The most likely path for unwinding global imbalances over the medium term is through appreciation of emerging market currencies. We expect this process to be only temporarily interrupted by bouts of risk aversion. Over the medium term, as their currencies appreciate, emerging economies will gradually come to rely more on domestic demand. In order for this shift to be non-inflationary, there will be a greater focus on addressing supply-side constraints, particularly through reforms, the development of corporate bond markets, and big pushes into infrastructure investment.
Protracted weakness in developed world demand will also spur south-south investment and trade. Countries will make further efforts to shift trade patterns more to emerging markets. Emerging market banks will take more market share from developed market peers, possibly including through acquisitions. Policymakers may take the initiative in persuading more companies to invoice in non-dollar currencies. We could also see further diversification into emerging assets by emerging central banks.
Not investing significantly in emerging markets is a form of gambling. Yet denial of this reality is strong: people believe what they want to believe. The argument for hanging on to outdated and simplistic concepts of risk and to prejudices about emerging markets is driven by hope more than rationality. We fear to question our assumptions too closely. The gambler on a losing streak may shut off reality to feed the addiction.
How long should we stay at the roulette wheel when we know our returns are likely to be low even if we don't lose everything? Do we think the status quo can last indefinitely and that the odds will continue to be rigged? Or do we just think we are lucky? Arguably, the more prudent are investing in emerging market asset classes to reduce risk - in cash markets, sovereign debt, corporate debt and, of course, equities for those with more of a stomach for short-term volatility.
David Fuller's view At Fullermoney, we think the term growth markets is more accurate today than emerging markets. They often have a higher beta but we think they will outperform over the longer term, for many of the reasons mentioned by Jerome Booth.Back to top