There’s a war on. Let’s see if Australia will join it. Let’s see if this is the week that the Reserve Bank of Australia starts cutting interest rates to weaken the Australian dollar and prevent the deindustrialisation of Australia. Let’s see if the RBA makes the strong Aussie dollar public enemy number one.
The RBA meets tomorrow. You’d think Brazil’s actions late last week are bound to come up. Brazil is talking about putting new controls on foreign investment and extending a tax on foreign borrowing in its currency. The controls are designed to prevent Brazil’s currency, the real, from getting stronger. That strength hurts the country’s manufacturers, according to Brazil’s politicians.
“When the real appreciates, it reduces our competitiveness,” says finance minister, Guido Mantega. “Exports are more expensive, imports are cheaper and it creates unfair competition for businesses in Brazil,” he added. He said Brazil would not “sit by passively” while more developed nations like the United States and the European Union pursue “expansionist” monetary policies.
Fairness lies in the eyes of the beholder in global currency markets. Brazil and its BRIC partners India, China, and Russia (welcome back, Putin) don’t mind a weak currency. A weak currency keeps exports ticking over. A weak currency indirectly contributes to higher employment. A weak currency produces economic strength! No wonder the rest of the world wants a weak currency too.
But not everyone can be the biggest loser. In the end, there can be only one. In the meantime, the BRIC nations have to navigate a dangerous transition. They have to keep growing. And they have to avoid getting sucked into the black hole of debt deflation. It won’t be easy.
The BRICs have built their emerging wealth on exports to the so-called developed world (Europe and North America). But the so-called developed world is in the throes of a self-inflicted perma-recession, thanks to too much debt. This makes “risk-on” assets (BRICs) dangerous bets in 2012, according to Richard Bernstein in last week’s Financial Times. He writes:
Risk-on assets’ performance during the 2000s was propelled by credit. The global economy is now on the downside of a credit bubble, the full effect of which has yet to be felt in places such as emerging markets. The history of financial bubbles and their subsequent deflation seem to favour the secular underperformance of risk-on assets.
The old “decoupling” argument raises its head again. Can an investor safely make money from the emergence of the BRICs, even as Europe implodes and America stagnates? Why don’t we ask Jim O’Neill, the man who coined the term “BRICs” while at Goldman Sachs?
O’Neill says the BRICs are no longer emerging markets. But you can’t call them “developed” in the same sense as Europe or America. In a great interview with Charlie Rose, O’Neill pointed out that in three years’ time, at current growth rates, the combined GDP of the BRICs will surpass the GDP of the United States. He says that in dollar terms, the BRICs create an economy the size of Italy…every year.
That’s all impressive stuff. So is the assertion that by 2025, the BRICs will make up 50% of global GDP. O’Neill says the more accurate term for these countries now is “growth markets”. He adds Indonesia, Turkey, Mexico, and South Korea to the list.
If all that is true, then all Aussie investors need to do is get in the slipstream of the growth freight train and buy the right stocks, right? It might mean getting out of your comfort zone and buying foreign stocks. Or maybe you don’t have to lift a single finger. Maybe the resource sector will thrive as the “growth markets” expand.
The only hitch in this giddyup is that the companies in the vanguard of the BRICs expansion are not always run for the benefit of shareholders. Bloomberg reports that the largest state-run companies are often asked to sacrifice profit on behalf of other public policy aims determined by politicians. Shareholders in those companies have been pummelled. According to Bloomberg…
Brazil’s Petroleo Brasileiro SA posted a 52 percent drop in fourth-quarter earnings on Feb. 9 after government-imposed price caps led to losses on fuel sales. Russia’s OAO Gazprom (GAZP) said last month that tax increases will cut 2012 profit by $2 billion, while Coal India Ltd. (COAL) was ordered to sign supply agreements with the nation’s power companies. China’s banks trade near record lows versus net assets on concern local governments may default.
Well that’s no good. What good is it investing in a “growth market” if you’re not entitled to any of the profits? We were having just this same discussion with Greg Canavan last week. What exactly is driving the allocation of capital in the “growth markets”? Is it government policy? Is it profit? Does it make a difference?
It most certainly DOES make a difference. If investors don’t have a chance to make profits by taking risk, the “growth markets” will struggle to attract capital in the future. Global investors will prefer the pitiful US dollar and the liquid US Treasury market. It will be “risk off” and the greenback will rally in 2012.
That would probably be welcome news at the RBA. A US dollar rally would save the RBA the trouble of having to insert itself into the debate over Australia’s manufacturing future. That future looks bleak no matter what. But that’s a story for another day.
for The Daily Reckoning Australia