Chinese manufacture the inflation would get exported to the US with the goods. As in the case of India, the economy is less dependent on Exports and though there may be an effect it may not be as profound as that in China. The best markets now to be in would be commodities and there is an inherent value that would support them at the higher prices for some time
    Reply
  •  
    Jul 08 11:59 AM
    Maybe true for China but not India. Actually, for India, the facts are that the currency was appreciating and NOT undervalued. The Rupee went from around Rs. 49 to 1USD to almost Rs. 38 over the past 18 months. (its now weakened back to Rs. 43 as of July 7). I think once high oil prices pullback, India should be back to about 7-8% growth for decades. I would buy EPI and stay invested there.
    Reply
  •  
    Jul 08 12:06 PM
    little increase in the narrowly defined U.S. money supply in 2008, etc...

    You can say the same thing as far back as late 2005.
    Reply
  •  
    Jul 08 12:54 PM
    Total Illusion those entirely new 3-4 constructed cities the size of say Philadelphia that spring up in China every year. That city involved in the Earthquake was one with 10 million people, it was not considered to be very large.

    Mirages every one.
    Reply
  •  
    Jul 14 06:33 PM
    China's currency has made leaps and bounds this year..way up! You living in a cave? Really a dumb article.. clueless
    Reply
  •  
    Jul 15 10:28 PM
    One ramification could possibly be the unwinding of the secular growth stories of the emerging countries and a return to economic supremacy of the developed countries...

    yes, it could... feel better at least...
    Reply
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