Global correction a big risk for emerging markets, short them!
Artificially low US interest rates are fuelling up asset inflation in emerging markets through the dollar carry trade: that is borrowing dollars cheaply and investing them in currencies paying higher interest rates or assets denominated in those currencies.
Fed money printing and cheap money policies are encouraging a shift into foreign currencies less at risk from devaluation. And countries that respond to worries about higher inflation by raising interest rates are just making this trade more attractive.
Could it be that the first signs of higher consumer price inflation are going to be seen first in the emerging markets rather than the developed world? Well, house price inflation is already big in China and the Indian and Chinese stock markets look the most inflated in the world.
CPI next
That is probably the start of the story with higher consumer price inflation to come next. Inflation is defined as too much money chasing too few goods and services.
At present in developed markets levels of demand are too depressed for anything except a stock market bubble to develop as a result of Fed lose money policies. Probably next will come housing, although that could still take a few years.
However, the strength of the Indian and Chinese economies is going to be severely tested if the global recession resumes its downtrend and stock markets have a big correction. It is a quick global recovery that these countries require for high growth rates, a slow recovery will begin to drag them down too.
Stimulus limitations
Government stimulus measures have been trumpeted as a huge success in both India and China but these can not be financed indefinitely with external trade still substantially lower than before the crisis. Bubbles in stock markets and housing may pop causing considerable loss of wealth and dampening latent consumer price inflation again.
Is it unreasonable to question the ability of emerging markets to continue to power ahead when the entire global trading system is still in crisis and global consumption levels are falling? It will take more than excess liquidity from the US to create general price inflation under such circumstances.
But if we are about to enter a second round of the global financial crisis from which the recovery appears to have been implausibly fast, then emerging markets are riding for a bigger fall than the rest of the world this time, for the simple reason that they are the most puffed up. Shorting emerging market stocks makes good sense if you think a global financial market correction is almost upon us.
