All this is fueling frantic activity among policymakers in Washington. Appropriately, the focus is extending beyond interest-rate cuts by the Federal Reserve and a government fiscal-stimulus package aimed at quickly getting cash in the hands of consumers. The Federal Reserve, the White House and Congress are all now in full crisis-management mode, looking for the least costly way to contain the market turmoil.
Some historical reflection is in order, because the way that the new crisis is playing out globally is quite different from in the past. Disruptions of the type being experienced by the U.S. financial system would normally pull the rug out from under economic growth all over the world. That’s not happening this time.
U.S. consumers have long provided the fuel for the engine of global growth. Accordingly, you would expect growth in the rest of the world to be slowing, particularly in emerging markets, where U.S. downturns have historically had an exponentially bad effect (following the old “if the United States sneezes, the rest of the world catches a nasty cold” maxim).
Instead, U.S. consumers are now challenged on many fronts. Employment is falling, credit is less readily available, and consumer wealth is being eroded by declines in housing and the stock market. Today, the United States has developed flu symptoms, yet the rest of the world is only coughing.
With some small exceptions, the farther east and/or south you head away from New York, the greater the robustness of the economies, and the larger the ability to resist contagion from the United States and sustain an economic and financial firewall. As a result, many emerging economies exhibit resilience and robustness that is unlike anything we have seen during the past 35 years.
What about inflation? History would suggest that a significant U.S. slowdown would moderate inflationary pressure. After all, as U.S. demand falters, fewer people are looking to buy the same goods and services, driving the prices down. History would also suggest that the prices of raw materials and other components of the “producer price index” would moderate faster than consumer prices.
But here, again, history has yet to repeat itself. Commodities continue to test record-high price levels, virtually across all major categories such as energy, hard metals, agricultural products, etc.—driven in large part by demand out of emerging economies. Higher prices translate into major windfall gains for commodity exporters, the majority of which reside in the emerging world.
On the other hand, these countries also have to deal with the fact that their citizens are facing higher inflation, especially in the sensitive areas of food and energy. The challenge is particularly acute for those countries that start with highly unequal income distributions and thus a significant number of vulnerable citizens.
It is not that the rest of the world is totally immune to the debacle in the United States. It is not. Rather, it is less vulnerable than history would suggest. The cross-border linkages are changing rapidly, and the policy challenges are different. It is therefore not surprising that, since the official start of the current phase of U.S. financial dislocations last summer, investors exposed to assets such as commodities and emerging-market equities have done better than those holding U.S. equities. This divergence in returns becomes even starker when you look at other asset classes such as corporate bonds, mortgages and bank loans.
So much for the past—how about the future? Will these divergences prove temporary? I believe not. The farther you move east and/or south from New York, the larger the likelihood that both economic conditions and financial valuations will continue to prove less vulnerable than history would suggest. Economic decoupling is a reality of today’s world.
Global investors are well advised to maintain a prudent and internationally diversified and forward-looking portfolio as they put their fresh capital to work. They would also benefit over time from pursuing certain opportunistic strategies: for example, the purchase of high-quality assets in the United States selling at “distressed” prices, such as agency mortgages, municipals and high-quality banks and corporates. The world is truly upside down.
