How the BRICs have been cursed by too much money...
SAVVY INVESTORS know there is far more to the markets than sitting on your hands worrying about the fiscal cliff, writes Martin Hutchinson for Money Morning.
Believe it or not the world doesn't revolve around the United States-or the Western world.
In fact, The IMF's World Economic Outlook projects an emerging markets forecast with growth at 5.6% in 2013. That's down slightly from 2011 but far ahead of the measly 1.5% growth projected in the "advanced" economies.
That means investors need to focus heavily their investments in emerging markets, as we have done successfully over the past few years.
However, there's one new trick investors will have to learn going into 2013: the BRIC economies (Brazil, Russia, India and China) that have been so fashionable over the years, will all run into trouble next year and should be avoided.
When Jim O'Neill of Goldman Sachs coined the BRICs acronym in 2001 it looked clever since all of them were poised to grow very rapidly and become major factors in the world economy over the next decade.
Of the four, Brazil looked like the weakest member at the time, since it was hovering close to bankruptcy. Meanwhile, Russia had a dynamic new leader, a new "flat tax" and incredible natural resource wealth.
As for the Far East, China was China, even then.
And India had a genuinely reformed its government under Atal Bihari Vajpayee, which helped cause growth to accelerate to very un-Indian levels.
I didn't trust Russia or Brazil, and China was difficult to buy back then, but I doubled my investment in the next three years on a simple investment in the Morgan Stanley India Investment Fund.
With Goldman Sachs recommending them, all these BRICs had to do was keep their governments under control and maintain a reasonable facsimile of free-market policies, and they would be rich within a generation – or even sooner.
Indeed the progress over the intervening decade, in terms of Gross Domestic Product (GDP), has been rapid in all four countries. Yet in the wake of the financial crisis all four stock markets have been pretty disappointing, and now the prospects of the BRICs are nowhere near as bright as they once were.
You can chalk it up to the curse of too much money.
In the last decade monetary authorities worldwide, led by Fed chairmen Alan Greenspan and Ben Bernanke, have kept interest rates too low. Money has flooded into the emerging markets, especially the favored BRICs.
The result has been a surge of corruption in all four BRICs, accompanied by a surge in "malinvestment," a term beloved of the Austrian school of economists and describing investments, like the Nevada housing market in 2004-06, that is entirely misdirected and a waste of resources.
In China, the economy is slowing and there is a gigantic morass of bad loans in the banking system, perhaps five times the size of the bad loans about which everyone worried a decade ago. A 2008-style banking collapse and government bailout in China seems inevitable – and we know what that does to an economy!
In India the fine Vajpayee government of 1998-2004 was replaced by an ungrateful electorate with a return to the socialist Congress party, which had wrecked India's economy from 1947-1990.
The budget deficit in India, by both the central and regional governments, is gigantic now and is "crowding out" the private sector from the financial market. We also can expect a surge in inflation and a balance of payments crisis. Fortunately, there's another election in 2014; we can hope that the Indian voters do a better job than in 2004.
As for Russia, Vladimir Putin has effectively established himself as President for life, and has taken control of the economy's major sectors. The Rosneft buyout of TNK-BP indicates that the Russian state will use its resources to assert economic control. This is already working poorly, and it will stop working altogether when the price of oil drops.
Finally, Brazil is meddling in its major companies such as Petrobras and Vale, whose results have sharply deteriorated. Public spending is way out of control, mostly through subsidized loans from the state bank BNDES. Like Russia, Brazil will fairly quickly run into a balance of payments crisis and certainly won't enjoy its past rapid growth.
Since investors saw BRICs as a bloc on the way up, they will almost certainly panic simultaneously about all four on the way down, and cause a global financial crisis involving all four. That's if the Eurozone's problems or Japan's government debt don't cause one first.
Time to Buy Gold?...