Meeting in London on 2 April 2009, the Group of Twenty (G-20) countries struck a tone of purpose and action, announcing increase in the International Monetary Fund’s (IMF) lending facilities, increase in trade finance for emerging nations and other measures totalling about $1.1 trillion. That announcement considerably boosted positive sentiment in financial markets, buoyed as it was already by the asset purchase programme announced by the US Federal Reserve in March. Contrast that with what the G-20 came up with in Seoul:
“Persistently large imbalances, assessed against indicative guidelines to be agreed by our finance ministers and central bank governors, warrant an assessment of their nature and the root causes of impediments to adjustment as part of the MAP, recognizing the need to take into account national or regional circumstances, including large commodity producers. These indicative guidelines composed of a range of indicators would serve as a mechanism to facilitate timely identification of large imbalances that require preventive and corrective actions to be taken. To support our efforts toward meeting these commitments, we call on our Framework Working Group, with technical support from the IMF and other international organizations, to develop these indicative guidelines, with progress to be discussed by our finance ministers and central bank governors in the first half of 2011.”
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The tortuous wording and the agreement to agree at a later date on indicative guidelines leaves no one in doubt that the world leaders could not see eye-to-eye on the key outstanding issues that they faced. That the G-20 meeting was held days after the Fed had delivered a second round of asset purchase with freshly printed dollars was an unfortunate coincidence. The US’ insistence on China revaluing its currency lost its legitimacy once it was seen that the Fed was not only trying to lower bond yields but also indirectly helping to weaken the dollar with its quantitative easing programme.
In other words, the momentum imparted to financial assets both by the speculation on quantitative easing and by its actual delivery in early November was lost due to the picture of a fractious and disunited global leadership.
In Asia, there has been a wholesale turnaround in China’s monetary policy stance. From a “moderately loose” setting, it is fast heading towards being onerously restrictive. The perils of micromanaging a $5 trillion economy through administrative fiat alone are becoming more evident. China, having battled throughout the year to rein in property prices while maintaining a moderately loose monetary policy, found itself confronting a more conventional inflation problem—that of an unwelcome rise in the cost of living. It has taken to blaming the US and its policy of quantitative easing for the rise in commodities prices and the resultant impact on inflation in China. There is a grain of truth in that.
But China has yet to acknowledge that its own rampant growth in money supply, in new bank loans, massive fiscal stimulus and ultra-low interest rates in the face of high nominal gross domestic product growth were bigger contributory factors. According to China’s English language daily Global Times, narrow money in the country stood at 152% of GDP in 2000. By September 2010, the ratio stood at 259% of GDP. China has experienced one of the world’s fastest money supply growth rates in recent times. Now, it is working overtime to come up with anti-inflation measures. Even price controls on food items are being contemplated. This is on top of the recent increases in bank reserve requirements and a small rise in interest rates. For financial markets that have been anticipating further policy loosening in China in the fourth quarter, this has come as a rude shock.
In the meantime, Fed chief Ben Bernanke has taken the fight to China. In a recent speech in Frankfurt, he said developing countries with systemically large and persistent current account surpluses should allow their currencies to appreciate. He is partially right that the problem of capital inflows into Asia could be better handled through stronger currencies. But the problem of higher cost of living induced by higher commodity prices is the Fed’s creation. As China battles inflation and tightens monetary policy, its trade surplus is likely to rise. Let us get set for the war of words between these two nations to escalate.
Thoughts for the next two years
As Russia-based fund manager Eric Kraus reminds us in his well-crafted missive (“Swimming with sharks”, at www.truthandbeauty.ru), “…. The smartest of our peers are now focused not on the developing bubble, but upon what is to come after—the inevitable unwind, as well as the possible cataclysmic changes in the global financial architecture and in asset values following upon the collapse of the dollar system.”
As we head into 2011 and 2012, political, social and economic contradictions within nations and outside would become bigger challenges. Consequently, investors have to brace themselves for higher volatility in the months ahead.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome firstname.lastname@example.org