Louis-Vincent Gave, partner in global research firm Gavekal, is one of those who believe we’re living in a “new paradigm” and that globalization and rapid technical change have ushered in a brave new world in which the bulls rule.
In fact, Brave New World is the title of one of his books, in which Gave and co-author Anatole Kaletsky say the outsourcing of manufacturing—the most capital-intensive part of the economy—to developing countries will lead to the end of the business cycle in the rich nations. And since US companies have outsourced their manufacturing operations, they have more cash, which they are using to buy back their stock and for acquisitions. So, US consumers get cheaper products, developing countries get capital investment and exports, and US companies get fat profits. It’s win-win for everybody.
Here’s a snapshot of the world according to Gavekal:
“1. Central banks (mostly in Asia and the Middle-East) want to control the level of their currencies against the US dollar.
2. This encourages the private sector to borrow US dollars and buy assets in those countries. This leads to a big increase in monetary aggregates (Singapore’s M3 is up 23% YoY, Hong Kong’s is up 17% YoY...), which in turn fuels a surge in economic growth and asset prices.
3. Asian and Middle-Eastern central banks end up with the excess US dollars created. The central banks mostly redeploy that excess money into fixed income instruments around the world.
4. This ‘forced buying’ of bonds everywhere helps to keep real interest rates low around the world. In turn, this makes risk-taking a very attractive proposition. Most asset prices move higher around the world...”
What could upset this neat scheme? That’s what Gave has been uncharacteristically musing about in a report titled ‘So what should we worry about?’ And the answer is that it’s not terrorism, not a giant liquidity bubble, but rising food prices that give him sleepless nights. Gave points to the Indian central bank, which has recently switched its tactics from fighting inflation by raising interest rates, to fighting it by allowing the currency to appreciate.
Why is that so important? Notice that the entire chain of benign events in the Gavekal world hinges on central banks wanting to keep their currencies stable against the dollar. If other Asian central banks follow the Indian example, the system could collapse. Says Gave, “If we had to have one concern, it would have to be a possible change of monetary policy across Asia and the impact that this would have on real rates around the world. As we view things, the only reason Asian central banks would change their policies is if food prices continued to increase (in that respect, owning some soft commodities—a hedge against rising real rates—makes sense to us; as does owning Asian currencies). Interestingly, such a turn of events seems to be unfolding in India, yet no one seems to care.”
Gave obviously doesn’t know Yaga Venugopal Reddy, or he wouldn’t have cast him in the unlikely role of the man who sounds the death knell for the new paradigm.
Support for Gave’s view that rising food prices are going to be a problem comes from an unlikely quarter. Bear guru Marc Faber, well-known author of the Gloom, Boom and Doom Report, has recently warned about inflation pressures.
But first, here’s an example of Faber’s remarkable prescience: The US Federal Reserve’s decision this week to underline the danger of inflation rather than the risks to growth was clearly anticipated by him. Faber’s logic was simple: US Fed chief Ben Bernanke knows fully well that he will be blamed if he allows inflation to resurface. But if the US economy slid into a recession, the blame would be pinned on Alan Greenspan, because everybody knows that Greenspan was the one who flooded the world with liquidity and allowed the housing sector to become overheated. Wrote Faber in a piece for The Daily Reckoning: “So, from a career and reputation risk point of view, Mr. Bernanke will likely move very slowly in cutting rates and rather take the risk of some mild form of recession occurring.” That’s precisely what he has done.
Faber then goes on to quote Bernanke on inflation. According to the US Fed chief, “There seems to be little basis for concluding that globalization overall has significantly reduced inflation in the US in recent years; indeed, the opposite may be true.” In a speech at Stanford, Bernanke said increased trade with China has reduced US inflation by only about 0.1 percentage point. Faber argues that if the perma bulls are right and the world economy continues to grow strongly, then commodity prices are bound to rise. That would stoke the inflationary fires. Writes Faber, “In the event, as the entire Goldilocks sect argues, that the global economy remains strong, inflationary pressures should increase. Commodity prices, especially for agricultural products, are in real terms still extremely depressed and, contrary to expectations, could rise far more than many would think possible.”
Simply put, the inflation dragon hasn’t been slain. The Bank of England has recently raised rates to a six-year high, the European Central Bank has signalled they’ll probably tighten further in June and the Fed is talking tough on inflation. In short, both Gave the perma bull and Faber the perma bear are agreed on one thing: Agricultural prices are going to rise. It’s a remarkable instance where both bulls and bears are of the same opinion. That should be incentive enough to go long on soft commodities.
(Mint’s resident market expert Manas Chakravarty looks at trends and issues related to investing in general and Indian bourses in particular. Your comments are welcome at firstname.lastname@example.org.)