Why The World Will Avoid Armageddon

However, relief is on the way. First, the sharp break in oil prices in the last few months is a huge gift to consumers in oil-poor nations around the world. Second, inflation is peaking as agricultural and industrial commodity prices decline. As a result, real wages (inflation adjusted) will soon be rising again. Third, the Fed has been cutting interest rates for about a year, but other central banks are just beginning to. For example, China cut rates this week. Official rate cuts and liquidity injections spur economic activity, but with a lag of at least a year.

The effect of these factors should be that economic activity first in the U.S. and then elsewhere will begin to revive by the spring of 2009. Historically, equity markets have anticipated an economic recovery six to nine months in advance. The developing world is still a huge engine of growth.

In the long run, equities are the place to be. Over the last century in the U.S. they returned 6.9 percent a year adjusted for inflation. That means the purchasing power of an investor's money doubled every 10 and a half years. The old investment adage is buy sheep, sell deer which translates into buy stocks low, sell them high. In the past few days, equity markets have rallied. It's not too late to do some buying.

Asia Will Weather This Storm
Haruhiko Kuroda, president of the Asian Development Bank, explains why fallen U.S. investment banks aren't his region's problem.

In Asia, the perspective is that the global financial turmoil has affected the financial sector here only … I wouldn't say marginally, but not so much. That is because Asian financial institutions have very little direct exposure to sub-prime loans or structured financial products. Although our financial markets are globalized and stock markets in Asia have been affected, Asia's financial system is bank dominated, and the commercial banks have not been affected so much. For those reasons, the impact on the Asian financial system is still limited. Of course, the global economic slowdown that started in the United States would inevitably [cloud] the economic outlook in Asian countries. But the [expected] slowdown—1 to 2 percent this year—would not create a recession or serious economic problems in the countries of the region. So from the Asian perspective, the global financial markets have probably overreacted a bit. What really concerns me is inflation, which in the double digits in most Asia countries. Inflation [will remain] unacceptably high this year as well as next year, so the number one challenge for Asian economies will be inflation rather than sustaining economic growth or keeping the financial sector functioning.

The Rest of the World Will Grow
Don Hanna, head of emerging markets, Citigroup Global Markets, believes that the fundamentals haven't changed for the developing world.

Is it time to buy emerging markets? It depends on the holding period. Because we're still in a situation where there is great uncertainty about the financial system in the United States and Europe, and the risk of economist and analyst forecasts is skewed to the down side, that creates a problem unless you have a very long holding period. But I don't see anything that has materially changed the underlying story about emerging markets and economies performing better. There are some exceptions that have to do with the cyclical positions of [some] economies. Those that are borrowing a lot in order to finance existing levels of activity will have a hard time continuing to do that in this environment, and that has been reflected in the performance of their bond spreads and sometimes their currencies. There's another worry, which is that as you get weakening economic activity in Europe and the United States, that some of the concerns that people had about tariffs and restrictions to international trade once again surface. There's been a strong reaction to commodity prices, and a focus on food security and energy security, which is not helpful for globalization. When you focus on those you're more or less explicitly saying "look, I can't trust the market." And yet it is important to remember that it is the market that has allowed for the technology transfers that have spurred growth and innovation in emerging markets.

© 2008