Now the question remains: is this a justified advance or another bubble?
Emerging markets are nations with relatively low standard of living. Usually it stemming from an underdeveloped infrastructure, economic policy, political issues, or corruption.
Historically, emerging market economies were rife with pitfalls. If we look over the last 15 years, we’ve witnessed a severe economic crisis in Mexico in 1994 and the Asian crisis in 1997 that brought Thailand, Korea, and Malaysia to the brink of bankruptcy.
In 1998, Russia declared bankruptcy, and in 2002 it was Argentina, followed by a similar crisis in Brazil.
The bubble years (2003-2007) were the golden era of emerging markets that enjoyed exceptional economic prosperity. It benefitted more from the global credit bubble than any true economic changes in those countries. The huge amount of money printed by global central banks, distributed by bond underwriters, created an illusion of wealth around the world.
When the credit bubble burst in 2008 emerging markets suffered a serious slowdown, even more so than the United States and Europe.
Now, optimism regarding emerging markets is once again percolating, and the question remains whether that optimism is justified. In my opinion, the answer is a bit more complicated. I am less optimistic about long term growth than others. Real growth for the long term requires an improvement in infrastructure, political and societal development—which means a democratic government that respects the freedom of its people and enterprises—along with working law enforcement and free market enforcement.
For an economy to really click, all of those factors must be in motion. But those things are difficult to achieve and even harder to maintain over a period of time—they require commitment from governments, individuals, and businesses. I don’t think most of the emerging markets are quite ready to embrace that change.
But when it comes to the short term, the emerging markets enjoy an extremely loose monetary policy in the West. The United States, the European Union, and Japan are recovering from a global financial crisis that will last for some time—and that requires them to have low interest rates and free flow of money. This also benefits emerging markets looking for investments.
With the cost of borrowing at historically low levels, banks in emerging markets are also loosening up their lending requirements.
The impact of this is mixed. In the short period it can boost private consumption, but on the other hand it could invite inflation and create new assets bubbles.
Anyone who is planning to invest in those countries should know how to distinguish between valid, real growth and artificial growth stemming from loose monetary policy.
Tightening of monetary policy in the West and increased inflation in developing nations can cause sharp downturns in emerging markets.
Finally, I want to refer to recent developments in China. There’s currently unprecedented growth in credit and if left unchecked, it could create a bubble and cause the Chinese economy to collapse.
Itay Slonim is an investment manager and owner of a portfolio management company.
