Article

Asia and the old world - a tale of two halves - John Redwood comment

March 23, 2010

Both India and China are growing strongly. India kept her economy advancing throughout the Western credit crunch. Now she is paying the price of easy money and substantial budget deficits, with rapid inflation. The India Central Bank has just started to rein in bank balance sheets and to raise interest rates. In China the economy has rebounded strongly from the downturn, thanks to a massive monetary stimulus and to the government’s own direct reflationary measures. The Chinese authorities have gently commenced limiting credit and money by taking direct regulatory action over banks balance sheets.

We should expect both China and India to take more measures to restrict credit in the months ahead, as they respond belatedly to rising inflation. Neither government is keen to deflate too much too quickly, as they are aware of the poor state of world money growth and demand generally. China has imported large quantities of raw materials and commodities, and may well now revert to more normal levels of demand for these items.

On the other side of the world private sectors are struggling to repay debts and damaged banks are under new and stricter regulatory requirements to strengthen their balance sheets before embarking on new loan expansion to individuals and companies. The US economy has recovered better than many, but even so housing starts, mortgage credit and consumer credit remain weak. Some inventory rebuilding has occurred. Broad money growth remains low in the US, UK and Euroland, despite special measures by Central banks and governments. Most of the action comes from swollen government deficits, with government acting to boost demand at a time of debt repayment and reduced activity in the private sector. The big build up of government debt also has an adverse effect on confidence, with some people worrying about the tax rises to come to meet the costs of extra spending and the need in due course to service and repay the debts.
In the UK the currency and government bond markets seem to be moving on the back of latest opinion polls, with markets seeming to favour any prospect of a change of government with a majority for the Conservatives, and to worry most about a hung Parliament. Some fear this would delay tackling the deficit, and leave open the prospect of another election within a matter of months. Others take the government’s view that early action to reduce the deficit by cutting spending would be unhelpful at a time of weak demand. In the US the President and his opponents are deep in dispute over his Health care reforms. The President claims it is now a modest compromise package, building on the US system of private insurance. The Republicans see it as an unattractive and unaffordable proposal which will swell the deficit further over the next decade at a time when the US is already spending and borrowing too much. All this is serving to distract the political forces form the prime issue of the state of the economy and the best way to fuel its recovery.

Euroland is still debating whether and how to bail out weaker members of the club. The idea of a formal fund has been floated, which would only serve to delay its creation. The Germans are wary about starting to fund other members more generously than the current EU schemes allow. At the same time the European Central Bank is not seeking to inject substantial liquidity into an economy which remains weak with slow money growth. German caution rules the approach.
The bottom line is we still have two worlds. In the East hard working employees on relatively low pay are led by governments keen to expand money and demand, now agonising over how far they need to slow it down for fear of worse inflation. As they agonise, the economies grow rapidly and asset prices rise. In the west we have struggling economies, with weak banks and private sectors busily repaying debt and controlling their demand, alongside substantial public sectors borrowing large sums in the belief that will prevent a collapse. Asset prices have risen, though by less than in Asia, as the easy money to finance government deficits in part spills over into risk assets. This is not a healthy position.

We continue to run balanced portfolios, as we think there is a little left in world markets and in asset classes where there is good income support. We are more nervous of commodities at these levels, after the stock rebuilding process. We should expect an erratic year, with alternate periods of worry over the feebleness of the recovery, and celebration of the authorities attempts to stimulate through easy money and low official interest rates.