One of the notions we hear about a lot these days is the idea of a so-called new normal.
There are many strands to this thesis, but the underlying idea is that the global economy has irrevocably changed as a result of the financial crisis and, as a result, we have to redefine what used to be the normal.
One important conclusion of those who swear by this new normal is that it’s going to take a long time before global growth goes back to the levels reached during the boom of 2003-07. You don’t have to search too hard for the reasons: many developed countries, including the US, were able to grow so fast only by increasing household debt and borrowing against rising asset prices, particularly rising house prices.
Now that the housing bubble has burst, US consumption will be depressed because all that the US consumer was doing was borrowing from the future. Also, since most emerging countries had high growth rates by exporting to the developed markets, even they will be affected. Pacific Investment Management Co. boss and bond guru Bill Gross is the best known exponent of this theory.
The other part of this argument is that the crisis will lead to a reassessment of the need for over-the-counter derivatives of all kinds and a relook at securitization. This will drive down global liquidity, because much of the liquidity provided to global markets during the boom years was from this shadow banking system.
And if liquidity goes down, then there won’t be any rush of money to emerging markets and asset prices there will lose their most important support.
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But there’s more to the new normal idea. The fact of the matter is that, unlike past crises such as the Asian meltdown, this time the core countries have been affected the most, while countries such as India, on the periphery of the world system, have not been hurt as badly. While before the crisis the US consumer held up the world economy, in future demand will come from the burgeoning middle classes of the emerging markets. But this demand shift will take time, which is why growth will be lower in the short term.
The shift in the centre of gravity of the world economy from the West to the East is a clear trend, brought out most vividly by the change from the Group of Seven to the Group of 20, by the attempts of countries to diversify their reserves away from the US dollar and by the bigger role now being assigned to the International Monetary Fund.
What has been the recent experience? Far from trying to usher in a new normal, governments and central banks have been trying their hardest to get back to the old one. If too much debt was at the centre of the crisis, their governments are busy taking on more of it. If too much leverage was what brought about the crash, leverage is being built up in new ways, such as the dollar carry trade. And there is precious little talk of putting a bit of sand in the wheels of speculation; British Prime Minister Gordon Brown had to backtrack very quickly from his proposal for an international tax on banking. Stock and commodity markets are awash with liquidity.
Doug Noland, senior portfolio manager of the Federated Prudent Global Income Fund and a long-time believer in the power of credit bubbles, believes that what we’re seeing is a fundamental change. Earlier, bubbles used to form at the core of the world economy in Wall Street through mortgage finance, securitization and the introduction of new financial products. Whenever the economy faltered, the US Federal Reserve slashed rates and that led to money flowing into the US economy, into US housing and encouraged US consumption. Now, says Noland, all that has changed. He writes, “Years of dollar debasement had come home to roost. Non-dollar (or global currencies, gold, precious metals, energy, commodities, China, India, Asia, Brazil and the emerging markets) assets supplanted US securities as the asset class demonstrating the most enticing upward, inflationary bias. These days, activist Fed monetary looseness lavishes liquidity first and foremost out to the periphery.”
The result, says Noland, is a new paradigm. He writes, “Credit systems in China, India, Asia, Brazil and the developing world—the periphery—are today significantly more robust than they are here at home (the Core). Powerful global financial flows to the inflating periphery (Monetary Processes) also work to ensure market and economic outperformance. The rising periphery—with its billions of consumers and rising demand for commodities—has realized a robust and self-reinforcing inflationary bias. Moreover, secular dollar weakness has increased the investment and speculative merits of commodities and other hard assets when contrasted with dollar securities. Dollar weakness begets global reflation that begets dollar underperformance that begets a new paradigm.”
He points out that the rush of liquidity to emerging markets is not just a bubble, but a reflection of the change in the underlying fundamentals of the global economy.
Noland’s contention has been made before. Indeed, the annualized return in the last 10 years from the MSCI US index has been minus 2.41%, compared with an annualized return of 13.17% for MSCI India and 8.5% for MSCI Emerging Markets. That suggests that the shift in the global economy from the core to the periphery—the real new normal—has been under way for quite some time.
Manas Chakravarty takes a weekly look at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org