The global balance of economic power has notably shifted over the past decade.
Now emerging and developing economies account for almost 60% of global gross domestic product (GDP).
Understanding the full scope of these changes, and the new roles of these participants in the global economy, is essential for investors looking to position their portfolios for the future.
Marc Faber, editor and publisher of the Gloom, Boom & Doom Report, shared his perspective on these shifting dynamics along with his concerns that policy makers have increased the risk of unintended economic consequences, at the 2016 Financial Analysts Seminar in Chicago.
China occupies an important space in the current economic landscape. The country embraced the infrastructure growth model to catapult itself into a high-growth phase — following the examples set by Japan starting in 1950 and the Asian Tiger economies of South Korea, Taiwan, and Singapore in the 1960s and 1970s — and it has been the driver of substantial economic activity for other emerging market countries, especially in Asia and Africa. The Export-Import Bank of China overtook the World Bank in 2011 as the biggest lender to sub-Saharan Africa, and China is the leading financier of infrastructure projects on the African continent.
Tourism spending has created additional economic links between China and other countries. Outbound tourism expenditures from China reached US$215 billion in 2015, which was a 53% increase over the total recorded by the World Travel & Tourism Council (WTTC) in the previous year. China’s increased travel spending boosted economic activity in other countries in the region, including a “mini-boom” in money spent by foreign visitors in Japan. During his presentation, Faber estimated that China contributed around 130 million outbound tourists each year to the global economy.
As a key driver of economic activity for emerging markets, what happens if China’s economy stumbles? According to some reports, shadow banking activity, characterized as less-regulated lending that could pose a higher risk of default, accounts for as much as two-thirds of China’s economy. Even regulated lending could pose substantial risks: According to Faber, banks in China don’t write-off bad loans, and eventually the chickens will come home to roost. He was quick to emphasize, however, that other Asian nations are ready to pick up the baton if China falls short.
As the emerging market economies in Asia have developed, they have built up their own domestic needs and capabilities. The increased consumer demand within these countries has created investment opportunities for regional partners: In the first seven months of 2016, the three largest sources of foreign direct investment in Vietnam were South Korea, Singapore, and Japan. While productivity in developed markets has stagnated due to excessive regulation and rising levels of unproductive debt, productivity is booming in Asia.
Faber said the current system in the developed markets is not sustainable and will come to a bad end. He declared that the change in hours of work needed to buy one unit of the S&P 500 composite — which climbed from 20 hours in the 1960s to almost 100 today — was evidence of the massive wealth inequality created by monetary policy that has made it more difficult for those on the lower rungs of the economic ladder to climb up.
Faber takes a dim view of central bank activities that have led to a substantial increase in the size of their balance sheets. Although central banks can continue these policies indefinitely, he noted that eventually they will own everything, resulting in backdoor socialism. The present-day reality of central bank activity is that stock market capitalizations relative to GDP are way above historical averages. Consequently, Faber thinks that US investors will be lucky to earn 1% or 2% returns per year.
With so much latent risk in the financial system, one might be tempted to shift substantial amounts of a portfolio to cash. But even cash is risky today. “Cash is the safest investment in normal times,” said Faber. “However, today the most dangerous asset is cash. Cash in bank accounts may be worthless like in Cyprus,” referring to the possibility of a state-imposed bail-in putting deposits at risk.
Faber lamented that “capitalism requires companies to fail and bad behavior to be punished harshly. And this is not happening.” To protect against runaway central bank interventions, Faber recommends that investors hold real assets that will appreciate with inflation, such as holding 25% in gold and “some” in real estate. He says that once you take into account the dramatic growth of central bank balance sheets, gold is cheaper today than it was when it traded in the $300 range at the end of the 1990s.